Production and Costs in the Short Run

Production and Costs in the Short Run fig

Aims • The main aim of the producer is to make a profit • Firms will be interested in the costs of production as well as revenue

Costs • Costs involve payment to those who have provided the resources • Rent for land • Wages for workers • Interest to the bank • Owner’s enterprise: normal profit the return the entrepreneur can expect to earn or the profit that a business owner considers necessary to make running the business worth his/her while

In the short run … • In the short run, because at least one factor of production is fixed, output can be increased only by adding more variable factors

Costs • Fixed costs do not vary with output. Even if output is 0 these costs must be paid • Rent • Rates • Interest on loans • Insurance • Depreciation … ALSO CALLED OVERHEADS A change in fixed cost does not affect marginal costs

Costs • Variable costs vary with the level of production • Raw materials • Fuel • Wages (not always) • WHEN OUTPUT IS ZERO VC = 0

Output (Q) 0 1 2 3 4 5 6 7 TFC (£) 12 12 12 12 12 12 12 12 Total costs for firm X TFC

Output (Q) 0 1 2 3 4 5 6 7 TVC (£) 0 10 16 21 28 40 60 91 TFC (£) 12 12 12 12 12 12 12 12 Total costs for firm X TVC TFC

Output (Q) 0 1 2 3 4 5 6 7 TVC (£) 0 10 16 21 28 40 60 91 TC (£) 12 22 28 33 40 52 72 103 TFC (£) 12 12 12 12 12 12 12 12 Total costs for firm X TC TVC TFC

Total costs for firm X TC TVC Diminishing marginal returns set in here TFC

Draw the curves

Wheat production per year from a particular farm Number of workers 0 1 2 3 4 5 6 7 8 Total Output 0 3 10 24 36 40 42 42 40 Tonnes of wheat produced per year fig Number of farm workers

Wheat production per year from a particular farm Total Output Tonnes of wheat produced per year fig Number of farm workers

Production in the Short Run Number of Workers 0 1 2 3 4 5 6 7 8 Total Output 0 3 10 24 36 40 42 42 40 Marginal Output 3 7 14 12 4 2 0 -2

14 12 10 8 6 4 2 0 0 1 2 3 4 5 6 7 8 -2 Wheat production per year from a particular farm Total Output Tonnes of wheat per year D Total Output = 7 Number of farm workers (L) DL = 1 Marginal Output = DTQ/ DL = 7 Tonnes of wheat per year Number of farm workers (L) fig

Wheat production per year from a particular farm Total Output Tonnes of wheat per year Number of farm workers (L) Number of Workers 0 1 2 3 4 5 6 7 8 Marginal Output 3 7 14 12 4 2 0 -2 Tonnes of wheat per year Number of farm workers (L) fig Marginal Output

Production in the Short Run Number of Workers 0 1 2 3 4 5 6 7 8 Average Output 0 3 5 8 9 8 7 6 5 Total Output 0 3 10 24 36 40 42 42 40

Production in the Short run • The short-run production function: • the graphical relationship between • total output • average output, and • marginal output

Wheat production per year from a particular farm Total Output Tonnes of wheat per year Number of farm workers (L) Marginal Output = TQ/ L Tonnes of wheat per year Average Output Number of farm workers (L) fig Marginal Output

Wheat production per year from a particular farm Total Output Tonnes of wheat per year b Diminishing returns set in here Number of farm workers (L) b Tonnes of wheat per year Average Output Number of farm workers (L) fig Marginal Output

Wheat production per year from a particular farm d Total Output Maximum output Tonnes of wheat per year b Number of farm workers (L) b Tonnes of wheat per year Average Output d Number of farm workers (L) fig Marginal Output

Draw the curves

Total Costs TC = VC + FC Costs Output

Use the same information • Calculate and draw: • Average Fixed Cost curve • Average Variable Cost curve • Average Total Cost curve • Homework page 54 in notes booklet

Explain shape of AFC

Explain shape of AVC

Average Cost Curve • Falling Costs • Constant Costs • Rising Costs

Marginal Cost • The extra cost of producing one more unit of output • Costs which change when output changes are variable costs – NOT FIXED COSTS • MC = the additional VC when one extra unit is produced • NOW PLOT MARGINAL COST ON YOUR CURVE

Costs in the Short Run Output (Q) 0 1 2 3 4 5 6 7 TVC (£) 0 10 16 21 28 40 60 91 TC (£) 12 22 28 33 40 52 72 103 MC (£) 10 6 5 7 12 20 31

Marginal cost MC Costs (£) x fig Output (Q)

Marginal cost MC Costs (£) Diminishing Returns start at X x fig Output (Q)

Diminishing Returns Defined • In the short run, the law of diminishing returns states that as we add more units of a variable input (i.e. labour or raw materials) to fixed amounts of land and capital, the change in total output will at first rise and then fall • Diminishing returns to labour occurs when marginal product of labour starts to fall. This means that total output will still be rising – but increasing at a decreasing rate as more workers are employed

Costs in the Short Run Average Variable Cost (£) - 10 8 7 7 8 10 13 Output (Q) 0 1 2 3 4 5 6 7 TVC (£) 0 10 16 21 28 40 60 91

Average and marginal costs MC AVC Costs (£) y x fig Output (Q)

Costs in the Short Run Output (Q) 0 1 2 3 4 5 6 7 TFC (£) 12 12 12 12 12 12 12 12 AFC (£) - 12 6 4 3 2.4 2 1.7

Average and marginal costs MC AVC Costs (£) y x AFC Output (Q) fig

Costs in the Short Run Output (Q) 0 1 2 3 4 5 6 7 TC (£) 12 22 28 33 40 52 72 103 Average Cost (£) - 22 14 11 10 10.4 12 14.7

Average and marginal costs AC MC AVC Costs (£) z y x AFC fig Output (Q)

Relationship between Marginal and Average Costs • Both are U shaped, MC is steeper • When MC is below AC, AC is falling • When MC is above AC, AC is rising • When the curves cross MC=AC • This is the optimum point The marginal cost curve cuts the AVC and AC curves at their lowest point

Production in the Short run • Periods of Supply, not time- • Short-run : • production capacity is fixed • fixed and variable factors of production • at least one factor is fixed e.g. land • others can be changed e.g. labour • The long run: • All factors become variable

Production and Costs in the Short Run