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

Widget Production Simulation

Production Simulation Overview 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 count Responsibilities 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 Returns MP rising. TP increasing at an increasing rate. Why? Specialization. Average Product 10 Marginal Product

Three Stages of Returns Total Product Quantity of Labor Marginal and Average Product Quantity of Labor Total Product Stage II: Decreasing Marginal Returns MP Falling. TP increasing at a decreasing rate. Why? Fixed Resources. Each worker adds less and less. Average Product 11 Marginal Product

Total Product Quantity of Labor Marginal and Average Product Quantity of Labor Total Product Stage III: Negative Marginal Returns MP 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)

# of Workers (Input) Total Product(TP) PIZZAS Marginal Product(MP) Average Product(AP) 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) 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) Identify the three stages of returns 17

# of Workers (Input) Total Product(TP) PIZZAS Marginal Product(MP) Average Product(AP) 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: 1.1 st hour: large returns 2.2 nd hour: less returns 3.3 rd hour: small returns 4.4 th hour: negative returns (tired and confused)

VI. Economic Costs a)FC = Total Fixed Costs b)VC = Total Variable Costs c)TC = Total Costs d)AFC = Average Fixed Costs e)AVC = Average Variable Costs f)ATC = Average Total Costs g)MC = Marginal Costs

VII. Cost Definitions a)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 Costs Quantity Average Variable Costs = Variable Costs Quantity

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 Costs Quantity Marginal Cost = Change in Total Costs Change in Quantity

Calculating TC, VC, FC, ATC, AFC, and MC TPVCFCTCMCAVCAFCATC Draw this in your notes 23

Calculating TC, VC, FC, ATC, AFC, and MC TPVCFCTCMCAVCAFCATC

Calculating TC, VC, FC, ATC, AFC, and MC TPVCFCTCMCAVCAFCATC

Per Unit Costs TPVCFCTCMCAVCAFCATC

Per Unit Costs TPVCFCTCMCAVCAFCATC

TPVCFCTCMCAVCAFCATC Per Unit Costs 28

TPVCFCTCMCAVCAFCATC Asymptote Per Unit Costs 29

TPVCFCTCMCAVCAFCATC Per Unit Costs 30

TPVCFCTCMCAVCAFCATC Per Unit Costs 31

Quantity Costs (dollars) AFC AVC ATC MC Per-Unit Costs (Average and Marginal) 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: TC VC FC 0CDQ 0BEQ 0AFQ or BCDE 33

Why is the MC curve U-shaped? Quantity Costs (dollars) MC

Relationship between Production and Cost Costs Marginal Product 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 workers 3.I rent a factory, buy 20 saws and hire 40 workers 4.I build my own plant an use robots to build bird houses. 5.I create plants in every major city in the U.S. 1.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 39 Quantity Cars Costs ATC 1 MC , ,000 1,000,0000 $9,900,000 $50,000 $6,000 $3,000

Long Run AVERAGE Total Cost 40 Quantity Cars Costs ATC 1 MC 1 MC , ,000 1,000,0000 $9,900,000 ATC 2 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 41 Quantity Cars Costs ATC 1 MC 1 ATC 2 MC 2 ATC 3 MC , ,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 42 Quantity Cars Costs ATC 1 MC 1 ATC 2 MC 2 ATC 3 MC , ,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. MC 4 ATC 4

Long Run AVERAGE Total Cost 43 Quantity Cars Costs ATC 1 MC 1 ATC 2 MC 2 ATC 3 MC 3 MC , ,000 1,000,0000 $9,900,000 MC 4 ATC 5 $6,000 $3,000 ATC 4 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 44 Quantity Cars Costs ATC 1 MC 1 ATC 2 MC 2 ATC 3 MC 3 MC , ,000 1,000,0000 $9,900,000 MC 4 ATC 5 $6,000 $3,000 ATC 4 Diseconomies of Scale- The LRATC is increasing as the firm gets too big and difficult to manage. $50,000

Long Run AVERAGE Total Cost 45 Quantity Cars Costs ATC 1 MC 1 ATC 2 MC 2 ATC 3 MC 3 MC , ,000 1,000,0000 $9,900,000 MC 4 ATC 5 $6,000 $3,000 ATC 4 These are all short run average costs curves. Where is the Long Run Average Cost Curve? $50,000

Long Run AVERAGE Total Cost 46 Quantity Cars Costs , ,000 1,000,0000 Long Run Average Cost Curve Economies of Scale Constant Returns to Scale Diseconomies of Scale

LRATC Simplified 47 Quantity 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