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Lecture

Topic 7 - Production & Cost Schedule.pdf

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Department
Economics
Course
ECO100Y1
Professor
James Pesando
Semester
Fall

Description
Topic 7 – Production & Cost Schedule (Week seven Oct 25 -Nov 1 ) st Outline: 1. Production Function; 2. Product Schedule (Short Run) -- Definition; -- Law of Diminishing Returns; 3. Cost of Productions (Short Run) -- Terminology; -- Examples; -- Properties of firms’ cost curves; 4. Average Costs -- Terminology -- Examples; -- why curves are shaped that way and their intercepts; 4. Long-Run Average Cost Curve; 5. Opportunity Cost and the Measurement of Economic Profit  Production Function: relationship between output and the quantity of input. Short-run: one input (capital) is fixed; while on input (labor) can vary; Long-run: all inputs (capital, labor, etc.) can vary. -- e.g. General Motors; Short-run: GM can vary the amount of labor (overtime, lay-offs), but cannot vary the number of plants (selling land); Long-run: GM can vary both number of plants and amount of labor;  Product Schedules (short-run) 1. Terminology TP Total Product Total output, given the labor input MP Marginal Product Increase in total output divided by increase in labor input; AP Average Product Total product divided by labor input. 2.Law of Diminishing Returns The marginal product of a variable input, in the presence of a fixed input, eventually diminishes. e.g. Numerical Example Labor TP MP AP Observation: a. This illustration strictly accords with the law of 0 0 diminishing returns 1 4 4 4 (as labor increases, MP eventually decreases.). 2 10 6 5 b. If MP is above AP, AP is rising; if MP is less than AP, AP is 3 13 3 4.33 falling. 4 15 2 3.75 (this is merely mathematical observation, no economic significance is involved. ) 5 16 1 3.20 Application – Restaurant (Intuition of the Law of Diminishing Returns) e.g. Number of Chefs in a restaurant kitchen. a) chef: labor – variable input; restaurant: capital – fixed input; b) 1 Chef: As the only chef, he must make all meals, attend all ovens; there is no specialization; 2 Chef: the two chefs can specialize, help one another (marginal product goes up); Both chefs become more productive; 3 , 4 ….more chefs added: Eventually the kitchen becomes too crowded; chefs must wait to use the ovens, etc. Chefs become less productive, and marginal product declines. c) However, all these assumptions are based on “short run”, i.e. capital is fixed (the size of the restaurant is fixed.) Insight: Law of Diminishing Returns holds true only in the short run since it assume there is a fixed input.  Cost of Productions (short-run) 1. Terminology TC Total Cost Total of all costs TC=TFC+TVC TFC Total Fixed Cost Total cost of fixed input - TVC Total Variable Cost Total cost of variable input -- MC Marginal Cost Increase in total cost/increase in outputMC=△TC/△Q 2. Examples. (Suppose wage rate is $10/hr): Labor Total Marginal Total Fixed Total Variable Total Cost Marginal Cost Product Product Cost Cost L Q MP TFC TVC TC MC 0 0 - 100 0 100 -- 1 15 15 100 10 110 0.67 2 34 17 100 20 120 0.53 3 48 14 100 30 130 0.71 4 60 12 100 40 140 0.83 5 62 2 100 50 150 5.00 Output PPrice Observation (both the graph and the schedule): ee MP -- two fundamental insights: a. This is an illustration of short-run situation; b. law of diminishing returns is demonstrated. Labor Cost -- When MP increases, MC decreases; PPrice When MP eventually decreases, MC eventually increases; ee MC -- MP reaches the maximum when MC reaches its minimum. Labor  Average Costs 1. Terminology ATC Average Total Cost ATC=TC/Q AVC Average Variable Cost AVC=TVC/Q AFC Average Fixed Cost AFC=TFC/Q ATC=AVC + AFC 2. Numerical Example Labor Total Total Fixed Total Variable Total Marginal Average Average Average Product Cost Cost Cost Cost Fixed Cost Variable Cost Total Cost L Q TFC TVC TC MC AFC AVC ATC 0 0 100 0 100 -- -- -- -- 1 15 100 10 110 0.67 0.67 0.67 7.33 2 34 100 20 120 0.53 2.94 0.59 3.53 3 48 100 30 130 0.71 2.08 0.62 2.71 4 60 100 40 140 0.83 1.67 0.67 2.33 5 62 100 50 150 5.00 1.61 0.81 2.42 3. Average Costs Curves and Their Shapes Cost PPrice ee
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