ECO101H1 Study Guide - Final Guide: Diminishing Returns, Active Valve Control System, Marginal Cost
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Topic 7 – Production & Cost Schedule
(Week seven Oct 25th-Nov 1st)
1. Production Function;
2. Product Schedule (Short Run)
-- Law of Diminishing Returns;
3. Cost of Productions (Short Run)
-- Properties of firms’ cost curves;
4. Average Costs
-- 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)
Total output, given the labor input
Increase in total output divided by increase in labor input;
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
a. This illustration strictly accords with the law of
(as labor increases, MP eventually decreases.).
b. If MP is above AP, AP is rising; if MP is less than AP, AP is
(this is merely mathematical observation, no economic
significance is involved. )
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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) 1st Chef: As the only chef, he must make all meals, attend all ovens; there is no specialization;
2nd Chef: the two chefs can specialize, help one another (marginal product goes up);
Both chefs become more productive;
3rd, 4th….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
Law of Diminishing Returns holds true only in the short run since it assume there is a fixed input.
Cost of Productions (short-run)
Total of all costs
Total Fixed Cost
Total cost of fixed input
Total Variable Cost
Total cost of variable input
Increase in total cost/increase in output.
2. Examples. (Suppose wage rate is $10/hr):
Observation (both the graph and the schedule):
-- two fundamental insights:
a. This is an illustration of short-run situation;
b. law of diminishing returns is demonstrated.
-- When MP increases, MC decreases;
When MP eventually decreases, MC eventually increases;
-- MP reaches the maximum when MC reaches its minimum.
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