Chapter 6

1. Chapter 6 The production process Choice of technology

2. The Production Process • Production technology relates inputs to outputs. • Labor-intensive technology: Technology that relies heavily on human labor rather than capital. • Capital-intensive technology: Technology that relies heavily on capital rather than human labor • The optimal method of production, for a profit-maximizing firm, is the one that minimizes costs.

3. There are three important ways to measure the productivity of inputs: • Total product (TP) • Average product (AP) • Marginal product (MP)

4. Total Product (TP) Function • Production function or total product function: • A mathematical or numerical expression of a relationship between inputs and outputs • Shows units of total product as a function of units of inputs.

5. Average Product (AP) • The average amount of output produced by each unit of a variable factor of production • Output per unit of an input.

6. Marginal Product (MP) • The additional output that can be produced by adding one more unit of a specific input, ceteris paribus.

7. Example • Consider a small sandwich shop, with a fixed capital base consisting of a 2-person grill. • This data can be plotted as follows:

8. Example

9. Example

10. Example At point A,MP begins to fall At point B, MP=AP At point C, MP=0, more labor yields no more output A B C

11. The Law of Diminishing Returns • After a certain point, when additional units of a variable input are added to fixed inputs, the marginal product of the variable input declines.

12. Example • In the sandwich shop, as more employees are added to the fixed inputs, eventually MP falls. • Diminishing returns sets in after the second worker is hired.

13. Production Functions with Two Variable Factors of Production: K & L • K=capital; L=labor • In many production processes, inputs work together and are viewed as complementary. • For example, increases in capital usage lead to increases in the productivity of labor.

14. Returning to our sandwich shop • Suppose the owners can invest in either one or two grills.

15. Returning to our sandwich shop • Notice that the MP of labor is higher with two grills than it is with one grill.

16. Example-Production Functions with Two Variable Factors of Production: K & L • Table 6.3-production of 100 diapers • Suppose Pk=Pl=$1.00 • You will chose technology C, which cost 4*Pk+4*Pl=4*$1+4*$1=$8 Which minimize the cost of production.

17. Example-Production Functions with Two Variable Factors of Production: K & L • Suppose the wage rate Pl were to rise sharply, from $1 to $5, Pk didn’t change. • Table 6.4 • You will chose technology E to minimize your cost. 10*$1+2*$5=$20

18. Chapter Summary • Profit-maximizing, perfectly competitive firms face a perfectly elastic demand curve. • A firm’s profits might be normal or economic, positive or negative. • Total, average, and marginal product are three ways of measuring the productivity of an input. • The law of diminishing returns states that in the short run, marginal product will eventually decline.

19. Chapter 7 Short-Run Costs and Output Decisions

20. Costs in the Short Run • Short run: A period of time so short that some of the firm’s inputs are fixed in total supply. • There are several ways to categorize short-run costs...

21. Fixed Costs (FC) • Any cost that a firm bears in the short run that does not depend on its level of output. These costs are incurred even if the firm is producing nothing. There are no fixed cost in the long run. • Sometimes called sunk costs because firms have no control over fixed costs in the short run.

22. Variable Costs (VC) • Any cost that a firm bears that depends on the level of production chosen.

23. Total Costs (TC) • Total Costs=Total Fixed Costs (TFC) + Total Variable Costs (TVC) • TC = TFC + TVC

24. FC-Total fixed cost (TFC) • The total of all costs that do not change with output, even if output is zero.

25. FC-Average Fixed Costs (AFC) • AFC = Total Fixed Costs • q=quantity of output

26. VC-total variable cost(TVC) • Total variable cost: the total of all costs that vary with output in the short run

27. VC-Average Variable Costs (AVC) • AVC = Total Variable Costs • q=quantity of output

28. Average total cost(ATC)

29. Marginal Costs (MC) • The increase in total cost that results from producing one more unit of output • Marginal costs reflect changes in variable costs.

30. MP curve and MC curve • The marginal cost curve is closely related to the marginal product curve. • When marginal product begins to fall, marginal cost begins to rise. Marginal product Marginal cost ($) Diminishing returns set in. Diminishing returns set in. MC MP Units of labor Units of labor

31. TVC curve Total variable costs • Given the law of diminishing returns, the total variable cost curve has a distinctive shape. • Diminishing returns set in where TVC begins to increase at an increasing rate. TVC Units of output

32. AFC curve • Average fixed costs decline as output increases. • AFC = Total Fixed Costs /quantity of output Average fixed costs Units of output

33. FC/AFC – example • Suppose fixed cost is $1,000 • Average fixed costs decline as output increases.

34. Law of diminishing returns • Average total and average variable costs are also affected by the law of diminishing returns. $$ ATC AVC MC Units of output

35. Some important points about cost curves: • Average total cost equals marginal cost where average total cost is minimized. • Average variable cost equals marginal cost where average variable cost is minimized. • The slope of the total variable cost curve describes the change in TVC when output increases by one unit. • The slope of the total variable cost curve is equal to marginal cost.

36. Review questions • Know the shapes of TP, MP, AP curves • Choose the technology to minimize cost. • Know FC, TFC, AFC, VC, TVC, AVC, MC and their curves. • The law of diminishing returns of both chapters. • Important points about cost curves. • In this quiz, you will be only tested on the knowledge of chapter 7. Next quiz will be the test on chapter 8.