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Final

ECO101H1 Study Guide - Final Guide: Diminishing Returns, Active Valve Control System, Marginal Cost


Department
Economics
Course Code
ECO101H1
Professor
James Pesando
Study Guide
Final

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Topic 7 Production & Cost Schedule
(Week seven Oct 25th-Nov 1st)
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
0
0
1
4
4
4
2
10
6
5
3
13
3
4.33
4
15
2
3.75
5
16
1
3.20
Observation:
a. This illustration strictly accords with the law of
diminishing returns
(as labor increases, MP eventually decreases.).
b. If MP is above AP, AP is rising; if MP is less than AP, AP is
falling.
(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
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 of all costs
TC=TFC+TVC
TFC
Total cost of fixed input
-
TVC
Total cost of variable input
--
MC
Increase in total cost/increase in output.
MC=TC/Q
2. Examples. (Suppose wage rate is $10/hr):
Labor
Total
Product
Marginal
Product
Total Fixed
Cost
Total Variable
Cost
Total Cost
Marginal 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
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.
Labor
Output
PPrice
ee
Labor
Cost
PPrice
ee
MP
MC
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