AGENDA Tues 10/6

• QOD #20: Caution! Curves Ahead

• Law of Diminishing Marginal Returns

• Costs of Production (Review HW Q#1,2,5,6)

• Short & Long Run (Q # 8, 9, 10)

• Partner Practice Ch 7 P # 2&3

• HW: Prep for Ch 6 & 7 Quiz/Assessment/

Opportunity for demonstrating understanding or

areas of confusion

QOD #20: Caution! Curves Ahead

• Part 1: Calculate MP and AP

Input of

Labor

Total

Production

Marginal

Product

Average

Product

0 0

1 15

2 34

3 51

4 65

5 74

6 80

7 83

8 82

QOD #20: Caution! Curves Ahead

• Part 1: Calculate MP and AP

Input of

Labor

Total

Production

Marginal

Product

Average

Product

0 0 ---- ----

1 15 15 15

2 34 19 17

3 51 17 17

4 65 14 16.25

5 74 9 14.8

6 80 6 13.33

7 83 3 11.86

8 82 -1 10.25

QOD #20: Caution! Curves Ahead

• Part 2: Draw the Total, Marginal and Average

products graphs.

The Law of Diminishing Returns

LO2

TP

MP

AP

Increasing

Marginal

Returns

Diminishing

Marginal

Returns

Negative

Marginal

Returns

1 2 3 4 5 6 7 8 9

0

10

20

30

To

tal

Pro

du

ct,

TP

1 2 3 4 5 6 7 8 9

20

10

Marg

inal

Pro

du

ct,

MP

7-5

QOD #20: Caution! Curves Ahead

• Part 3: Explain relationship between each pair

of curves.

– Why does marginal product first rise, then

decline, and ultimately become negative?

– What bearing does the law of diminishing returns

have on short run costs?

– When marginal product is rising, marginal costs is

falling and vice versa. Draw this graph.

QOD #20: Curves Solution

• MP is the slope (the rate of change) of the TP

curve.

• When TP is rising at an increasing rate, MP is

positive and rising.

• When TP is rising at a diminishing rate, MP is

positive but falling. When TP is falling, MP is

negative and falling.

QOD #20: Curves Solution

• AP rises when MP is above it; AP falls when MP is

below it.

• MP first rises because workers specialize and the

fixed capital is used more productively as added

workers are employed.

• Each added worker contributes more to output than

the previous worker because the firm is better able to

use its fixed plant and equipment.

• As still more labor is added, the law of diminishing

returns takes hold. Labor becomes so abundant,

relative to the fixed capital, that congestion occurs

and marginal product falls.

QOD #20: Curves Solution

• At the extreme, the addition of labor so

overcrowds the plant that the marginal product

of still more labor is negative, and total output

falls.

• Because labor is the only variable input and its

price (wage rate) is constant, MC is found by

dividing the wage rate by MP.

• As illustrated by Figure 7.6 in the textbook,

when MP is rising, MC is falling; when MP

reaches its maximum, MC is at its minimum,

and when MP is falling, MC is rising.

MC and Marginal Product

LO3

Avera

ge P

rod

uct

an

d

Marg

inal

Pro

du

ct

Co

st

(Do

llars

)

MP

AP

MC AVC

Quantity of Output

Quantity of Labor

Production Curves

Cost Curves

7-10

Short-Run Production Costs

LO3

Co

sts

1 2 3 4 5 6 7 8 9 10 0 Q

100

200

300

400

500

600

700

800

900

1000

$1100

TFC

TC

TVC

Total Cost

Variable Cost

Fixed Cost

7-11

Per-Unit, or Average, Costs

• Average Fixed Costs AFC = TFC/Q

• Average Variable Costs AVC = TVC/Q

• Average Total Costs ATC = TC/Q

• Marginal Costs MC = ΔTC/ΔQ

LO3 7-12

Per-Unit, or Average, Costs

LO3

Co

sts

1 2 3 4 5 6 7 8 9 10 0 Q

50

100

150

$200

AFC

ATC

AVC

AVC

AFC

7-13

Marginal Cost

LO3

Co

sts

1 2 3 4 5 6 7 8 9 10 0 Q

50

100

150

$200

AFC

MC

ATC

AVC

AVC

AFC

7-14

Long-Run Production Costs

• The firm can change all input

amounts, including plant size.

• All costs are variable in the long run.

• Long run ATC

•Different short run ATCs

LO4 7-15

The Long-Run Cost Curve

LO4

Long-Run ATC

Ave

rag

e T

ota

l C

osts

ATC-1

ATC-2

ATC-3 ATC-4

ATC-5

Output

7-16

Economies and Diseconomies of Scale

• Economies of scale

• Labor specialization

•Managerial specialization

•Efficient capital

•Other factors

• Constant returns to scale

LO4 7-17

Economies and Diseconomies of Scale

• Diseconomies of scale

•Control and coordination problems

•Communication problems

•Worker alienation

•Shirking

LO4 7-18

MES and Industry Structure

• Minimum Efficient Scale (MES):

• Lowest level of output where long-

run average costs are minimized

•Can determine the structure of the

industry

LO4 7-19

MES and Industry Structure

LO4

Output

Ave

rag

e T

ota

l C

os

ts

Long-Run ATC

Economies

Of Scale

Constant Returns

To Scale

Diseconomies

Of Scale

q1 q2

7-20

Don’t Cry Over Sunk Costs

• Sunk costs

•Costs have already been incurred

and thus are irrecoverable

• Rule: Do not engage in any activity

where MB<MC

• Rule: Ignore sunk costs

• They are irrecoverable

7-21