Lecture 12-Production and Cost Schedules

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1 Aug 2010
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Tuesday, October 27th, 2009.
Production and Cost Schedules
Production Function
Production function: Relates output to quantity of inputs (capital, labour)
Short-run: One input (capital) is fixed, while one input (labour) can vary
Long-run: All inputs (capital, labour) can vary
Example: General Motors
Short-run: GM can vary amount of labour (overtime, lay-offs)
GM cannot vary number of plants (capital)
Long-run: GM can vary number of plants and amount of labour
Product Schedules (Short-Run)
(TP) Total Product: total output, given labour input
(MP) Marginal Product*: increase in total output divided by increase in labour input
(AP) Average Product: total output divided by labour input
Law of Diminishing Returns:
The marginal product of a variable input, in the presence of a fixed input,
eventually diminished
Example:
Labour Output Marginal Product Average Product
(Total Product)
0 0
1 4 4 4.00
2 10 6 5.00
3 13 3 4.33
4 15 2 3.75
5 16 1 3.20
Note: if MP is above AP, AP is rising: if MP is less than AP, AP is falling
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L=1 AP = 4
MP = 6 (exceeds AP)
L = 2 AP = 5
L = 3 AP = 4.33
MP = 2 (is less than AP)
L = 4 AP = 3.75
Law of Diminishing Returns: Intuition
Number of chefs in restaurant kitchen:
1. First chef: must make all meals, attend all ovens, no specialization
2. An additional chef: chefs can specialize, help one another
Æ marginal product rises
3. Additional chefs are added: eventually, kitchen becomes too crowded, chefs must
wait to use ovens, etc.
Æ marginal product declines
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Total Cost (TC): Total of all costs
Total Fixed Cost (TFC): Total Cost of fixed input
Total Variable Cost (TVC): Total Cost of variable input
TC = TFC + TVC
**Marginal Cost (MC): Increases in total cost / increase in output
Note: TFC "Sunk Costs"
Example: Total Cost ($) Marginal Cost
($ per unit)
(1) (2) (3) (4) (5) (6)
Labour (L) Output (Q) Fixed (TFC) Variable (TVC) Total (TC) (MC)
0 0 100 0 100
1 15 100 10 110 0.67
2 34 100 20 120 0.53
3 48 100 30 130 0.71
4 60 100 40 140 0.83
5 62 100 50 150 5.00
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