1. Making paper cups
What you’ll need
1. Paper
2. Markers (1 red
and 1 blue)
3. Workers
Which are fixed inputs? Which are variable?

2. We’ll go through 4 rounds of production.
Round 1 will start with one worker, Round 2 will have 2 workers, and so on.
You MUST follow the directions PERFECTLY – no shortcuts! I must have good, quality products made. This is not a race, so chill out. 
Each round will take 90 seconds.
After each round, note total product and marginal product on your group’s scorecard.
For each round, you have to start back at zero product – you can’t count each round as an accumulation.

3. Imagine I assigned a major project
Imagine I assigned a major project. The project would require a good deal of research, a detailed visual component, and a 15-minute oral presentation.
If you could choose groups, how many people would you choose to work with? Why that quantity?

4. The Production Function (10/7)
A firm’s quantity of output depends on the quantity of inputs
Fixed input: quantity fixed for period of time – cannot be varied
Variable input: quantity can be varied at any time – depends on the level of output
Example – wheat farm
Fixed inputs:
Variable inputs:

5. Negative returns: MP of labor is negative – bad!
Quantity of Labor
Quantity of Wheat (total product)
Marginal Product of Labor -- 1 7 2 20 13 3 38 18 4 62 24 5 90 28 6
110
129 19 8
138 9
144 10
148 11
145 -3 12
135
-10
Land: fixed input
Labor: variable input
Adding each add’l worker adds to total product, and TP increases at a greater and greater rate– increasing returns to labor
Adding more workers adds to TP, but TP increases at a decreasing rate – decreasing returns to labor
Negative returns: MP of labor is negative – bad!

6. Production Function and TP Curve for George and Martha’s Farm
Quantity of wheat (bushels)
Quantity of labor L
Quantity
of wheat Q
MP of labor
MPL =  Q /  L
(worker)
(bushels)
(bushels per worker)
Adding a 7th worker leads to an increase in output of only 7 bushels 19 1 19 17 2 36 15
Total product, TP 3 51
100
Adding a 2nd worker leads to an increase in output of only 17 bushels 13 4 64 11 80 5 75 9 6 84 7 60 7 91 5 8 96 40 20
Figure Caption: Figure 12-1: Production Function and Total Product Curve for George and Martha’s Farm
The table shows the production function, the relationship between the quantity of the variable input (labor, measured in number of workers) and the quantity of output (wheat, measured in bushels) for a given quantity of the fixed input. It also calculates the marginal product of labor on George and Martha’s farm. The total product curve shows the production function graphically. It slopes upward because more wheat is produced as more workers are employed. It also becomes flatter because the marginal product of labor declines as more and more workers are employed. 1 2 3 4 5 6 7 8
Quantity of labor (workers)
Although the total product curve in the figure slopes upward along its entire length, the slope isn’t constant: as you move up the curve to the right, it flattens out due to changing marginal product of labor. 6

7. Marginal product of labor (bushels per worker)
Marginal Product of Labor Curve
Marginal product of labor (bushels per worker)
There are diminishing returns to labor. 19 17 15 13 11 9 7 5
Marginal product of labor, MPL
Figure Caption: Figure 12-2: Marginal Product of Labor Curve for George and Martha’s Farm
The marginal product of labor curve plots each worker’s marginal product, the increase in the quantity of output generated by each additional worker. The change in the quantity of output is measured on the vertical axis and the number of workers employed on the horizontal axis. The first worker employed generates an increase in output of 19 bushels, the second worker generates an increase of 17 bushels, and so on. The curve slopes downward due to diminishing returns to labor. 1 2 3 4 5 6 7 8
Quantity of labor (workers) 7

8. Marginal product of labor
Total Product, Marginal Product, and the Fixed Input
Quantity of wheat
(bushels)
Marginal product of labor
(bushels per worker)
160 30
140 TP 20 25
120
100 20 TP 10 80 15 60 10 40
MPL 5 20 20
MPL 10 1 2 3 4 5 6 7 8 1 2 3 4 5 6 7 8
Quantity of labor (workers)
Quantity of labor (workers)
(a) Total Product Curves
(b) Marginal Product Curves
With more land, each worker can produce more wheat. So an increase in the fixed input shifts the total product curve up from TP10 to TP20.
This shift also implies that the marginal product of each worker is higher when the farm is larger. As a result, an increase in acreage also shifts the marginal product of labor curve up from MPL10 to MPL20.
Figure Caption: Figure 12-3: Total Product, Marginal Product, and the Fixed Input
This figure shows how the quantity of output—illustrated by the total product curve—and marginal product depend on the level of the fixed input. Panel (a) shows two total product curves for George and Martha’s farm, TP10when their farm is 10 acres and TP20when it is 20 acres. With more land, each worker can produce more wheat. So an increase in the fixed input shifts the total product curve up from TP10to TP20. This also implies that the marginal product of each worker is higher when the farm is 20 acres than when it is 10 acres. As a result, an increase in acreage also shifts the marginal product of labor curve up from MPL10 to MPL20. Panel (b) shows the marginal product of labor curves. Note that both marginal product of labor curves still slope downward due to diminishing returns to labor. 8

9. Costs of Production
Fixed costs: costs that do not depend on level of output
“overhead” costs
Examples:
Variable costs: costs that depend on level of output
Total cost = fixed costs + variable costs
TC = FC + VC

10. Total Cost Curve for George and Martha’s Farm
Total cost, TC
$2,000 I
1,800 H
1,600 G
1,400 F
1,200 E
1,000 D
800 C
600 B
400 A
200 19 36 51 64 75 84 91 96
Quantity of wheat (bushels)
Figure Caption: Figure 12-4: Total Cost Curve for George and Martha’s Farm
The table shows the variable cost, fixed cost, and total cost for various output quantities on George and Martha’s 10-acre farm. The total cost curve shows how total cost (measured on the vertical axis) depends on the quantity of output (measured on the horizontal axis). The labeled points on the curve correspond to the rows of the table. The total cost curve slopes upward because the number of workers employed, and hence total cost, increases as the quantity of output increases. The curve gets steeper as output increases due to diminishing returns to labor.
Quantity of labor L
Quantity of wheat Q
Variable cost
(VC)
Fixed Cost (FC)
Total cost
Point on graph
(worker)
(bushels)
(TC = FC + VC) A $ O
$400 $
400 B 1 19
200
400
600 C 2 36
400
400
800 D 3 51
600
400
1,000 E 4 64
800
400
1,200 F 5 75
1,000
400
1,400 G 6 84
1,200
400
1,600 H 7 91
1,400
400
1,800 I 8 96
1,600
400
2,000

11. Marginal cost: change in total cost generated by producing one more unit of output
MC = change in total cost/change in quantity of output (or MP)
It’s basically like this: If I hire one more worker to make cookies, how much will each of his/her cookies produced cost me?

12. Total Cost and Marginal Cost Curves for Selena’s Gourmet Salsas
(a) Total Cost
(b) Marginal Cost
Cost
Cost of case
8th case of salsa increases total cost by $180.
$1,400 T C
$250 MC
1,200
200
1,000
2nd case of salsa increases total cost by $36.
800
150
600
10 0
400
Figure Caption: Figure 12-6: Total Cost and Marginal Cost Curves for Selena’s Gourmet Salsas
Panel (a) shows the total cost curve from Table Like the total cost curve in Figure 12-4, it slopes upward and gets steeper as we move up it to the right. Panel (b) shows the marginal cost curve. It also slopes upward, reflecting diminishing returns to the variable input. 50
200 1 2 3 4 5 6 7 8 9 10 1 2 3 4 5 6 7 8 9 10
Quantity of salsa (cases)
Quantity of salsa (cases)
Why does marginal cost slope upwards? Diminishing returns to inputs:

13. AFC will ALWAYS decrease as output increases!
Average Cost
Average total cost, often referred to simply as average cost, is total cost divided by quantity of output produced.
ATC = TC/Q = (Total Cost) / (Quantity of Output)
A U-shaped average total cost curve falls at low levels of output, then rises at higher levels.
Average fixed cost is the fixed cost per unit of output.
AFC = FC/Q = (Fixed Cost) / (Quantity of Output)
AFC will ALWAYS decrease as output increases! 13

14. Average Total Cost Curve
Increasing output, therefore, has two opposing effects on average total cost:
The spreading effect: the larger the output, the greater the quantity of output over which fixed cost is spread, leading to lower the average fixed cost.
The diminishing returns effect: the larger the output, the greater the amount of variable input required to produce additional units leading to higher average variable cost. 14

15. AFC will ALWAYS decrease as output increases!
More Average Cost
Average variable cost is the variable cost per unit of output.
AVC = VC/Q= (Variable Cost) / (Quantity of Output)
U-shaped curve as well: increasing returns, then diminishing returns to labor
Average fixed cost is the fixed cost per unit of output.
AFC = FC/Q = (Fixed Cost) / (Quantity of Output)
AFC will ALWAYS decrease as output increases! 15

16. The minimum-cost output is the quantity of output at which average total cost is lowest—the bottom of the U-shaped average total cost curve.

17. Have your completed graphs on your desk.

18. Generic Cost Curves Cost of unit
2. … but diminishing returns set in once the benefits from specialization are exhausted and marginal cost rises. MC A T C A VC
Figure Caption: Figure 12-10: More Realistic Cost Curves
A realistic marginal cost curve has a “swoosh” shape. Starting from a very low output level, marginal cost often falls as the firm increases output. That’s because hiring additional workers allows greater specialization of their tasks and leads to increasing returns. Once specialization is achieved, however, diminishing returns to additional workers set in and marginal cost rises. The corresponding average variable cost curve is now U-shaped, like the average total cost curve.
Marginal cost curves do not always slope upward. The benefits of specialization of labor can lead to increasing returns at first represented by a downward-sloping marginal cost curve. Once there are enough workers to permit specialization, however, diminishing returns set in.
1. Increasing specialization leads to lower marginal cost…
Quantity

19. Graph for Marty’s Fro-Yo

20. Graph for generic example

21. Warm-up: March 18, 2016 Units of Labor Total Product (TP) 0 cups 1 5 2
0 cups 1 5 2 15 3 30 4 40 45 6 7
Warm-up: March 18, 2016
The table above shows how hiring increasing amounts of labor to a fixed amount of capital affects the hourly output of Molly's lemonade stand. Based on this table of production data, which of the following can be said?
(A) Diminishing marginal returns begins with the first worker hired.
(B) Marginal cost begins to rise at the 6th worker hired.
(C) Total product is maximized at the 3rd worker hired.
(D) Average product begins to decline with the first worker hired.
(E) Diminishing marginal returns begins with the 4th worker hired.

22. Output TC
$20 1 32 2 46 3 62 4 80 5
100
Fixed cost:
ATC of producing 3 units:
AFC of producing 4 units:
Variable cost of producing 2 units:
Marginal cost of producing the 5th unit:
AVC of producing the 1st unit:

23. Which of the following is the firm’s variable cost of producing 3 units?
$20
$42
$20.67
$6.67
$14
Which is the firm’s average total cost of producing 2 units?
$32
$10
$13
$23
Which of the following is the marginal cost of producing the 4th unit?
$18
$4.50 $9
$80
Output TC
$20 1 32 2 46 3 62 4 80 5
100

24. Short-Run vs. Long-Run Costs
Let’s say I want to adjust my fixed inputs – I’m thinking about buying another oven for my bakery. How will this affect my fixed cost? How will this affect my variable cost? (hint: will the new oven affect my level of employment?)

25. Short-Run versus Long-Run Costs
In the short run, fixed cost is completely outside the control of a firm. But all inputs are variable in the long run: This means that in the long run fixed cost may also be varied. In the long run, in other words, a firm’s fixed cost becomes a variable it can choose.
The firm will choose its fixed cost in the long run based on the level of output it expects to produce. 25

26. The Long-run Average Total Cost Curve
The long-run average total cost curve shows the relationship between output and average total cost when fixed cost has been chosen to minimize average total cost for each level of output. 26

27. Short-Run and Long-Run Average Total Cost Curves
Cost of case
Constant returns to scale
Increasing returns to scale
Decreasing returns to scale A T C A T C A T C L R A T C 3 6 9
ATC3 = 1 machine
ATC6 = 2 machines
ATC9 = 3 machines B Y A X
Figure Caption: Figure 12-12: Short-Run and Long-Run Average Total Cost Curves
Short-run and long-run average total cost curves differ because a firm can choose its fixed cost in the long run. If Selena has chosen the level of fixed cost that minimizes short-run average total cost at an output of 6 cases, and actually produces 6 cases, then she will be at point Con LRATC and ATC6. But if she produces only 3 cases, she will move to point B. If she expects to produce only 3 cases for a long time, in the long run she will reduce her fixed cost and move to point A on ATC3. Likewise, if she produces 9 cases (putting her at point Y) and expects to continue this for a long time, she will increase her fixed cost in the long run and move to point X. C 3 4 5 6 7 8 9
Quantity of salsa (cases)
Increasing returns (economies of scale): LRATC declines as output increases
Decreasing returns (diseconomies of scale): LRATC increases as output increases
Constant returns: LRATC is constant as output increases

28. 5. Don owns a small concrete-mixing company
5. Don owns a small concrete-mixing company. His fixed cost is the cost of the concrete-batching machinery and his mixer trucks. His variable cost is the cost of the sand, gravel, and other inputs for producing concrete; the gas and maintenance for the machinery and trucks; and his workers. He is trying to decide how many mixer trucks to purchase. He has estimated the costs shown in the accompanying table based on estimates of the number of orders his company will receive per week.
Variable Cost
Quantity of trucks FC
20 orders
40 orders
60 orders 2
$6000
$2000
$5000
$12000 3
$7000
$1800
$3800
$10800 4
$8000
$1200
$3600
$8400

29. For each level of fixed cost, calculate Don’s total cost and average total cost per order for producing 20, 40 and 60 orders per week. (It helps to keep the info in a chart.)
b. If Don is producing 20 orders per week, how many trucks should he purchase? Answer the same questions for 40 and 60 orders per week.

30. 6. Consider Don’s concrete-mixing business described in Problem 13
6. Consider Don’s concrete-mixing business described in Problem 13. Assume that Don purchased 3 trucks, expecting to produce 40 orders per week.
a. Suppose that, in the short run, business declines to 20 orders per week. What is Don’s average total cost per order in the short run? What will his average total cost per order in the short run be if his business booms to 60 orders per week?
b. What is Don’s long run average total cost for 20 orders per week? Explain why his short run average total cost of producing 20 orders per week when the number of trucks is fixed at 3 is greater than his long run average total cost of producing 20 orders per week.
c. Draw Don’s long run average total cost curve. Draw his short run average total cost curve if he owns three trucks.