Chapter 10 output and costs
1. Distinguish between the short run and the long run
To study the relationship between a firm’s output decision and its costs, we distinguish between
two decisions time frames;
- The short run
The quantity of at least one factor of production is fixed. Land capital, entrepreneurship. We call
these Plant. Labour is variable, in order to increase output it needs to increase the quantity of
labour (variable). Short run decisions are easily reversed.
- The long run
The Long run is a time frame in which all factors of production can be varied. Decisions in the long
run cannot be changed quickly and we emphasize here on the sunk cost, cost that have nothing to do
with the current decision. (past expenditure on a plant that has no resale value).
2. Explain the relationship between a firms output and labor employed in the short run
The relationship between output and the quantity of labour employed by using three related
concepts
1. Total product
The maximum output that a given quantity of labor can produce.
2. Marginal product
The marginal product of labor is the increase in total product resulting from a one unit increase in the
quantity of labor employed with all other inputs remaining the same.
3. Average product
Tells how productive workers are on average. (total product / quantity of labor employed)
The relationships between employment and the three product concepts we just studied s called a
Product curve or a product schedule. The total product curve shows the total product at various
quantities of labor per day. They show the points that are attainable (below the curve) and the points
that are unattainable (above the curve). The marginal product curve is measured by the slope of the
total product curve.
The shapes of product curves are similar because almost every production process has two features;
Increasing marginal returns. These occur when the marginal product of an additional worker
exceeds the marginal product of the previous worker. Diminishing marginal returns occurs when the
marginal product of an additional worker is less than the marginal product of the previous worker.
The law of diminishing returns states that: As a firm uses more of a variable factor of production,
with a given quantity of the fixed factor of production the marginal product of the variable factor
eventually diminishes.
The average product is largest when average product and marginal product are equal. For the
number of workers at which the marginal product exceeds average product. Average product is
, increasing. For the number of workers at which marginal product is less than average product the
average product is decreasing.
3. Explain the relationship between a firms output and costs in the short run and derive a
firms short run cost curves
We are talking about increased output, this comes along with increase costs. The relationship
between output and costs is described by
1. Total costs
A firms total costs is the costs of all the factors of production it uses. We separate total cost into total
fixed cost and total variable cost. Total fixed costs are the costs of the firms fixed factors. (cost of
renting machines, normal profit) Total variable cost are the cost of the firm’s variable inputs. ( TC =
TVC + TFC)
2. Marginal costs
A Marginal costs is the change in total costs resulting from 1 more output. It is calculated by change
in TC / change in output (labour). mArginal costs decreases at low outputs because of economies
from greater specialization. It eventually increases because of the law of diminishing returns. The
more workers the higher the costs but lower Addition to output.
3. Average costs
a. Average fixed costs
b. Average variable costs
c. Average total costs
i. It is TC/Q = TFC / Q + TVC / Q
When marginal cost is less than average cost, average cost is decreasing, and when marginal cost
exceeds average cost, average cost is increasing. As output increases, the same constant fixed cost is
spread over a larger output. Distance between ATV and AVC curves shrinks as output increases
because ATC decreases as output increases.
The average total costs is always in a U shape because of two opposing forces
1. Spreading fixed cost over a larger output
2. Eventually diminishing returns.
When output increases. The firm spreads it total fixed costs over a larger output and its average fixed
cost decreases – its AFC curve slopes downward Diminishing returns earns that as output increases
even larger amounts of labor are needed to produce an additional unit of output. So as output
increases, average variable cost decreases initially but eventually increases and the firms AVC curve
eventually slopes upward. The shape of the ATC curve combines these two effects. Intially as output
increases, both average fixed cost and average variable cost decrease, so average total cost
decreases and the ATC curve slopes downward. But as output increases further and diminishing
returns set in in, average variable cost begins to increase. With average fixed costs decreasing ore
quickly than average variable cost is increasing, the ATC curve continues to slope downward.
Eventually, average variable cost increase more quickly than average fixed cost decreases, so average
total cost increases ant the ATC curve slopes upward.
When output increases total cost increases and arginal cost increases. The marginal cost is a u shape.
And intersects the average variable cost curve and the average total cost curve at their miniu oints.
1. Distinguish between the short run and the long run
To study the relationship between a firm’s output decision and its costs, we distinguish between
two decisions time frames;
- The short run
The quantity of at least one factor of production is fixed. Land capital, entrepreneurship. We call
these Plant. Labour is variable, in order to increase output it needs to increase the quantity of
labour (variable). Short run decisions are easily reversed.
- The long run
The Long run is a time frame in which all factors of production can be varied. Decisions in the long
run cannot be changed quickly and we emphasize here on the sunk cost, cost that have nothing to do
with the current decision. (past expenditure on a plant that has no resale value).
2. Explain the relationship between a firms output and labor employed in the short run
The relationship between output and the quantity of labour employed by using three related
concepts
1. Total product
The maximum output that a given quantity of labor can produce.
2. Marginal product
The marginal product of labor is the increase in total product resulting from a one unit increase in the
quantity of labor employed with all other inputs remaining the same.
3. Average product
Tells how productive workers are on average. (total product / quantity of labor employed)
The relationships between employment and the three product concepts we just studied s called a
Product curve or a product schedule. The total product curve shows the total product at various
quantities of labor per day. They show the points that are attainable (below the curve) and the points
that are unattainable (above the curve). The marginal product curve is measured by the slope of the
total product curve.
The shapes of product curves are similar because almost every production process has two features;
Increasing marginal returns. These occur when the marginal product of an additional worker
exceeds the marginal product of the previous worker. Diminishing marginal returns occurs when the
marginal product of an additional worker is less than the marginal product of the previous worker.
The law of diminishing returns states that: As a firm uses more of a variable factor of production,
with a given quantity of the fixed factor of production the marginal product of the variable factor
eventually diminishes.
The average product is largest when average product and marginal product are equal. For the
number of workers at which the marginal product exceeds average product. Average product is
, increasing. For the number of workers at which marginal product is less than average product the
average product is decreasing.
3. Explain the relationship between a firms output and costs in the short run and derive a
firms short run cost curves
We are talking about increased output, this comes along with increase costs. The relationship
between output and costs is described by
1. Total costs
A firms total costs is the costs of all the factors of production it uses. We separate total cost into total
fixed cost and total variable cost. Total fixed costs are the costs of the firms fixed factors. (cost of
renting machines, normal profit) Total variable cost are the cost of the firm’s variable inputs. ( TC =
TVC + TFC)
2. Marginal costs
A Marginal costs is the change in total costs resulting from 1 more output. It is calculated by change
in TC / change in output (labour). mArginal costs decreases at low outputs because of economies
from greater specialization. It eventually increases because of the law of diminishing returns. The
more workers the higher the costs but lower Addition to output.
3. Average costs
a. Average fixed costs
b. Average variable costs
c. Average total costs
i. It is TC/Q = TFC / Q + TVC / Q
When marginal cost is less than average cost, average cost is decreasing, and when marginal cost
exceeds average cost, average cost is increasing. As output increases, the same constant fixed cost is
spread over a larger output. Distance between ATV and AVC curves shrinks as output increases
because ATC decreases as output increases.
The average total costs is always in a U shape because of two opposing forces
1. Spreading fixed cost over a larger output
2. Eventually diminishing returns.
When output increases. The firm spreads it total fixed costs over a larger output and its average fixed
cost decreases – its AFC curve slopes downward Diminishing returns earns that as output increases
even larger amounts of labor are needed to produce an additional unit of output. So as output
increases, average variable cost decreases initially but eventually increases and the firms AVC curve
eventually slopes upward. The shape of the ATC curve combines these two effects. Intially as output
increases, both average fixed cost and average variable cost decrease, so average total cost
decreases and the ATC curve slopes downward. But as output increases further and diminishing
returns set in in, average variable cost begins to increase. With average fixed costs decreasing ore
quickly than average variable cost is increasing, the ATC curve continues to slope downward.
Eventually, average variable cost increase more quickly than average fixed cost decreases, so average
total cost increases ant the ATC curve slopes upward.
When output increases total cost increases and arginal cost increases. The marginal cost is a u shape.
And intersects the average variable cost curve and the average total cost curve at their miniu oints.
