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Chapter 11

Economics 1021A/B Chapter Notes - Chapter 11: Diminishing Returns, Average Variable Cost, Sunk Costs

Course Code
ECON 1021A/B
Michael Parkin

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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
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
Product Curves
product curves are graphs of the relationships between employment and the three product
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

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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
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
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
equipment is being operated closer to its limits
hiring more and more workers continues to increase output but by successively smaller
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
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