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Chapter 11

Economics 1021 Chapter 11 Notes

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Western University
Economics 1021A/B
Jeannie Gillmore

Chapter 11 Decision Time Frames  To study the relationship between a firm’s output decisions and its costs, we use two decision time frames.  Short run: A time frame in which the quantity of at least one factor of production is fixed. o For most firms: capital, land and entrepreneurship are fixed, while labour is the variable factor of production. o To increase output in the short run, firms must increase the quantity of variable factor of production. o Decisions are reversed easily. o Fixed Plant: A firm’s fixed factor of production  Long run: A time frame in which the quantities of all factors of production can be varied. o To increase output in the long run, firms can change their plants as well as the quantity of labour o Decisions are not easily reversed. o Sunk cost: Past expenditure on a plant that has no resale value, and is irrelevant to the firm’s current decisions Short-Run Technology Constraint  Total product (TP): Maximum output that a given quantity of labour can produce o The TP curve separates what is attainable from what is unattainable. o The points on the TP curve are technologically efficient.  Marginal product (MP): Increase in total products that result from a one-unit increase in the quantity of labour. o Measured by the slope of the TP curve. o Height of the MP curve measures the slope of the TP curve. o Increasing marginal returns:  Occurs when the MP of an additional worker exceeds the MP of the previous worker  Arises from increased specialization and division of labour in the production. o Decreasing marginal returns:  Occurs when the MP of an additional worker is less than the MP of the previous worker  Arises because more and more workers are using the same capital and working space.  All products eventually reach a point of diminishing marginal returns.  Law of diminishing returns: As a firm uses more of a variable factor of production with a given quantity of the fixed factor of production, the MP of the variable factor eventually diminishes.  Average product (AP): TP divided by the quantity of labour employed. o When MP exceeds AP, AP is increasing. o When MP is less than AP, AP is decreasing. o When MP equals AP, AP is at its maximum.  Product curve: Graphs of the relationships between employment and the three product concepts Short-Run Cost  Total cost: o Total cost (TC): The cost of all factors of production.  TC = TFC + TVC o Total fixed cost (TFC): The cost of the firm’s fixed factors.  Does not change as output increases or decreases (horizontal curve).  Normal profit: The opportunity cost of running a business. o Total variable cost (TVC): The cost of the firm’s variable factors.  Changes as output increase or decreases.  Since labour is the largest factor of production, wage makes a large component of TVC.  Marginal cost (MC): The increase in total cost that result from a one-unit increase in output. o Calculated as the increase in total cost divided by the increase in output.  Average cost: o Average total cost (ATC): The total cost per unit of output.  ATC = AFC + AVC  ATC curve is U shaped. This is because of two opposing forces:  Spreading TFC over a larger output decreases AFC.
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