Economics 2010 Lecture 11 Organizing Production (I) Production and Costs (The short run)

Output and Costs  Product Concepts and Definitions  Product Curves  Cost Concepts and Definitions  Short-Run Cost Curves

Product Concepts and Definitions  Total product (TP) is the number of units of output produced in a given time period.  Marginal product (MP) is the increase in total product, TP, resulting from a one-unit increase in the amount of the variable factor (labor) employed.  Average product (AP) is total product per unit of the variable factor (labor) employed.

Total Product Curve  Figure shows the total product (TP) curve for sweaters  The curve separates what is attainable from what is unattainable

Marginal Product Curve  We show here the total product (TP) curve for sweaters again  But now, we emphasize the idea of marginal product

Marginal Product Curve  The marginal product (MP) curve for sweaters  Marginal product in this case increases and then diminishes  This is to be expected

Average Product Curve  average product (AP) curve for sweaters (purple)  and the marginal product curve (pink)

Average Product Curve  Average product equals marginal product at the maximum of average product

Average Product Curve  When marginal product exceeds average product, average product is increasing

Average Product Curve  When marginal product is less than average product, average product is decreasing

Average Product Curve  When marginal product equals average product, average product is at its maximum

Marginal-Average Relations  The relationship between a marginal value and an average value that you’ve just seen is universal (it is a mathematical certainty!)

Initial Increasing Returns  We know that as a firm uses more of a variable input, with the quantity of fixed inputs held constant, the marginal product of the variable input at first increases

The Law of Diminishing Returns  As a firm uses more of a variable input, with the quantity of fixed inputs held constant, the marginal product of the variable input eventually diminishes

Intuition on product curves  Marginal product and average product at first increase because of specialization and the division of labor  Marginal product and average product eventually diminish because the gains from specialization and the division of labor are limited and the plant eventually becomes congested  Too many people in the kitchen will spoil the broth!

Cost Concepts and Definitions  Total cost (TC) is the sum of the costs of all the inputs used in production. Total cost is divided into two parts:  Total fixed cost (TFC) is cost of all fixed inputs. Total fixed cost is independent of the level of output  Total variable cost (TVC) is cost of all variable inputs. Total variable cost varies with the level of output

TC = TFC + TVC Cost Concepts and Definitions

 Marginal cost is the increase in TC resulting from a one-unit increase in output. It is calculated as the change in total cost divided by the change in total output Cost Concepts and Definitions

 Average cost is cost per unit of output  Average fixed cost (AFC) is total fixed cost per unit of output.  Average variable cost (AVC) is total variable cost per unit of output.  Average total cost (ATC) is total cost per unit of output.  ATC = AFC + AVC Cost Concepts and Definitions

Short-run Cost Curves  Total cost curves  Average cost curves  Marginal cost curve  They apply when at least some of our inputs are fixed

Total Cost Curves  Look at the total cost curves for sweaters  TFC is constant at $25, remember?  TVC is based on the TP curve.

Total Cost Curves  TC is the sum of TFC and TVC.

Average and Marginal Curves  We show here the average cost curves and the marginal cost curve

Average and Marginal Curves  ATC is the sum of AVC and AFC  MC intersects ATC and AVC at their minimum points

Average and Marginal Curves  When marginal cost is less than average cost, average cost is decreasing

Average and Marginal Curves  When marginal cost exceeds average cost, average cost is increasing.

Average and Marginal Curves  When marginal cost equals average cost, average cost is at its minimum

Product Curves and Cost Curves  When marginal product is increasing, marginal cost is decreasing.  When marginal product is decreasing, marginal cost is increasing.

Product Curves and Cost Curves  When average product is increasing, average cost is decreasing  When average product is decreasing, average cost is increasing

Product Curves and Cost Curves  When average product is at its maximum, average variable cost is at its minimum

 Relate the ideas of cost and product curves  Product curves are using only information from the technological cookbook  Cost curves add the information on prices too