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Unit 4 Consumers and Producers
Chapter 12 Inputs and Costs
I. Production Function
a) Relationship between quantity of inputs a firm uses and the quantity of output it produces
b) Fixed input: quantity cannot be varied for a period of time.
c) Variable input: quantity the firm can vary at any time.
II. Long run vs. Short run
a) Long run: period of time in which all inputs can be varied.
b) Short run: period of time in which at least one input is fixed
WidgetProduction Simulation
Production SimulationOverview• The class will be divided into two firms. • There will be several rounds in which each firm will produce chains out
of paper. • Each round last exactly 2 minutes • Each firm is going to hire one more worker at the start of each round. Resources• 1 stapler, 1 scissors, 1 table, and plenty of staples and paper Rules• Workers cannot stockpile slips of paper. No extras • Workers cannot cut more than one paper at a time • Workers can only add links to one side of the chain• Each link must pass inspection• If links don’t meet specifications they won’t countResponsibilities• The manager will hire the workers.• The inspector will check to make sure each product is made to
specifications
Production Simulation
Step 1: Cut paper down the
middle into two piece
Step 2: Fold piece down the
middle
Step 3: Wrap ends around and staple
Step 4: Add more links to one end
III. Inputs vs. Outputs
a) To earn profit, firms must make products (outputs)b) Inputs are the resources used to make outputs.c) Marginal product: the additional output generated
by additional inputs (workers)
d) Average Product: the output per unit of input
Marginal Product =Change in Total Product
Change in Inputs
Average Product =Total Product
Units of Labor
IV. Law of Diminishing Marginal Returns
a) As variable resources (workers) are added to fixed resources (machinery, tools, etc.) the additional output produced from each new worker will eventually fall.
Too many cooks in the kitchen!
Graphing Production
9
Three Stages of Returns
Total Product
Quantity of Labor
Marginal and
Average Product
Quantity of Labor
Total Product
Stage I: Increasing Marginal ReturnsMP rising. TP increasing at an increasing rate.
Why? Specialization.
Average Product
10Marginal Product
Three Stages of Returns
Total Product
Quantity of Labor
Marginal and
Average Product
Quantity of Labor
Total Product
Stage II: Decreasing Marginal ReturnsMP Falling. TP increasing at a decreasing rate.
Why? Fixed Resources. Each worker adds less and less.
Average Product
11Marginal Product
Total Product
Quantity of Labor
Marginal and
Average Product
Quantity of Labor
Total Product
Stage III: Negative Marginal ReturnsMP is negative. TP decreasing. Workers get in each others way
Marginal Product
Average Product
12
Three Stages of Returns
The Law of Diminishing Marginal Returns is NOT the results of laziness, it is the result of limited fixed
resources. 13
With a partner calculate MP and AP then discuss what the graphs for TP, MP, and AP look like.
Remember quantity of workers goes on the x-axis.
# of Workers(Input)
Total Product(TP) PIZZAS
Marginal Product(MP)
Average Product(AP)
0 0
1 10
2 25
3 45
4 60
5 70
6 75
7 75
8 70 14
# of Workers(Input)
Total Product(TP) PIZZAS
Marginal Product(MP)
Average Product(AP)
0 0 - -
1 10 10
2 25 15
3 45 20
4 60 15
5 70 10
6 75 5
7 75 0
8 70 -5
With a partner calculate MP and AP then discuss what the graphs for TP, MP, and AP look like.
Remember quantity of workers goes on the x-axis.
15
# of Workers(Input)
Total Product(TP) PIZZAS
Marginal Product(MP)
Average Product(AP)
0 0 - -
1 10 10 10
2 25 15 12.5
3 45 20 15
4 60 15 15
5 70 10 14
6 75 5 12.5
7 75 0 10.71
8 70 -5 8.75
With a partner calculate MP and AP then discuss what the graphs for TP, MP, and AP look like.
Remember quantity of workers goes on the x-axis.
16
# of Workers(Input)
Total Product(TP) PIZZAS
Marginal Product(MP)
Average Product(AP)
0 0 - -
1 10 10 10
2 25 15 12.5
3 45 20 15
4 60 15 15
5 70 10 14
6 75 5 12.5
7 75 0 10.71
8 70 -5 8.75
Identify the three stages of returns
17
# of Workers(Input)
Total Product(TP) PIZZAS
Marginal Product(MP)
Average Product(AP)
0 0 - -
1 10 10 10
2 25 15 12.5
3 45 20 15
4 60 15 15
5 70 10 14
6 75 5 12.5
7 75 0 10.71
8 70 -5 8.75
Identify the three stages of returns
18
V. More examples of Diminishing Marginal Returns
a) Learning curve when studying for an exam.b) Fixed Resources: amount of class time,
textbook, etc.c) Variable Resources: Study time at home.d) Marginal Returns:
1. 1st hour: large returns2. 2nd hour: less returns3. 3rd hour: small returns4. 4th hour: negative returns (tired and confused)
VI. Economic Costs
a) FC = Total Fixed Costsb) VC = Total Variable Costsc) TC = Total Costsd) AFC = Average Fixed Costse) AVC = Average Variable Costsf) ATC = Average Total Costsg) MC = Marginal Costs
VII. Cost Definitionsa) Fixed Costs: Cost of fixed resources that
DON’T change with the amount produced. Ex. Rent, Insurance, Salaries
b) Variable Costs: Costs for variable resources that DO change as more or less is produced. Ex. Raw Materials, Labor, Electricity
Average Fixed Costs = Fixed CostsQuantity
Average Variable Costs = Variable CostsQuantity
VII. Cost Definitions
c) Total Cost: Sum of Fixed and Variable Cost.
d) Marginal Cost: Additional costs of an additional output. Ex. If the production of two more output increases total cost from $100 to $120, the MC is $10.
Average Total Cost = Total CostsQuantity
Marginal Cost = Change in Total CostsChange in Quantity
Calculating TC, VC, FC, ATC, AFC, and MC
TP VC FC TC MC AVC AFC ATC
0 0 100
1 10
2 16
3 21
4 26
5 30
6 36
7 46
Draw this in your notes 23
Calculating TC, VC, FC, ATC, AFC, and MC
TP VC FC TC MC AVC AFC ATC
0 0 100
1 10 100
2 16 100
3 21 100
4 26 100
5 30 100
6 36 100
7 46 100
24
Calculating TC, VC, FC, ATC, AFC, and MC
TP VC FC TC MC AVC AFC ATC
0 0 100 100
1 10 100 110
2 16 100 116
3 21 100 121
4 26 100 126
5 30 100 130
6 36 100 136
7 46 100 146
25
Per Unit CostsTP VC FC TC MC AVC AFC ATC
0 0 100 100 -
1 10 100 110
2 16 100 116
3 21 100 121
4 26 100 126
5 30 100 130
6 36 100 136
7 46 100 146
26
Per Unit CostsTP VC FC TC MC AVC AFC ATC
0 0 100 100 -
1 10 100 110 10
2 16 100 116 6
3 21 100 121 5
4 26 100 126 5
5 30 100 130 4
6 36 100 136 6
7 46 100 146 10
27
TP VC FC TC MC AVC AFC ATC
0 0 100 100 - -
1 10 100 110 10 10
2 16 100 116 6 8
3 21 100 121 5 7
4 26 100 126 5 6.5
5 30 100 130 4 6
6 36 100 136 6 6
7 46 100 146 10 6.6
Per Unit Costs
28
TP VC FC TC MC AVC AFC ATC
0 0 100 100 - - -
1 10 100 110 10 10 100
2 16 100 116 6 8 50
3 21 100 121 5 7 33.3
4 26 100 126 5 6.5 25
5 30 100 130 4 6 20
6 36 100 136 6 6 16.67
7 46 100 146 10 6.6 14.3
Asymptote
Per Unit Costs
29
TP VC FC TC MC AVC AFC ATC
0 0 100 100 - - - -
1 10 100 110 10 10 100 110
2 16 100 116 6 8 50 58
3 21 100 121 5 7 33.3 40.3
4 26 100 126 5 6.5 25 31.5
5 30 100 130 4 6 20 26
6 36 100 136 6 6 16.67 22.67
7 46 100 146 10 6.6 14.3 20.9
Per Unit Costs
30
TP VC FC TC MC AVC AFC ATC
0 0 100 100 - - - -
1 10 100 110 10 10 100 110
2 16 100 116 6 8 50 58
3 21 100 121 5 7 33.3 40.3
4 26 100 126 5 6.5 25 31.5
5 30 100 130 4 6 20 26
6 36 100 136 6 6 16.67 22.67
7 46 100 146 10 6.6 14.3 20.9
Per Unit Costs
31
Quantity
Co
sts
(do
llar
s)
AFC
AVC
ATC
MC
Per-Unit Costs (Average and Marginal)
121110987654321
0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15
Average Fixed Cost
ATC and AVC get closer and closer but NEVER touch
32
Per-Unit Costs (Average and Marginal)
At output Q, what area represents:
TCVCFC
0CDQ0BEQ0AFQ or BCDE
33
Why is the MC curve U-shaped?
Quantity
Co
sts
(do
llar
s)
MC121110987654321
0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 1534
Relationship between Production and Cost
C
os
tsM
arg
inal
Pro
du
ct
Quantity of labor
Quantity of output
MP
MC
Why is the MC curve U-shaped?
•When marginal product is increasing, marginal cost falls.•When marginal product falls, marginal costs increase.MP and MC are mirror images
of each other.
35
VIII. Long-Run Costs
a) All resources are variable. Plant capacity /size can change.
b) Ex. Assume a firm is producing 100 bikes with fixed number of resources (workers, machines, etc.)
c) If this firm decides to DOUBLE the number of resources, what will happen to the number of bikes it can produce?
1. Number of bikes will double (constant returns of scale)2. Number of bikes will more than double (economies of scale)3. Number of bikes will less than double (diseconomies of
scale)
IX. Long Run ATC
a) What happens to the ATC of a product when a firm increases its plant capacity?
1. I make bird houses out of my garage with one saw.2. I rent out a building, buy 5 saws, hire 3 workers3. I rent a factory, buy 20 saws and hire 40 workers4. I build my own plant an use robots to build bird houses.5. I create plants in every major city in the U.S.
6. Long Run ATC curve is made up of all the different short run ATC curves of various plant sizes.
X. Economies of Scale
a) Firms that produce more can better use Mass Production Techniques and Specialization.
b) Ex. 1. A car company that makes 50 cars will have a
very high average cost per car.2. A car company that can produce 100,000 cars
will have a low average cost per car.
Long Run AVERAGE Total Cost
39Quantity Cars
Costs
ATC1
MC1
0 1 100 1,000 100,000 1,000,0000
$9,900,000
$50,000
$6,000
$3,000
Long Run AVERAGE Total Cost
40Quantity Cars
Costs
ATC1
MC1
MC2
0 1 100 1,000 100,000 1,000,0000
$9,900,000
ATC2
Economies of Scale- Long Run Average Cost falls because mass production techniques are used.
$50,000
$6,000
$3,000
Long Run AVERAGE Total Cost
41Quantity Cars
Costs
ATC1
MC1
ATC2
MC2
ATC3
MC3
0 1 100 1,000 100,000 1,000,0000
$9,900,000
$50,000
$6,000
$3,000
Economies of Scale- Long Run Average Cost falls because mass production techniques are used.
Long Run AVERAGE Total Cost
42Quantity Cars
Costs
ATC1
MC1
ATC2
MC2
ATC3
MC3
0 1 100 1,000 100,000 1,000,0000
$9,900,000
$50,000
$6,000
$3,000
Constant Returns to Scale- The long-run average total cost is as low as it can get.
MC4
ATC4
Long Run AVERAGE Total Cost
43Quantity Cars
Costs
ATC1
MC1
ATC2
MC2
ATC3
MC3MC5
0 1 100 1,000 100,000 1,000,0000
$9,900,000
MC4 ATC5
$6,000
$3,000
ATC4
Diseconomies of Scale- Long run average costs increase as the firm gets too big and difficult to manage.
$50,000
Long Run AVERAGE Total Cost
44Quantity Cars
Costs
ATC1
MC1
ATC2
MC2
ATC3
MC3MC5
0 1 100 1,000 100,000 1,000,0000
$9,900,000
MC4 ATC5
$6,000
$3,000
ATC4
Diseconomies of Scale- The LRATC is increasing as the firm gets too big and difficult to manage.
$50,000
Long Run AVERAGE Total Cost
45Quantity Cars
Costs
ATC1
MC1
ATC2
MC2
ATC3
MC3MC5
0 1 100 1,000 100,000 1,000,0000
$9,900,000
MC4 ATC5
$6,000
$3,000
ATC4
These are all short run average costs curves. Where is the Long Run Average Cost Curve?
$50,000
Long Run AVERAGE Total Cost
46Quantity Cars
Costs
0 1 100 1,000 100,000 1,000,0000
Long Run Average Cost Curve
Economies of Scale
Constant Returns to Scale
Diseconomies of Scale
LRATC Simplified
47Quantity
Costs
Long Run Average Cost Curve
Economies of Scale
Constant Returns to Scale
Diseconomies of Scale
The law of diminishing marginal returns doesn’t apply in the long run because there are no FIXED RESOURCES.
REAL WORLD ECONOMIES OF SCALE
48