1. Production and Costs
Standard12.2.1: Understand the relationship of the concept of incentives to the law of supply and the relationship of the concept of incentives and substitutes to the law of demand

2. E.Q: How do firms make decisions?
Explain how firms decide how much labor to hire to produce a certain level of output
Analyze the production costs of a firm
Understand how a firm chooses to set output
Explain how a firm decides to shut down an unprofitable business.

3. E.Q: How do firms make decisions?
Thinking at the margin
Marginal simply means “additional”
Marginal Product of labor- output change from hiring one additional worker.
Marginal cost- the additional cost of producing one additional unit
Marginal Revenue – the additional revenue from producing one additional unit.
E.Q: How do firms make decisions?

4. How many workers should I hire?
We must consider how the number of workers will affect total production.
Labor (# of workers)
Output (beans bags per hour)
Marginal product of labor - 1 4 2 10 3 17 23 5 28 6 31 7 32 8
E.Q: How do firms make decisions?

5. Marginal Production of Labor
E.Q: How do firms make decisions?

6. E.Q: How do firms make decisions?
Revenue
Marginal Revenue = Market Price
Total Revenue (TR) = Price x Quantity
Profit = Total Revenue – Total Costs
E.Q: How do firms make decisions?

7. Different Measures of Cost
Total Cost (TC) = FC+VC
Fixed Cost (FC) – are costs that do not vary with output. FC only are present in the short-run are the result of fixed factors.
Variable Cost (VC) – are costs that vary with output. VC result from different levels of fixed factors. All costs are VC in the long-run.
Marginal Cost (MC) = change in TC/ change in Q and measures the cost of producing another unit. (general formula)
E.Q: How do firms make decisions?

8. Production and Total Cost: Hungry Helen’s Cookies
Cookies (dozen)
Factory rent (FC)
Workers (VC)
Total Costs
Marginal Costs
Marginal Revenue
Total Revenue
Profit (TR –TC) 36 - 24 1 8 44 2 12 48 4 3 15 51 72 20 56 5 96 27 63 7
120 6 9
144 84
168 99
192 82
118 19
216 10
106
142
240 11
136
172 30
264
173
209 37
288
The best level of output is where marginal Costs equal Marginal Revenue

9. What if MR = MC but TR < TC?
The Shutdown Decision
What if MR = MC but TR < TC?
The firm is losing money should they shut down?
Remember that the company has to pay the fixed costs whether they stay open or not…
If the company can cover the variable costs, they should remain open.
E.Q: How do firms make decisions?

10. Summary
Short-run – at least one input is fixed so the primary decision is how best to use existing plant capacity
Long-run – all inputs are variable so the primary decision is what overall scale of operations or plant size should be chosen.

11. Assignment: Page 114 #1-7