Marginal Productivity and Marginal Cost

How we get a neoclassical supply curve.

And why it is wrong.

The BIG ideas• In the short-run, when other inputs like

machinery or buildings are fixed, marginal productivity falls because variable inputs (labor) run out of other inputs with which to work.

• Marginal costs rise because of diminishing marginal productivity. That makes the supply curve upward sloping

• In the long run, where no inputs are fixed, marginal productivity is constant or increasing. Therefore, the long-run supply curve is flat or downward sloping.

Thinking along the margin

How do you increase output?

Imagine, you are a farmer

Don’t laugh. Marijuana is the largest crop in California at $14 b. It is the largest for the US at $36 billion.http://www.drugscience.org/Archive/bcr2/cashcrops.html

To increase output, hire more workers to weed, water, feed, and prune.

The first workers are very productive. They are busy with lots to do.

You hire more workers. That doesn’t work so well.

Your farm is getting crowded. Your new workers are less productive because they have fewer plants, fewer tools, and less space with which to work.

A good manager, you make a spreadsheet of outputs and inputs

Workers Output (ounces)

Marginal Product of Labor (MPL) or (ΔQ)/L

Workers for marginal ounce.Inverse of MPL

(L/(ΔQ))

Marginal Cost for one more ounce

($10 times Workers)

1 10 10 0.1 $1.00 2 19 9 0.11 $1.10 3 27 8 0.13 $1.30 4 34 7 0.14 $1.40 5 40 6 0.17 $1.70 6 45 5 0.2 $2.00 7 49 4 0.25 $2.50 8 52 3 0.33 $3.30 9 54 2 0.5 $5.00

10 55 1 1 $10.00

Output rises when you add workers

But it increases at a diminishing rate.We call this diminishing marginal

productivity of labor.Because workers have less and less with

which to work, additional workers add less to your total output.

10:58:12 AM

Diminishing Marginal Productivity of Labor (or any other variable input!)

Output rises with inputs But at a diminishing rate

Why does the Marginal Productivity of Labor fall?

Because additional workers have less and less with which to work.

MC rises because MPL falls.

Because additional workers are less and less productive, you need to add more and more of them to get the same increase in output

Oops!

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Because more and more additional workers are needed to increase

output, output increases come at ever rising costs.

We call this increasing marginal costs

You may know that they grow pot in the hill towns around Amherst, MA.

The DEA also monitors electricity usage to find grow houses.

They do overflights to find “hot spots.” (Evidence of grow lamps).

Personally, I think that this is a waste.

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They also grow a lot of pot in Afghanistan. (And lots of heroin.)

That funds the Taliban. And the Afghan government. Strange.

The Obama Administration has stopped the persecution of

medical marijuana

Why do Marginal Costs rise?

Because marginal productivity falls.

You need more and more labor to get the same increases in output

More and more people to get the same increase in output means you

spend more and more

Piles of people Piles of money

Marginal Costs rise because marginal productivity falls

Because when you add workers, they run out of things to do and stuff with which to work.

But what would happen if you increased all inputs simultaneously?

Additional workers would have stuff to work with!

Marginal productivity of labor would not fall!

Marginal costs would not rise!

Inputs

Falling long run marginal costs

In the long run costs fall

Economies to scale and greater specialization and detail division of labor.

Learning by doing: the more you do, the better you get.

Improvements in technology with practice.

That is why we have become more efficient even while increasing employment.

Our long-run MPL curve is downward sloping.

If Marginal Costs do not rise in the long run, then what happens to the

long-run supply curve?

It is flat. Or downward sloping.

If the long-run supply curve is flat, then prices are flat, or even fall with

rising demand!Does this sound like

some products you use?

To lower costs (and prices), we should encourage consumption!

Take-away points

• Short-run marginal costs rise because of diminishing marginal productivity.

• Marginal productivity falls because of the ratio of variable to other inputs rises.

• In the long run, however, there are no fixed inputs and marginal productivity remains constant or increases. Therefore, long-run marginal costs don’t rise and the long-run supply curve is flat or falls.