1. Chapter 5.2: Costs of production

2. Objectives
Explain how firms decide how much labor to hire in order to produce a certain level of output.
Analyze the production costs of a firm.
Explain how a firm chooses to set output.
Identify the factors that a firm must consider before shutting down a profitable business.

3. Bell Ringer – Costs of Production
According to some reports, supermarkets make a profit of three to six cents for every dollar of revenue. Where does the rest of the money go? Think of specifics

4. Introduction How can a producer maximize profits?
When thinking about how to maximize profits, producers think about the cost involved in producing one more unit of a good.
Costs producers take into consideration are:
Operating cost – the cost of operating a facility
Variable cost – a cost that changes
Total cost – sum of fixed costs + variable costs
Marginal cost – the cost of producing one more

5. Costs of Production
How does a business decide how many workers to hire?
Video
Marginal product of labor
The change in output from hiring one more additional unit of labor

6. Labor and Output
All business owners must decide how many workers they will hire.
The addition of new workers will increase production until it reaches its peak, at which point, production actually decreases.
#1 and #2 pg. 117

7. How to make a beanbag #8 #7 #6 #5 #4 #3 #1 #2
Referring to fig 5.3 on page 117, explain that one person can cut the fabric, stuff the beans and sew and you will have 4 beanbags in an hour.
With 2 people, you can make 10 an hour while increasing your marginal product of labor by 6
With 3 ppl, you can make 17 and are increasing marginal product
With 4, show that yes, you make more beanbags but your efficiency goes down to 6
Reinforce that with 8 workers you will be making (31) and at 3 you only make 17 but it’s not worth the extra money to hire the additional 5 workers (marginal product is -1) #8 #3 #1 #2

8. Labor and Output
How many workers should the beanbag company hire? Why? 3
What could the company do to experience increasing returns with more than 3 workers?
Invest more capital = buy more equipment

9. Labor and Output
Excel activity on my wiki

10. Marginal Returns
The addition of more workers to a firm allow for a greater amount of specialization.
Specialization increases the output and the firm enjoys increasing marginal returns.

11. Marginal Returns, cont.
Eventually, the benefits of specialization end and the addition of more workers increases total output but at a diminishing rate.
A firm with diminishing marginal returns will produce less and less output from each additional unit of labor.
Answer: 5 beanbags per hour
Questions #1 and #2 figure 5.4

12. Marginal returns activity
6 volunteers, pens, paper
Put one ascending(1,2,3..) number on one paper and fold it into halves three times
Team 1: 1 Student
Team 2: Students 2 and 3
Team 3: Students 4, 5 and 6
Who do you think will win? Why?
Do all businesses have unlimited capital resources?
On page 117 on right hand side. Have students fold paper in half 3 times.
Explain with team 3 that the company has too many workers and gives meaningless job to the one who helps write the number on the paper, what should they do to increase output? Lay off a worker and buy more capital (pens)

13. Marginal returns activity
Capital resources - 3 pens, unlimited paper
Put one ascending(1,2,3..) number on one paper and fold it into halves three times
Team 1: 1 Student – do it all by yourself
Team 2: Students 2 and 3 – one writes, the other folds
Team 3: Students 4, 5 and 6 – one pen, alternate who writes number, last person always folds.
Who ever makes the most in one min wins
On page 117 on right hand side. Have students fold paper in half 3 times.
Explain with team 3 that the company has too many workers and gives meaningless job to the one who helps write the number on the paper, what should they do to increase output? Lay off a worker and buy more capital (pens)

14. Marginal returns activity
What was the result?
Why?
Why didn’t team with three on it win?
Lacked capital, not enough equipment for three people
Slowed production
“Too many cooks in the kitchen”

15. Fixed Costs
Production costs are divided into two categories - fixed costs and variable costs.
Fixed costs mainly involve the production facility and include:
Rent
Property taxes
Worker’s salaries

16. Variable Costs Video Variable costs include:
Price of raw materials
Some labor (hourly and overtime pay)
Electricity and heating bills
Video
Fixed costs and variable costs are added together to find the total cost.

17. Marginal Savings and High Volume
Suppose a manufacturer of MP3 players cut its cost for a memory chip from $1 to 80 cents. Only 20 cents savings, right?
The firm makes and sells a million MP3 players a year. How much savings is that?
$200,000!

18. The Shutdown Decision
What happens to a factory that starts to lose money?
Sometimes, even though a factory is producing at its most profitable level, the market price is so low that the factory’s total revenue is still less than its total cost.
The factory owners have two choices:
Continue to produce goods and lose money
Shut down the factory
Amazon Article

19. Option 1: Continue to Produce
Checkpoint: When should a firm keep a money-losing factory open?
The firm should keep the factory open if the total revenue from the goods is greater than the variable cost of keeping the factory open.
So Mr. Hakim, why do we look at variable cost and not total cost to see if we should shutdown?
Fixed are fixed, have to pay them no matter what – opened or closed – producing or not producing…might as well make some money producing!
Checkpoint Answer: The firm should keep the factory open if the total revenue from the goods is greater than the cost of keeping the factory open

20. Option 2: Shut Down the Factory
If a firm shuts the factory down it still has to pay all of its fixed costs so it would have money going out but nothing coming in.
The firm would lose an amount equal to its fixed costs.

21. Review
Now that you have learned how a producer can maximize profits, go back and answer the Chapter Essential Question.
How do suppliers decide what goods and services to offer?