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ECONOMICS 200PRINCIPLES OF MICROECONOMICS

Professor Lucia F. Dunn

Department of Economics

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Technology

(1) Variable Factors(1) Variable Factors:

One that can be varied quickly and easily to increase or

decrease output within a production unit (or plant) of a

given size.

(2) Fixed Factors:Fixed Factors:

Ones that cannot be varied quickly or easily.

The quantity of the fixed factors determine the size of

the plant.

Long-Run vs. Short-Run

First we must define variable and fixed factors of production (or inputs).

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Technology

Short-Run: Long enough to alter the variable but not the fixed factors of production.

Long-Run: Long enough to alter both the variable and the fixed factors of production; but cannot alter the technology.

Very-Long-Run: Long enough for even the basic technology to be changed.

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Technology

INDUSTRYINDUSTRY:

All the firms in one line of business.

The firms can each have a number of plants.

So there is the following hierarchy:So there is the following hierarchy:

IndustryIndustry

FirmsFirms

Plants

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Technology

A technical, mathematical relationship that tells the maximum amount of output that can be produced with a given set of inputs, given the current state of technical knowledge.

Production Function

Total Product (TP) = f (inputs)Total Product (TP) = f (inputs)

TP = f (capital, land, labor, ...)TP = f (capital, land, labor, ...)

or

Example: Corn = f(land, labor, sun)

10 bu.= 1 acre + 5 work hours +

100 watts of sun energy

per square acre.

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Technology

(1) Total Product TP.

(2) Average Product AP.

Product Concepts

product per unit of an input factor.

AP of labor (APL) = LTP

AP of capital (APK) = K

TP

(3) Marginal Product MP.

The change in TP that comes from using one additional

unit of a factor.

L

TPMPL

TP, AP,MP, ...

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Technology

Units of Labor TP MPL APL

0 0 -- --

1 1000 1000 1000

2 3000 2000 1500

3 3500 500 1167

4 3800 300 950

5 3900 100 780

Example:

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Relationship Between TP and MPTP

4,000

01 2 3 4 5

3,000

2,000

1,000Labor

Units (L)

MP

4,000

01 2 3 4 5

3,000

2,000

1,000Labor

Units (L)

Diminishing MP

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Relationship Between MP and AP

Product

Labor Units

MPMPAPAP

Summary:Summary:

(1) If MP is above AP AP is rising.

(2) If MP is below AP AP is falling.

(3) If MP is equal AP AP is peaking out.

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Law of Diminishing Marginal Returns

If additional units of a variable factor are added to a

fixed factor, eventually the marginal product of the

variable factor will decrease.

The Law of Diminishing The Law of Diminishing Marginal Returns!Marginal Returns!

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Cost Concepts

I. Total Costs (TC)

— whatever total cost is for any level of output

Two Sub-Components:Two Sub-Components:

(A)Total Fixed Costs — TFC (Overhead Costs)

— do not vary with output.

(B) Total Variable Costs — TVC

— vary with output.

Note: TC = TFC + TVC

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Cost Concepts

II. Average Total Costs (ATC)

Two Sub-Components:Two Sub-Components:

TP

TCATC

(A) Average Fixed Cost: TP

TFCAFC

(B) Average Variable Cost: TP

TVCAVC

TwoAverageCosts!!

Note: ATC = AFC + AVC

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Cost Concepts

III. Marginal Costs (MC)

TP

TCMC

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Cost Concepts

CostCost

Output or TPOutput or TP

I. Graph of Total Cost Concept

TC

TVC

TFC

(TFC)

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Cost Concepts

CostCost

OutputOutput

II. Graph of Average & Marginal Cost Concept

AVC

AFC

ATCMC

QC

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Cost Concept

(1) When marginal is below average (1) When marginal is below average average is falling. average is falling.

(2) When marginal is above average (2) When marginal is above average average is rising. average is rising.

(3) When marginal is equal average (3) When marginal is equal average average is at its lowest average is at its lowest

point.point.

Definition:Definition:

Capacity — The output level that corresponds to the minimum

point on the short-run ATC curve.

Excess Capacity Producing at any output level smaller than

the capacity level QC.

— By producing more, the firm could get to

cheaper per unit costs.

Summary of Relationship Between Marginal Cost & Average Cost

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