1. 1 Understanding Economics 3 rd edition by Mark Lovewell, Khoa Nguyen and Brennan Thompson Chapter 4 Costs of Production Copyright © 2005 by McGraw-Hill Ryerson Limited. All rights reserved.

2. 2 Learning Objectives  In this chapter you will: 1. learn about economic costs (explicit and implicit) of production and economic profit 2. analyze short-run (total, average, and marginal) products, and the law of diminishing marginal returns 3. derive short-run (total, average, and marginal) costs 4. examine long-run results of production (increasing returns to scale, constant to scale, and decreasing to scale) and long-run costs

3. Copyright © 2005 by McGraw-Hill Ryerson Limited. All rights reserved. 3 T 2, Production in the Short Run (a)  In the short run some inputs (such as capital) are fixed other inputs (such as labour) are variable  Inputs are combined to make a business’s total product Total product: the overall quantity of output produced with a given workforce average product is total product divided by the number of workers marginal product is the extra total product with an additional worker

4. Copyright © 2005 by McGraw-Hill Ryerson Limited. All rights reserved. 4  Average product = total product (q)  number of workers (L)  Marginal product  = change in total product ( Δ q)  change in workforce ( Δ L)

5. Copyright © 2005 by McGraw-Hill Ryerson Limited. All rights reserved. Total chairs made Average Product Marginal Product Total Product 1 st person3 chairs 2 nd person7 chairs 3 rd person12 chairs 5 One reason that the marginal product increases can be that teamwork fosters productivity. Also, with more people, delegation of tasks is possible, leading to an increase in productivity. What happens if you have a group of 20 students all working on the same project. Do you think that the productivity will increase, decrease or will be the same?

6. Copyright © 2005 by McGraw-Hill Ryerson Limited. All rights reserved. Total chairs made Average Product Marginal Product Total Product 1 st person3 chairs333 2 nd person7 chairs3.547 3 rd person12 chairs4512 6 One reason that the marginal product increases can be that teamwork fosters productivity. Also, with more people, delegation of tasks is possible, leading to an increase in productivity. What happens if you have a group of 20 students all working on the same project. Do you think that the productivity will increase, decrease or will be the same?

7. Copyright © 2005 by McGraw-Hill Ryerson Limited. All rights reserved. 7 The Law of Diminishing Marginal Returns  Short-run production is determined by the law of diminishing marginal returns  the law of diminishing marginal returns: At some point, as more units of a variable input are added to a fixed input, the marginal product will start to decrease  average product also falls after some point

8. Copyright © 2005 by McGraw-Hill Ryerson Limited. All rights reserved. Relationship between marginal product and average product 8 Test 1Test 2Test 3 Marginal80marks90marks80marks Average Test 1Test 2Test 3 Marginal80marks90marks85marks Average Test 1Test 2Test 3 Marginal80 marks90marks88marks Average

9. Copyright © 2005 by McGraw-Hill Ryerson Limited. All rights reserved. Relationship between marginal product and average product 9 Test 1Test 2Test 3 Marginal80marks90marks80marks Average808583.333 Test 1Test 2Test 3 Marginal80marks90marks85marks Average8085 Test 1Test 2Test 3 Marginal80 marks90marks88marks Average808586

10. Copyright © 2005 by McGraw-Hill Ryerson Limited. All rights reserved.  Focusing on the test 3 column, why do you see the average differ in all three cases?  What seems to be the relationship between the marginal mark and the average mark?  (Refer to Excel) 10

11. Copyright © 2005 by McGraw-Hill Ryerson Limited. All rights reserved. 11 Relating Average and Marginal Values  Average and marginal values are related using three rules if an average value rises then the marginal value must be above the average value if an average value falls then the marginal value must be below the average value if an average value stays constant then the marginal value must equal the average value

12. Copyright © 2005 by McGraw-Hill Ryerson Limited. All rights reserved. 12 01234 5 6 Number of Workers Employed per Day T-Shirts Produced per Day 50 100 150 200 250 300 Total, Marginal, and Average Products Figure 4.2, Page 89 and Figure 4.3, Page 91 0 123 4 56 Number of Workers Employed per Day T-Shirts Produced per Day 40 60 80 100 120 -20 20 Labour (L) (workers per day) Total Product (q) (T-shirts per day) Marginal Product (Δq/ΔL) (T-shirts per day) Average Product (q/L) (T-shirts per day) 01234560123456 0 80 200 250 270 280 270 -- 80 100 83.3 67.5 56 45 80 120 50 20 10 -10 TP MP AP Diminishing returns set in

13. Copyright © 2005 by McGraw-Hill Ryerson Limited. All rights reserved.  Whether the marginal product curve is itself sloping upward or downward is irrelevant  If an additional worker is to raise the average product of all workers, that additional worker's output must be greater than the average output of all the other workers. 13

14. Copyright © 2005 by McGraw-Hill Ryerson Limited. All rights reserved.  It is immaterial whether the new worker's contribution to output is greater or less than the contribution of the previous worker hired immediately before; all that matters it that the new worker's contribution to output exceeds the average output of all workers hired previously 14

15. Copyright © 2005 by McGraw-Hill Ryerson Limited. All rights reserved.  As we can see, although MP is going down, the AP does not go down until MP is below the AP 15 0 123 4 56 Number of Workers Employed per Day T-Shirts Produced per Day 40 60 80 100 120 -20 20 MP AP Diminishing returns set in