Chapter 11 Output and Costs
Decision Time Frames:
Firms are aimed at maximizing profit
The biggest decision that an entrepreneur makes is in what industry to establish a
o Decision depends on profit prospects.
To study the relationship between a firm’s output decision and its costs, we
distinguish between two decision time frames:
1. The Short Run
2. The Long Run
The Short Run
The quantity of at least one factor of production is fixed (=plant).
To increase output in the short run, a firm must increase the quantity of a variable
factor of production. E.g. hire more workers
The Long Run
A time frame in which the quantities of all factors of production can be varied;
plant can be changed.
To increase output in the long run, the firm can change its plant as well as its
quantity of labor.
Long run decisions are not easily reversed.
o To emphasize this, we call past expenditure on a plant that has no resale
value a sunk cost.
A sunk cost is irrelevant to a firm’s current decisions.
• The only costs that influence current decisions are the
shortrun cost of changing its labor inputs and the longrun
cost of changing its plant.
ShortRun Technology Constraint
To increase output in the short run, a firm must increase the quantity of labor
The relationship b/w output and labor can be described by using three concepts:
a. Total Product (= the max. output that a given quantity of labor can
b. Marginal Product (= …of labor is the increase in total product that
results from a oneunit increase in the quantity of labor employed,
with all other inputs remaining the same)
c. Average Product (=… of labor is equal to total product divided by
the quantity of labor employed)
They can be illustrated by product schedules or product curves.
Total Product Curve
Similar to PPF it separates attainable output levels an unattainable ones.
Only the points on the TPC are technologically efficient
Marginal Product Curve
Height of a bar measures marginal product; also measured by slope of TPC
The TPC and MPC differ across firms and types of goods but the shapes are
similar because almost every production process has 2 features: Chapter 11 Output and Costs
a. Increasing marginal returns initially
b. Diminishing marginal returns eventually (occurs when the marginal product of an
addition worker is less than the marginal product of the previous worker)
as more workers are added there becomes less and less for the additional body
to do that is productive
The law of diminishing returns
o 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
When MP>AP, average product is increasing