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Chapter 11

Chapter 11

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Department
Economics
Course
Economics 1021A/B
Professor
Michael Parkin
Semester
Fall

Description
Chapter 11- Decision Time Frames • one overriding goal: maximum attainable profit • the biggest decision that an entrepreneur makes is in what industry to establish a firm • decisions about the quantity to produce and the price to charge depend on the type of market in which the firm operates The Short Run short run is a time frame in which the quantity of at least one factor of production is fixed • • capital, land, entrepreneurship are fixed factors of production and labour is the variable factor • we call the fixed factors of production the firm’s plant • to increase output in the short run, a firm must increase the quantity of a variable factor of production which is usually labour • short-run decisions are easily reversed The Long Run • long run is a time frame in which the quantities of all factors of production can be varied • the long run is a period in which the firm can changes its plant • to increase output in the long run, a firm can change its plant as well as the quantity of labour it hires • long-run decisions are not easily reversed • past expenditure on a plant that has no resale value is a sunk cost a sunk cost is irrelevant to the firm’s current decisions • • the only costs that influence its current decisions are the short-run cost of changing its labour inputs and the long-run cost of changing its plant Short-Run Technology Constraint Product Schedules • total product is the maximum output that a given quantity of labour can produce • as more labour is employed, total product increases • marginal produce of labour is the increase in the total product that results from a one-unit increase in the quantity of labour employed, other inputs remaining the same • average product tells how productive workers are on average • the average product of labour is equal to the total product divided by the quantity of labour employed Product Curves • product curves are graphs of the relationships between employment and the three product concepts • show how total product, marginal product and average product change as employment changes Total Product Curve • total product curve is similar to the production possibilities frontier • it separates the attainable output levels from those that are unattainable • points that lie below the curve are attainable, but they are inefficient- they use more labour than is necessary to produce a given output • only the points on the total product curve are technologically efficient Marginal Product Curve • marginal product is also measured by the slope of the total product curves • height of marginal product curve measures the slope of the total product curve at a point • marginal product reaches a peak • total product and marginal product curves differ across firms and types of goods • shapes of the product curves are similar because almost every production process has two features INCREASING MARGINAL RETURNS INITIALLY • increasing marginal returns occur when the marginal product of an additional worker exceeds the marginal product of the previous workers • arise from increased specialization and division of labour in the production process if Campus Sweaters hires a second person, the two workers can specialize in different parts of • the production process and can produce more than twice as much as one worker DIMINISHING MARGINAL RETURNS EVENTUALLY • most production processes experience increasing marginal returns initially, but all production processes eventually reach a point of diminishing marginal returns diminishing marginal returns occur when the marginal product of an additional worker is less • than the marginal product of the previous worker • arise from the fact that more and more workers are using the same capital and working in the same space • as more workers are added, there is less and less for the additional workers to do that is productive • equipment is being operated closer to its limits • hiring more and more workers continues to increase output but by successively smaller amounts • law of diminishing returns states that:As a firm uses more of a variable factor of production, with a given quantity of the fixed factor of production, the marginal product of the variable factor eventually diminishes. Average Product Curve • average product is largest when average product and marginal product are equal • that is, the marginal product curve cuts the average product curve at the point of maximum average product • for the number of workers at which marginal product exceeds average product, average product is increasing • for the number of workers at which marginal product is less than average product, average product is decreasing • relationship between average product and marginal product is a general feature of the relationship between the average and marginal values of any variable Short-Run Cost Total Cost • total cost (TC) is the cost of all the factors of production it uses • total fixed cost (TFC) is the cost of the firm’s fixed factors include normal profit, which is the opportunity cost of entrepreneurship • • quantities of fixed factors don’t change as output changes, so total fixed cost is the same at all outputs • total variable cost (TVC) is the cost of the firm’s variable factors i.e. labour • total variable cost changes as output changes • total cost is the sum of total fixed cost and total variable cost • TC = TFC + TVC • total fixed cost equals the vertical distance between the TVC and TC curves Marginal Cost • total variable cost and total cost increase at a decreasing rate as small outputs, but eventually as output increases, total variable cost and total cost increase at an increasing rate • marginal cost is the increase in total cost that results from a one-unit increase in output • calculate marginal cost as the increase in total cost divided by the increase in output marginal cost curve MC, curve is U-shape • • at small outputs, marginal cost decreases as output increases because of greater specialization and the division of labour, but as output increases further, marginal cost eventually increases because of the law of diminishing returns • means that the output produced by each additional worker is successively smaller • marginal cost tells us how total cost changes as output increases Average Cost • average fixed cost (AFC) is total fixed cost per unit of output • average variable cost (AVC) is total variable cost per unit of output • average total cost (ATC) is total cost per unit of output • TC= TFC + TVC • divide each total cost term by the quantity produced, Q • TC/Q= TFC/Q + TVC/Q orATC= AFC +AVC • average total cost is equal to average fixed cost plus average variable cost • average fixed cost curve (AFC) slopes downward • as output increases, the same constant total fixed cost is spread over a larger output • average total cost curve (ATC) and variable cost curve (AVC) are U-shaped the vertical distance between the average total cost curve and average variable cost curves is • equal to average fixed cost Marginal Cost and Average Cost • marginal cost curve (MC) intersects the average variable cost curve and the average total cost curve at their minimum points • when marginal cost is less than average cost, average cost is decreasing and when marginal cost exceeds average cost, average cost is increasing Why the Average Total Cost Curve is U-Shaped • the shaped of theATC curve combines the shapes of theAFC andAVC curves • the U-shape of theATC curve arises from the influence o
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