Economics 1021A Chapter 11 20131103
A firm makes many decisions to achieve its main objective: profit maximization .
Some decisions are critical to the survival of the firm (a big decision that turns out to be incorrect could lead
to a firm’s demise)
Some decisions are irreversible (or very costly to reverse).
All decisions can be placed in two time frames:
The short run
The short run is a time frame in which the quantity of one or more resources used in production is fixed.
For most firms, the capital, called the firmplant , is fixed in the short run.
Other resources used by the firm (such as labour, raw materials, and energy) can be changed in the short
Shortrun decisions are easily reversed.
The long run
The long run is a time frame in which the quantities of all resources—including the plant size—can be
Longrun decisions are not easily reversed.
A sunk cost is a fixed cost incurred by the firm that cannot be changed or avoided.
Although a firm may incur fixed costs in the long run, these fixed costs are avoidable rather than sunk
costs, as in the short run.
Sunk fixed costs are irrelevant to a firm’s current decisions.
To increase output in the short run, a firm must increase the amount of variable inputs used, which is
Three concepts describe the relationship between output and the quantity of labour employed:
Total product is the total output produced in a given period.
The marginal product of labour is the change in total product that results from a oneunit increase in
the quantity of labour employed, with all other inputs remaining the same.
The average product of labour is equal o total product divided by the quantity of labour employed. Product curves show how the firm’s total product, marginal product, and average product change as the
firm varies the quantity of labour employed.
Almost all production processes have:
Increasing marginal returns initially
Initially, the marginal product of a worexceeds the marginal product of the previous worker.
The firm experiences increasing marginal returns
Increasing marginal returns arise from increased specialization and division of labour.
Diminishing marginal returns eventually
Eventually, the marginal product of a worker iless than the marginal product of the previous worker.
The firm experiences diminishing marginal returns.
Diminishing marginal returns arises because each additional worker has less access to capital and less
space in which to work.
The law of diminishing returns states that: As a firm uses more of a variable input with a given
quantity of fixed inputs, the marginal product of the variable ieventually diminishes .
When marginal product exceeds average product, average product increases.
When marginal product is below average product, average product decreases.
When marginal product equals average product, average product is at its maximum.
To produce more output in the short run, the firm must employ more labour, which means that it must
increase its costs.
Three cost concepts and three types of cost curves are
A firm’s total cost (TC) is the cost all resources used
Total fixed cost (TFC) is the cost of the firm’s fixed inputs. Fixed costs do not change with output.
Total variable cost (TVC) is the cost of the firm’s variable inputs. Variable costs do change with
Total cost equals total fixed cost plus total variable cost. TTC TFC TVC +