LONG-RUN, SHORT-RUN AND DIMINISHING RETURNS Chapter 20 Presentation 2.

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Presentation transcript:

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-run The firm can vary its output by applying smaller or larger amounts of labor, materials Can use existing plant more or less intensively Long-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 productivity AP = 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 quality 2. 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

Increasing Marginal Returns 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) Average Product (AP), (2)/(1) ] ] ] ] ] ] ] ] Diminishing Marginal Returns Negative Marginal Returns O 20.1

Law of Diminishing Returns Total Product, TP Marginal Product, MP TP MP AP Increasing Marginal Returns Diminishing Marginal Returns Negative Marginal Returns O 20.2

Fixed Costs (Overhead) Costs that in total do not vary with changes in output Must be paid even if output is zero Ex- rent, interest on debt, insurance premiums ***incurred at all levels of output

Variable Cost Costs that change with the level of output Ex- materials, fuel, power

Total Cost = TFC + TVC Costs Q $1100 TFC TC TVC Total Cost Variable Cost Fixed Cost