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Chapter 11

ECON 1000 Chapter 11: ECON 1000 Chapter 11 Notes

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ECON 1000
Andrea Podhorsky

Outputs and Costs Decision Time Frames Firms must decide: • How much to produce • How many people to employ • How much and what type of capital equipment to use How do Firms make these decisions? • Main objective: Profit Maximization • Critical to the survival of the firm • Some decisions are irreversible or very costly to reverse • Some are easily reversible and less critical for survival but still influence profit Decisions are placed in two time frames • Short-run o Time frame in which the quantity of one or more resources used in production is fixed o Short-run decisions are easily reversed • Long-run o Time frame in which the quantities of all resources, including the plant size, can be varied o Long-run decisions are not easily reversed Sunk costs - Costs that have already been incurred and cannot be recovered • Sunk costs are irrelevant to a firm’s current decisions • If a firm’s plant has no resale value, the amount paid for it is a sunk cost Non-sunk costs - Costs that are incurred only if a particular decision is made (avoidable cost) Short-Run Technology Constraints To increase output in the short-run, a firm must increase quantity of labour employed Relationship between output and labour is described using three related concepts: 1. Total Product 2. Marginal Product 3. Average Product Total Product – The maximum output that a given quantity of labour could produce. Marginal Product – The increase in total product that results from a one-unit increase in labour Average Product – Equal to total product divided by labour Product Curves – graphs of the relationship between employment and the three product concepts • Show how Total Product, Marginal Product, and Average Product change as employment changes Total Product Curve • Similar to the production possibilities frontier Marginal Product Curve Both curves have two features: • Increasing marginal returns initially o Occurs when the marginal product of an additional worker exceeds the marginal product of the pervious worker o Arises from increased specialization and division of labour • Decreasing marginal returns eventually o Occurs when the marginal product of an additional worker is less than the marginal product of the pervious worker o Arises from the fact that more and more workers are using the same capital and working in the same space o More workers results in less productive work being done by the additional worker 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 marginal product of the variable factor eventually diminishes Average Product Curve • The marginal product curve cuts the average product curve at the point of maximum average product • When AP is increasing in labour, MP is greater than AP • When AP is decreasing in labour, MP is less than AP Short-Run Costs Relationship between output and cost is described using three cost concepts: 1. Total Cost 2. Marginal Cost 3. Average Cost Total Cost • Total Cost (TC) – The cost of all the factors of production it uses • Total Fixed Cost (TFC) – The cost of the firm’s fixed factors • Total Variable Cost (TVC) – The cost of the firms variable factors TC = TFC +
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