Unit 4 Consumers and Producers

Chapter 12 Inputs and Costs

I. Production Function

a) Relationship between quantity of inputs a firm uses and the quantity of output it produces

b) Fixed input: quantity cannot be varied for a period of time.

c) Variable input: quantity the firm can vary at any time.

II. Long run vs. Short run

a) Long run: period of time in which all inputs can be varied.

b) Short run: period of time in which at least one input is fixed

WidgetProduction Simulation

Production SimulationOverview• The class will be divided into two firms. • There will be several rounds in which each firm will produce chains out

of paper. • Each round last exactly 2 minutes • Each firm is going to hire one more worker at the start of each round. Resources• 1 stapler, 1 scissors, 1 table, and plenty of staples and paper Rules• Workers cannot stockpile slips of paper. No extras • Workers cannot cut more than one paper at a time • Workers can only add links to one side of the chain• Each link must pass inspection• If links don’t meet specifications they won’t countResponsibilities• The manager will hire the workers.• The inspector will check to make sure each product is made to

specifications

Production Simulation

Step 1: Cut paper down the

middle into two piece

Step 2: Fold piece down the

middle

Step 3: Wrap ends around and staple

Step 4: Add more links to one end

III. Inputs vs. Outputs

a) To earn profit, firms must make products (outputs)b) Inputs are the resources used to make outputs.c) Marginal product: the additional output generated

by additional inputs (workers)

d) Average Product: the output per unit of input

Marginal Product =Change in Total Product

Change in Inputs

Average Product =Total Product

Units of Labor

IV. Law of Diminishing Marginal Returns

a) As variable resources (workers) are added to fixed resources (machinery, tools, etc.) the additional output produced from each new worker will eventually fall.

Too many cooks in the kitchen!

Graphing Production

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Three Stages of Returns

Total Product

Quantity of Labor

Marginal and

Average Product

Quantity of Labor

Total Product

Stage I: Increasing Marginal ReturnsMP rising. TP increasing at an increasing rate.

Why? Specialization.

Average Product

10Marginal Product

Three Stages of Returns

Total Product

Quantity of Labor

Marginal and

Average Product

Quantity of Labor

Total Product

Stage II: Decreasing Marginal ReturnsMP Falling. TP increasing at a decreasing rate.

Why? Fixed Resources. Each worker adds less and less.

Average Product

11Marginal Product

Total Product

Quantity of Labor

Marginal and

Average Product

Quantity of Labor

Total Product

Stage III: Negative Marginal ReturnsMP is negative. TP decreasing. Workers get in each others way

Marginal Product

Average Product

12

Three Stages of Returns

The Law of Diminishing Marginal Returns is NOT the results of laziness, it is the result of limited fixed

resources. 13

With a partner calculate MP and AP then discuss what the graphs for TP, MP, and AP look like.

Remember quantity of workers goes on the x-axis.

# of Workers(Input)

Total Product(TP) PIZZAS

Marginal Product(MP)

Average Product(AP)

0 0

1 10

2 25

3 45

4 60

5 70

6 75

7 75

8 70 14

# of Workers(Input)

Total Product(TP) PIZZAS

Marginal Product(MP)

Average Product(AP)

0 0 - -

1 10 10

2 25 15

3 45 20

4 60 15

5 70 10

6 75 5

7 75 0

8 70 -5

With a partner calculate MP and AP then discuss what the graphs for TP, MP, and AP look like.

Remember quantity of workers goes on the x-axis.

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# of Workers(Input)

Total Product(TP) PIZZAS

Marginal Product(MP)

Average Product(AP)

0 0 - -

1 10 10 10

2 25 15 12.5

3 45 20 15

4 60 15 15

5 70 10 14

6 75 5 12.5

7 75 0 10.71

8 70 -5 8.75

With a partner calculate MP and AP then discuss what the graphs for TP, MP, and AP look like.

Remember quantity of workers goes on the x-axis.

16

# of Workers(Input)

Total Product(TP) PIZZAS

Marginal Product(MP)

Average Product(AP)

0 0 - -

1 10 10 10

2 25 15 12.5

3 45 20 15

4 60 15 15

5 70 10 14

6 75 5 12.5

7 75 0 10.71

8 70 -5 8.75

Identify the three stages of returns

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# of Workers(Input)

Total Product(TP) PIZZAS

Marginal Product(MP)

Average Product(AP)

0 0 - -

1 10 10 10

2 25 15 12.5

3 45 20 15

4 60 15 15

5 70 10 14

6 75 5 12.5

7 75 0 10.71

8 70 -5 8.75

Identify the three stages of returns

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V. More examples of Diminishing Marginal Returns

a) Learning curve when studying for an exam.b) Fixed Resources: amount of class time,

textbook, etc.c) Variable Resources: Study time at home.d) Marginal Returns:

1. 1st hour: large returns2. 2nd hour: less returns3. 3rd hour: small returns4. 4th hour: negative returns (tired and confused)

VI. Economic Costs

a) FC = Total Fixed Costsb) VC = Total Variable Costsc) TC = Total Costsd) AFC = Average Fixed Costse) AVC = Average Variable Costsf) ATC = Average Total Costsg) MC = Marginal Costs

VII. Cost Definitionsa) Fixed Costs: Cost of fixed resources that

DON’T change with the amount produced. Ex. Rent, Insurance, Salaries

b) Variable Costs: Costs for variable resources that DO change as more or less is produced. Ex. Raw Materials, Labor, Electricity

Average Fixed Costs = Fixed CostsQuantity

Average Variable Costs = Variable CostsQuantity

VII. Cost Definitions

c) Total Cost: Sum of Fixed and Variable Cost.

d) Marginal Cost: Additional costs of an additional output. Ex. If the production of two more output increases total cost from $100 to $120, the MC is $10.

Average Total Cost = Total CostsQuantity

Marginal Cost = Change in Total CostsChange in Quantity

Calculating TC, VC, FC, ATC, AFC, and MC

TP VC FC TC MC AVC AFC ATC

0 0 100

1 10

2 16

3 21

4 26

5 30

6 36

7 46

Draw this in your notes 23

Calculating TC, VC, FC, ATC, AFC, and MC

TP VC FC TC MC AVC AFC ATC

0 0 100

1 10 100

2 16 100

3 21 100

4 26 100

5 30 100

6 36 100

7 46 100

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Calculating TC, VC, FC, ATC, AFC, and MC

TP VC FC TC MC AVC AFC ATC

0 0 100 100

1 10 100 110

2 16 100 116

3 21 100 121

4 26 100 126

5 30 100 130

6 36 100 136

7 46 100 146

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Per Unit CostsTP VC FC TC MC AVC AFC ATC

0 0 100 100 -

1 10 100 110

2 16 100 116

3 21 100 121

4 26 100 126

5 30 100 130

6 36 100 136

7 46 100 146

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Per Unit CostsTP VC FC TC MC AVC AFC ATC

0 0 100 100 -

1 10 100 110 10

2 16 100 116 6

3 21 100 121 5

4 26 100 126 5

5 30 100 130 4

6 36 100 136 6

7 46 100 146 10

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TP VC FC TC MC AVC AFC ATC

0 0 100 100 - -

1 10 100 110 10 10

2 16 100 116 6 8

3 21 100 121 5 7

4 26 100 126 5 6.5

5 30 100 130 4 6

6 36 100 136 6 6

7 46 100 146 10 6.6

Per Unit Costs

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TP VC FC TC MC AVC AFC ATC

0 0 100 100 - - -

1 10 100 110 10 10 100

2 16 100 116 6 8 50

3 21 100 121 5 7 33.3

4 26 100 126 5 6.5 25

5 30 100 130 4 6 20

6 36 100 136 6 6 16.67

7 46 100 146 10 6.6 14.3

Asymptote

Per Unit Costs

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TP VC FC TC MC AVC AFC ATC

0 0 100 100 - - - -

1 10 100 110 10 10 100 110

2 16 100 116 6 8 50 58

3 21 100 121 5 7 33.3 40.3

4 26 100 126 5 6.5 25 31.5

5 30 100 130 4 6 20 26

6 36 100 136 6 6 16.67 22.67

7 46 100 146 10 6.6 14.3 20.9

Per Unit Costs

30

TP VC FC TC MC AVC AFC ATC

0 0 100 100 - - - -

1 10 100 110 10 10 100 110

2 16 100 116 6 8 50 58

3 21 100 121 5 7 33.3 40.3

4 26 100 126 5 6.5 25 31.5

5 30 100 130 4 6 20 26

6 36 100 136 6 6 16.67 22.67

7 46 100 146 10 6.6 14.3 20.9

Per Unit Costs

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Quantity

Co

sts

(do

llar

s)

AFC

AVC

ATC

MC

Per-Unit Costs (Average and Marginal)

121110987654321

0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15

Average Fixed Cost

ATC and AVC get closer and closer but NEVER touch

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Per-Unit Costs (Average and Marginal)

At output Q, what area represents:

TCVCFC

0CDQ0BEQ0AFQ or BCDE

33

Why is the MC curve U-shaped?

Quantity

Co

sts

(do

llar

s)

MC121110987654321

0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 1534

Relationship between Production and Cost

C

os

tsM

arg

inal

Pro

du

ct

Quantity of labor

Quantity of output

MP

MC

Why is the MC curve U-shaped?

•When marginal product is increasing, marginal cost falls.•When marginal product falls, marginal costs increase.MP and MC are mirror images

of each other.

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VIII. Long-Run Costs

a) All resources are variable. Plant capacity /size can change.

b) Ex. Assume a firm is producing 100 bikes with fixed number of resources (workers, machines, etc.)

c) If this firm decides to DOUBLE the number of resources, what will happen to the number of bikes it can produce?

1. Number of bikes will double (constant returns of scale)2. Number of bikes will more than double (economies of scale)3. Number of bikes will less than double (diseconomies of

scale)

IX. Long Run ATC

a) What happens to the ATC of a product when a firm increases its plant capacity?

1. I make bird houses out of my garage with one saw.2. I rent out a building, buy 5 saws, hire 3 workers3. I rent a factory, buy 20 saws and hire 40 workers4. I build my own plant an use robots to build bird houses.5. I create plants in every major city in the U.S.

6. Long Run ATC curve is made up of all the different short run ATC curves of various plant sizes.

X. Economies of Scale

a) Firms that produce more can better use Mass Production Techniques and Specialization.

b) Ex. 1. A car company that makes 50 cars will have a

very high average cost per car.2. A car company that can produce 100,000 cars

will have a low average cost per car.

Long Run AVERAGE Total Cost

39Quantity Cars

Costs

ATC1

MC1

0 1 100 1,000 100,000 1,000,0000

$9,900,000

$50,000

$6,000

$3,000

Long Run AVERAGE Total Cost

40Quantity Cars

Costs

ATC1

MC1

MC2

0 1 100 1,000 100,000 1,000,0000

$9,900,000

ATC2

Economies of Scale- Long Run Average Cost falls because mass production techniques are used.

$50,000

$6,000

$3,000

Long Run AVERAGE Total Cost

41Quantity Cars

Costs

ATC1

MC1

ATC2

MC2

ATC3

MC3

0 1 100 1,000 100,000 1,000,0000

$9,900,000

$50,000

$6,000

$3,000

Economies of Scale- Long Run Average Cost falls because mass production techniques are used.

Long Run AVERAGE Total Cost

42Quantity Cars

Costs

ATC1

MC1

ATC2

MC2

ATC3

MC3

0 1 100 1,000 100,000 1,000,0000

$9,900,000

$50,000

$6,000

$3,000

Constant Returns to Scale- The long-run average total cost is as low as it can get.

MC4

ATC4

Long Run AVERAGE Total Cost

43Quantity Cars

Costs

ATC1

MC1

ATC2

MC2

ATC3

MC3MC5

0 1 100 1,000 100,000 1,000,0000

$9,900,000

MC4 ATC5

$6,000

$3,000

ATC4

Diseconomies of Scale- Long run average costs increase as the firm gets too big and difficult to manage.

$50,000

Long Run AVERAGE Total Cost

44Quantity Cars

Costs

ATC1

MC1

ATC2

MC2

ATC3

MC3MC5

0 1 100 1,000 100,000 1,000,0000

$9,900,000

MC4 ATC5

$6,000

$3,000

ATC4

Diseconomies of Scale- The LRATC is increasing as the firm gets too big and difficult to manage.

$50,000

Long Run AVERAGE Total Cost

45Quantity Cars

Costs

ATC1

MC1

ATC2

MC2

ATC3

MC3MC5

0 1 100 1,000 100,000 1,000,0000

$9,900,000

MC4 ATC5

$6,000

$3,000

ATC4

These are all short run average costs curves. Where is the Long Run Average Cost Curve?

$50,000

Long Run AVERAGE Total Cost

46Quantity Cars

Costs

0 1 100 1,000 100,000 1,000,0000

Long Run Average Cost Curve

Economies of Scale

Constant Returns to Scale

Diseconomies of Scale

LRATC Simplified

47Quantity

Costs

Long Run Average Cost Curve

Economies of Scale

Constant Returns to Scale

Diseconomies of Scale

The law of diminishing marginal returns doesn’t apply in the long run because there are no FIXED RESOURCES.

REAL WORLD ECONOMIES OF SCALE

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