LONG-RUN, SHORT-RUN AND DIMINISHING RETURNS

Chapter 20 Presentation 2

Plant Capacity

The size of the factory building, the amount of machinery and equipment, and other capital resources (human-made resources such as buildings)

Short-Run: Fixed Plant

Plant capacity is fixed in the short-runThe firm can vary its output by applying

smaller or larger amounts of labor, materialsCan use existing plant more or less

intensivelyLong-Run = variable plant

SR and LR Examples

Boeing hires 100 extra workers = short-run adjustment

Boeing adds a new production facility and/or installs more equipment = long-run adjustment

Total Product (TP)

The total quantity or total output of a particular good or service produced

Marginal Product (MP)

The extra output or added product associated with adding a unit of variable resources to the production process

MP = change in total product/change in labor input

Law of Diminishing Returns

As more units of a variable resource (ie labor) are added to a fixed resource (ie land, factory), at some point the marginal product that can be attributed to each additional unit of the variable resource will decline

Ex- if more workers are hired to work w/ a constant amount of equipment, output will eventually rise by smaller and smaller amounts

Average Product (AP)

AKA Labor productivityAP = total product/units of labor

Diminishing Returns Example

Farmer has a fixed resource of 80 acres planted in corn

No cultivation (weeding) leads to 40 bushels of corn

Cultivating the weeds once leads to 50 bushels

Cultivating the weeds twice leads to 57 bushels

Cultivating the weeds three time leads to 61

Diminishing Returns Assumptions

1. All units of labor are of equal quality2. Each successive unit is presumed to have

the same ability, motor coordination, education, training and work experience

3. MP eventually ultimately diminishes not because successive workers are less skilled but because there is a fixed amount of resources

IncreasingMarginalReturns

Law of Diminishing Returns

(1)Units of the

Variable Resource(Labor)

(2)Total Product

(TP)

(3)Marginal Product

(MP),Change in (2)/Change in (1)

(3)AverageProduct

(AP),(2)/(1)

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DiminishingMarginalReturns

NegativeMarginalReturns

O 20.1

Law of Diminishing Returns

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IncreasingMarginalReturns

DiminishingMarginalReturns

NegativeMarginalReturns

O 20.2

Fixed Costs (Overhead)

Costs that in total do not vary with changes in output

Must be paid even if output is zeroEx- rent, interest on debt, insurance

premiums***incurred at all levels of output

Variable Cost

Costs that change with the level of outputEx- materials, fuel, power

Total Cost = TFC + TVC

Co

sts

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TFC

TC

TVC

TotalCost

VariableCost

FixedCost