1. Costs/Productivity - Part 2 (Section 4.2 of textbook) M. Padula AIS 2011-12 Theory of the Firm Part I

2. Upcoming Topics Cost of Production – what inputs/costs generate what output/production? Total product, marginal product, average product The Law of Diminishing Marginal Return

3. Reminder: FC, VC, TC Fixed Costs (FC) Costs that do not vary with output (even when output is zero) Examples: Rent, Property taxes, Insurance, Interest on Loans Variable Costs (VC) Costs that do vary with output Examples: Labor (Wages/Payroll tax/Benefits), Shipping Total Costs (TC) TC = FC + VC In the long run, ALL inputs are variable—all costs are variable Marginal Costs Cost of producing one more unit of output

4. Reminder: AC, MC Average Costs Cost per unit of output –total cost divided by the total output Average Fixed Cost = Total Fixed Cost/Output Average Variable Cost = Total Variable Cost/Output Average Total Cost (ATC) = (AFC) + (AVC) Marginal Costs Cost of producing one more unit of output What is the increase in (Variable) cost for one more unit of output MC = ∆TC/∆Q = ∆TVC/∆Q Costs: Often expressed as units of input (e.g., labor)

5. Short-Run Cost and Productivity Cost of input goods Technical efficiency – Q inputs vs. Q output

6. Let’s practice… Units of Input (Labor) Total Product (Total Output) Marginal Product (Mar. Output) Average Product (Avg. Output) 0000 1222 2532.5 3943 41453.5 51843.6 62133.5 72323.3 82413 9 02.7 10232.3 1121-21.9

7. Diagrams: Total Output Diagram the relationship between Input (Labor) and Total Output (Total Product)

8. Diagrams: Marginal Output Diagram the relationship between Input (Labor) and Marginal Output (Marginal Product)

9. Diagrams: Average Output Diagram the relationship between Input (Labor) and Average Output (Average Product)

10. Diagrams: Putting It All Together Total Marginal Average

11. The Law of Diminishing Marginal Returns The marginal output of a production process tends to decrease as the amount of a single factor of production is increased (ceteris paribus) Adding more of one factor of production, while holding all others constant, will at some point yield lower per-unit returns. Does not imply that adding more of a factor will decrease the total production (a condition known as negative returns) Examples—farming, assembly line, trucking, studying

12. Before you leave… Be sure you can: Define the cost terms TC/FC/VC MC/AC Explain the law of diminishing returns In words and with diagrams Why it only operates in the short run Why the Marginal Output/Product always intersects the Average Output/Product at its highest point