[ 3.5 ] Costs of Production

[ 3.5 ] Costs of Production Learning Objectives Explain how businesses decide how much labor to hire in order to produce a certain level of output. Analyze the production costs of a business. Explain how a business chooses to set output. Identify the factors that a firm must consider before shutting down an unprofitable business.

Labor and Output In a beanbag factory, the physical capital is one sewing machine and one pair of scissors. Its inputs are workers and materials, including cloth, thread, and beans. Each beanbag requires the same amount of materials. How does the company decide how many beanbags to produce?

[ 3.5 ] Costs of Production Key Terms marginal product of labor: change in output from hiring one more worker increasing marginal returns: Due to specialization, less time is wasted by designating one worker to a specific task which increases output diminishing marginal returns: Adding another worker adds to the overall output of a company but once a specific task has a worker for that task and all those tasks are filled, is not efficient and causes a decreasing rate effect. (A company will begin to produce less and less output from each unit of labor added by wasting time) negative marginal return: When there is simply too many workers to the point where they get in the way of one another and cause a decrease in output

Labor and Output Marginal product of labor is the change in output that results when a unit of labor is added. Analyze Charts How does marginal product of labor change when a fourth worker is added?

fixed cost: A cost that simply does not change no matter how much of a good is produces (rent, machinery repairs, property taxes, salaries) Variable costs: costs that rise or fall depending on the quantity produced (raw materials, electricity, heating, total cost: Fixed and Variable Costs added together

Production Costs All producers need to understand their fixed, variable, and total costs. Explain Which categories of cost would increase for a business that decided to extend its hours of operation?

Marginal cost: The cost of producing one more unit Marginal revenue: The additional income from selling one more unit of a good Average cost: The total cost divided by the quantity produced At an output of 10 beanbags per hour, the average cost is $14.10 ($142 is the total cost divided by 10) The profit then would be $9.80 if the beanbag is sold for 24 dollars times 10 units= $98 in profit operating cost: The cost of operating the facility

Production Costs Producers must identify costs and revenues to calculate profit—total revenues minus total costs. Apply Concepts Why might this factory not seek the highest possible revenue?

Setting Output Behind all of the hiring decisions is the firm’s basic goal: to maximize profits. Profit is defined as total revenue minus total cost. A firm’s total revenue is the money the firm gets by selling its product. Total revenue is equal to the price of each good multiplied by the number of goods sold. Total revenue when the price of a beanbag is $24 is shown in Figure 3.13. To find the level of output with the highest profit, we look for the biggest gap between total revenue and total cost. The gap is greatest and profit is highest when the firm makes 9 or 10 beanbags per hour. At this rate, the firm can expect to make a profit.

Setting Output To maximize profits, a business must identify the amount of labor that will enable the company to achieve the widest gap between revenue and costs.

Setting Output Changes in price lead to a change in the ideal level of output. Analyze Graphs Based on this graph, what should output be if the price fell to $20?

Quiz 1. How would the decision by a beanbag factory to add more sewing machines affect marginal returns? A. It would reduce marginal returns. B. It would increase marginal returns. C. It would have no effect on marginal returns. D. It would hurt marginal returns at first but increase them later. 2. What costs might a factory that closes its doors and stops producing goods still face? A. fixed costs B. variable costs C. marginal revenues D. increasing marginal returns 3. What would be some examples of fixed costs and variable costs for a farm? 4. Why is it sometimes not a good idea for a company to simply produce more of a good or service? 5. What should be the basic goal of a firm when it sets a level of output? 6. Explain the effect an increase in prices in the market would have on a factory’s level of production. You can use the textbook if you’d like (pages 91-96)