economics 111.3 winter 14 march 10 th, 2014 lecture 21 ch. 11: output and costs
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Economics 111.3 Winter 14
March 10th, 2014Lecture 21
Ch. 11: Output and costs
Test 3• Friday, March 14th, 2014• 8:30 – 9:20 Room 200 STM• Chapters to be tested: 9, 10 (up to p. 231)
and 11 (short-run costs only)• Format: Multiple-Choice Questions (MCQ):
30 questions – 100% of Test mark Time – 50 minutes
Short-Run Production Relationship: a recap
Average product (the same as labour productivity) is calculated by dividing total output by the number of workers who produced it.
The Law of Diminishing Marginal Productivity (Diminishing Returns)
• The law of diminishing marginal productivity states that as more and more of a variable input is added to an existing fixed input, after some point the additional output obtained from the additional input will fall.
• This law is also called the flowerpot law, because it if did not hold true, the world’s entire food supply could be grown in a single flower pot.
units of labour TP MP AP
0 0
1 10
2 25
3 45
4 60
5 70
6 75
7 75
8 70
101520151050-5
10.0012.5015.0015.0014.0012.5010.71
8.75
total producttotal labour inputAP=
Marginal & Average Values
• If the average value is rising, the marginal value must be ABOVE the average value
• If the average value is falling, the marginal value must be BELOW the average value
Profit = Total revenue – Economic cost
Costs of production inthe short run are:Fixed Costs, Variable Costs, and Total Costs.
Fixed Costs• Fixed costs are those that are spent and cannot be
changed in the period of time under consideration. • Fixed costs do not vary with changes in output (e.g.,
firm’s debt, rental payments, interest, insurance premiums)
• In the long run there are no fixed costs since all costs are variable.
• Sunk costs – a subset of fixed costs that are not recoverable if a firm goes out of business. Examples: advertising expenditures, purchasing the advice of a management consultant, market research
Variable Costs
• Variable costs are costs that change as output changes, such as the costs of labour and materials.
• NB! The increases in variable costs associated with succeeding one-unit increase in output are not equal
Total Costs• The sum of the
variable and fixed costs are total costs:
TC = FC + VC
Average CostAverage fixed cost (AFC) is total fixed cost per unit of output.
Average variable cost (AVC) is total variable cost per unit of output.
Average total cost (ATC) is total cost per unit of output.
Average Cost
OR
TVC TFC TC
QTVC
Q
TFC
QTC
AVC AFC ATC
How are the average cost curves related to each other?
Q TFC TVC TC AFC AVC ATC MC
0 100 0
1 100 90
2 100 170
3 100 240
4 100 300
5 100 370
6 100 450
7 100 540
8 100 650
9 100 780
10 100 930
100190270340400470550640750880
1030
10050
33.33
25
20
16.67
14.29
12.50
11.11
10
AFC=TFC / QAFC=TFC / Q
Q TFC TVC TC AFC AVC ATC MC
0 100 0
1 100 90
2 100 170
3 100 240
4 100 300
5 100 370
6 100 450
7 100 540
8 100 650
9 100 780
10 100 930
100190270340400470550640750880
1030
10050
33.33
25
20
16.67
14.29
12.50
11.11
10
90858075
74
7577.14
81.25
86.67
93
AVC=TVC / QAVC=TVC / Q
Q TFC TVC TC AFC AVC ATC MC
0 100 0
1 100 90
2 100 170
3 100 240
4 100 300
5 100 370
6 100 450
7 100 540
8 100 650
9 100 780
10 100 930
100190270340400470550640750880
1030
10050
33.33
25
20
16.67
14.29
12.50
11.11
10
90858075
74
7577.14
81.25
86.67
93
190135
113.33
10094
91.67
91.43
93.75
97.78
103
ATC=TC / QATC=TC / Q
Marginal cost (MC) is the increase in total cost that results from a one-unit increase in output.
It equals the increase in total cost divided by the increase in output.
Marginal cost decreases at low outputs because of the gains from specialization, but eventually increases due to the law of diminishing returns.
Q TFC TVC TC AFC AVC ATC MC
0 100 0
1 100 90
2 100 170
3 100 240
4 100 300
5 100 370
6 100 450
7 100 540
8 100 650
9 100 780
10 100 930
100190270340400470550640750880
1030
10050
33.33
25
20
16.67
14.29
12.50
11.11
10
90858075
74
7577.14
81.25
86.67
93
190135
113.33
10094
91.67
91.43
93.75
97.78
103
90
80
70
60
70
80
90
110
130
150
MC=TC / QMC=TC / Q
• Average fixed cost declines continuously as output increases
• Average-Variable-Cost and Average-Total-Cost curves are U-shaped, reflecting increasing and then diminishing returns
• The Marginal-Cost curve falls when marginal returns increase, and rises when marginal returns diminish.
• The Marginal-Cost curve intersects both the Average-Variable- and Average-Total Cost curves at their minimum points.
Marginal Cost and Average Costs
0 5 10 15Output (sweaters per day)
5
10
15C
os
t (d
olla
rs p
er s
we
ate
r)
AFC
AVCATC
ATC = AFC + AVCMC
b) “At the current output level, this factory is subject to diminishing returns. Therefore, the firm is operating along the upward-sloping portion of its short-run average total cost curve”.
b) “At the current output level, this factory is subject to diminishing returns. Therefore, the firm is operating along the upward-sloping portion of its short-run average total cost curve”.
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