Economics 111.3 Winter 14 March 10 th, 2014 Lecture 21 Ch. 11: Output and costs.

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Presentation transcript:

Economics Winter 14 March 10 th, 2014 Lecture 21 Ch. 11: Output and costs

Test 3 Friday, March 14 th, :30 – 9:20 Room 200 STM Chapters to be tested: 9, 10 (up to p. 231) and 11 (short-run costs only) Format: Multiple-Choice Questions (MCQ): 30 questions – 100% of Test mark Time – 50 minutes

Short-Run Production Relationship: a recap Average product (the same as labour productivity) is calculated by dividing total output by the number of workers who produced it.

The Law of Diminishing Marginal Productivity (Diminishing Returns) The law of diminishing marginal productivity states that as more and more of a variable input is added to an existing fixed input, after some point the additional output obtained from the additional input will fall. This law is also called the flowerpot law, because it if did not hold true, the world’s entire food supply could be grown in a single flower pot.

units of labour TPMPAP total product total labour input AP=

Marginal & Average Values If the average value is rising, the marginal value must be ABOVE the average value If the average value is falling, the marginal value must be BELOW the average value

Marginal & Average Values AP MP MP>APMP>AP MP<APMP<AP average value rising average value falling

Profit = Total revenue – Economic cost Costs of production in the short run are: Fixed Costs, Variable Costs, and Total Costs.

Fixed Costs Fixed costs are those that are spent and cannot be changed in the period of time under consideration. Fixed costs do not vary with changes in output (e.g., firm’s debt, rental payments, interest, insurance premiums) In the long run there are no fixed costs since all costs are variable. Sunk costs – a subset of fixed costs that are not recoverable if a firm goes out of business. Examples: advertising expenditures, purchasing the advice of a management consultant, market research

Variable Costs Variable costs are costs that change as output changes, such as the costs of labour and materials. NB! The increases in variable costs associated with succeeding one-unit increase in output are not equal

Total Costs The sum of the variable and fixed costs are total costs: TC = FC + VC

Average Cost 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.

Average Cost OR How are the average cost curves related to each other?

QTFCTVCTCAFCAVCATCMC AFC=TFC / Q

QTFCTVCTCAFCAVCATCMC AVC=TVC / Q

QTFCTVCTCAFCAVCATCMC ATC=TC / Q

Marginal cost (MC) is the increase in total cost that results from a one-unit increase in output. It equals the increase in total cost divided by the increase in output. Marginal cost decreases at low outputs because of the gains from specialization, but eventually increases due to the law of diminishing returns.

QTFCTVCTCAFCAVCATCMC MC=  TC /  Q

Average fixed cost declines continuously as output increases Average-Variable-Cost and Average-Total-Cost curves are U-shaped, reflecting increasing and then diminishing returns The Marginal-Cost curve falls when marginal returns increase, and rises when marginal returns diminish. The Marginal-Cost curve intersects both the Average-Variable- and Average-Total Cost curves at their minimum points.

Marginal Cost and Average Costs Output (sweaters per day) Cost (dollars per sweater) AFC AVC ATC ATC = AFC + AVC MC

b) “At the current output level, this factory is subject to diminishing returns. Therefore, the firm is operating along the upward-sloping portion of its short-run average total cost curve”.