CHAPTER 11 Output and Costs. The Firm’s Objectives and Constraints The firm’s main objective is...

CHAPTER 11Output and Costs

The Firm’s Objectivesand Constraints

The firm’s main objective is to maximize economic profits.

This means they are making the best (most efficient) use of scarce resources.

Firms that try to maximize economic profits will have the best chance of surviving in a competitive environment.

The Firm’s Objectiveand Constraints

The Short Run and the Long Run

The short run is a period of time in which the quantity of capital is fixed and the quantities of the other inputs (mainly labor) can be varied.

The long run is a period of time in which the quantities of all inputs can be varied.

How Long Is the Long Run?

In some industries — consulting or photocopying services — the short run may last only a month or two.

In other industries, the short run can be several years. Electric power generating and railroads are two industries that take years to build new capital.

Short-Run Technology Constraint

In order to increase output in the short-run (holding the capital stock constant), firms must increase the quantity of labor.

Short-Run Technology Constraint

The effect of a change in the quantity of labor, holding the capital stock constant, can be described using three related concepts: Total product is the total output produced. Marginal product is the increase in total

product that result from a one-unit increase in an input.

Average product is the total product divided by the quantity of inputs.

Total Product

Total product (TP) is the total quantity of output produced with a given quantity of a fixed input.

The total product curve shows the maximum quantity of output that can be produced with a given amount of capital as the amount of labor employed is varied.

The Total Product Curve

The total product curve is similar to the production possibilities frontier.

Both separate attainable output levels from those that are unattainable.

Only points on the total product curve are technologically efficient.

Total Product Schedule

Labor Output

c 2 10

d 3 13

e 4 15

f 5 16

Total Product Curve

0 1 2 3 4 5Labor (workers per day)

Total Product Curve

Attainable

Unattainable

Marginal Product The marginal product of an input is

the increase in total product divided by the increase in the quantity of the input employed, when the quantity of all other inputs is constant.

Marginal Product of Labor

The marginal product of labor (MP) is the increase in total product divided by the increase in the quantity of labor employed, when the quantity of capital is constant.

MP= TP/ L

Marginal Product of Labor Schedule

Labor Total Product Marginal product

of Labor

a 0 0 -

c 2 10

d 3 13

e 4 15

f 5 16

of Labor

a 0 0 -

b 1 4 4

c 2 10

d 3 13

e 4 15

f 5 16

of Labor

a 0 0 -

b 1 4 4

c 2 10 6

d 3 13

e 4 15

f 5 16

of Labor

a 0 0 -

b 1 4 4

c 2 10 6

d 3 13 3

e 4 15

f 5 16

of Labor

a 0 0 -

b 1 4 4

c 2 10 6

d 3 13 3

e 4 15 2

f 5 16

of Labor

a 0 0 -

b 1 4 4

c 2 10 6

d 3 13 3

e 4 15 2

f 5 16 1

Marginal Product Curve

Marginal product is also measured by the slope of the total product curve.

Increasing marginal returns occur when the marginal product of an additional worker exceeds the marginal product of the previous worker.

Diminishing marginal returns Occur when the marginal product of an

additional worker is less than the marginal product of the previous worker

Law of diminishing returns As a firm uses more of a variable input,

with a given quantity of fixed inputs, the marginal product of the variable input eventually diminishes

The red highlightsthe point of diminishing returns

Average Product The average product of an input is

equal to total product divided by the quantity of the input employed.

Average product tells us how productive, on average, a factor of production is.

Average Product of Labor

The average product of labor is total product divided by the quantity of labor employed, when the quantity of capital is constant.

AP = TP/L

Average Product of Labor Schedule

Labor Total Product Marginal Average

Product Product

of Labor of Labor

a 0 0 - -

b 1 4 4

c 2 10 6

d 3 13 3

e 4 15 2

f 5 16 1

Product Product

of Labor of Labor

a 0 0 - -

b 1 4 4 4

c 2 10 6

d 3 13 3

e 4 15 2

f 5 16 1

Product Product

of Labor of Labor

a 0 0 - -

b 1 4 4 4

c 2 10 6 5

d 3 13 3

e 4 15 2

f 5 16 1

Product Product

of Labor of Labor

a 0 0 - -

b 1 4 4 4

c 2 10 6 5

d 3 13 3 4.33

e 4 15 2

f 5 16 1

Product Product

of Labor of Labor

a 0 0 - -

b 1 4 4 4

c 2 10 6 5

d 3 13 3 4.33

e 4 15 2 3.75

f 5 16 1

Product Product

of Labor of Labor

a 0 0 - -

b 1 4 4 4

c 2 10 6 5

d 3 13 3 4.33

e 4 15 2 3.75

f 5 16 1 3.20

Average Product Curve

What does the average product

curve look like?

Maximumaverageproduct

The Relationship Between Marginal and Average

When marginal product is above average product, average is rising — marginal is pulling average up.

When marginal product is below average product, average is falling — marginal is pulling average down.

Marginal product intersects average where average is at its maximum.

Marginal and Average Grade The marginal grade is the grade you

receive in this class. Your average grade is your G.P.A.

(grade point average). If the grade you get in this class is

higher than your G.P.A., it will pull your G.P.A. up.

If, on the other hand, ...

The Shapes of theProduct Curves

Total, marginal, and average product curves for different goods will still have similar shapes because almost every production process incorporates two features: Increasing marginal returns initially Diminishing marginal returns eventually

Increasing Marginal Returns

Increasing marginal returns occur when the marginal product of an additional worker exceeds the marginal product of the previous worker.

Increasing marginal returns will usually be the rule when the quantity of labor employed is low.

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.

All production processes eventually reach a point of diminishing marginal returns.

The Law ofDiminishing Returns

As a firm uses more of a variable input, with a given quantity of fixed inputs, the marginal product of the variable input eventually diminishes.

Because marginal product eventually diminishes, so does average product.

Short-Run Cost

To produce more output in the short run, a firm must employ more labor.

This will also increase its cost. To produce more output, a firm must

increase its costs.

Short-Run Cost

Total cost (TC) is the cost of all productive resources used by a firm.

Total fixed cost (TFC) is the cost of all the firm’s fixed inputs.

Total variable cost (TVC) is the cost of all the firm’s variable inputs.

Total Cost

A firm’s total cost is the sum of the costs of all the inputs it uses in production.

Total cost includes the cost of renting land, buildings and equipment; wages paid to the work force; and normal profit.

Total Fixed Cost andTotal Variable Cost

Total cost (TC) is divided into two categories: Total fixed cost (TFC) Total variable cost (TVC)

TC = TFC + TVC

Total Fixed Cost

A fixed cost is the cost of a fixed input.

Fixed cost doesn’t change when output changes.

Total fixed cost is the total cost of the fixed inputs.

Total Variable Cost

A variable cost is a cost of a variable input.

Variable costs change when the level of output changes.

Total variable cost is the total cost of the variable inputs.

Total Cost ScheduleTotal Totalfixed variable Totalcost cost cost

Labor Output (TFC) (TVC) (TC)(workers (sweatersper day) per day) (dollars per day)

c 2 10

d 3 13

e 4 15

f 5 16

Total Cost SchedulesTotal Totalfixed variable Totalcost cost cost

a 0 0 25

b 1 4 25

c 2 10 25

d 3 13 25

e 4 15 25

f 5 16 25

a 0 0 25 0

b 1 4 25 25

c 2 10 25 50

d 3 13 25 75

e 4 15 25 100

f 5 16 25 125

a 0 0 25 0 25

b 1 4 25 25 50

c 2 10 25 50 75

d 3 13 25 75 100

e 4 15 25 100 125

f 5 16 25 125 150

Total Cost Curves

0 5 10 15Output (sweaters per day)

Total Cost Curves

Marginal Cost

Marginal cost (MC) is the increase in its total cost divided by the increase in its output.

Marginal cost is the increase in total cost that results from a one unit increase in output.

MC = TC/ Q

Marginal Cost

Because fixed costs don’t change as output changes, marginal cost is also the increase in total variable cost divided by the increase in output.

MC = TC/ Q

MC = TVC/ Q + TFC/ Q

MC = TVC/ Q + 0

Marginal Cost

Marginal costs decrease at low outputs because of the gains from specialization, but it eventually increases due to the law of diminishing returns.

Average Cost

Average cost is the cost per unit of output.

There are three average costs: Average fixed cost Average variable cost Average total cost

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.

Average Cost Measures

Average total cost (ATC) is total cost per unit of output. It is the sum of average fixed cost (AFC) and average variable cost (AVC).

Average Cost

Total Cost = TC = TFC + TVC

Average Total Cost = ATC

TC TFC TVC OR Q Q Q

ATC = AFC+AVC

Marginal Cost and Average Costs

Total Total Average Average Average

fixed variable Total Marginal fixed variable TotalLabor Output cost cost cost cost cost cost cost

L Q (TFC) (TVC) (TC) (MC) (AFC) (AVC) (ATC) (workers (sweaters per day) per day) $/day $/day $/day $/day $/day $/day $/day

a 0 0 25 0 25 - - - -

b 1 4 25 25 50

c 2 10 25 50 75

d 3 13 25 75 100

e 4 15 25 100 125

f 5 16 25 125 150

a 0 0 25 0 25 - - - -

b 1 4 25 25 50 6.25

c 2 10 25 50 75

d 3 13 25 75 100

e 4 15 25 100 125

f 5 16 25 125 150

a 0 0 25 0 25 - - - -

b 1 4 25 25 50 6.25 6.25

c 2 10 25 50 75

d 3 13 25 75 100

e 4 15 25 100 125

f 5 16 25 125 150

a 0 0 25 0 25 - - - -

b 1 4 25 25 50 6.25 6.25 6.25

c 2 10 25 50 75

d 3 13 25 75 100

e 4 15 25 100 125

f 5 16 25 125 150

a 0 0 25 0 25 - - - -