9/21/15

Topic: Costs of Production EQ: How do firms decide how much of

a product to produce? Bellwork: Set up your Cornell notes.

Then, answer the following question in your notes: If the price of oil rises around the world,

what will happen to oil production in Texas? Why?

Costs of Production

Labor and Output

Marginal Product of Labor is the change in output from hiring one additional unit of labor

Increasing Marginal returns is a level of production in which the marginal product of labor increases as the number of workers increases

Diminishing Marginal Returns is a level of production in which the marginal product of labor decreases as the number of workers increases

Marginal Product of LaborLabor (number of workers)

Output (beanbags per hour)

Marginal Product of Labor

0 0 -1 4 42 10 63 17 74 23 65 28 56 31 37 32 18 31 -1

Marginal Returns

A firm has two factories, one twice as large as the second. As the number of workers at each factory increases, which factory will experience diminishing returns first?

Production Costs

Fixed costs are costs that do not change, no matter how much of a good is produced Rent, machinery repairs, taxes, salaries

Variable costs are costs that rise or fall depending on how much is produced Raw materials, some labor, electricity

Total Cost is fixed plus variable costs Marginal cost is the cost of producing one

more unit of a good

Production CostsBeanbags per hour

Fixed Cost Variable Cost Total Cost Marginal Cost

0 $36 $0 $36 -

1 $36 $8 $44 $8

2 $36 $12 $48 $4

3 $36 $15 $51 $3

4 $36 $20 $56 $5

5 $36 $27 $63 $7

6 $36 $36 $72 $9

7 $36 $48 $84 $12

8 $36 $63 $99 $15

9 $36 $82 $118 $19

10 $36 $106 $142 $24

11 $36 $136 $172 $30

12 $36 $173 $209 $37

Fixed or Variable? Repairs to a leaky roof

Fixed

Cotton Variable

Food for a factory’s cafeteria Fixed

Night security guard Fixed

Electricity Variable

Setting Output Profit is total revenue minus total cost Total revenue is equal to the price of each good

multiplied by the number of goods sold To find the level of output with the highest profit,

we look for the biggest gap between total revenue and total cost

Marginal Revenue is the additional income from selling one more unit of a good

If a firm has no control over the market price, marginal revenue equals the market price

Beanbags per hour

Fixed Cost

Variable Cost

Total Cost

Marginal Cost

Marginal

Revenue

Total Revenu

e

Profit

0 $36 $0 $36 - $24 $0 -$36

1 $36 $8 $44 $8 $24 $24 -$20

2 $36 $12 $48 $4 $24 $48 $0

3 $36 $15 $51 $3 $24 $72 $21

4 $36 $20 $56 $5 $24 $96 $40

5 $36 $27 $63 $7 $24 $120 $57

6 $36 $36 $72 $9 $24 $144 $72

7 $36 $48 $84 $12 $24 $168 $84

8 $36 $63 $99 $15 $24 $192 $93

9 $36 $82 $118 $19 $24 $216 $98

10 $36 $106 $142 $24 $24 $240 $98

11 $36 $136 $172 $30 $24 $264 $92

12 $36 $173 $209 $37 $24 $288 $79

Changes in Supply

There are shifters to the supply curve, just like with the demand curve.

Rising Costs - If the marginal cost increases, it may become higher than marginal revenue. If the firm has no control over the price (marginal revenue), they will have to reduce supply—the curve will shift left

Changes in Supply

Technology – Advances in technology can lower production costs. This drops marginal cost, and allows business to increase production to meet marginal revenue. The curve will shift right.

Subsidies and Taxes – A subsidy is a government payment that supports a business or market. They allow firms to earn a profit for producing more of a good, and can shift the curve right. An excise tax is a tax on the production or sale of a good, and will increase production costs, causing the curve to shift left.

Changes in Supply

Future expectations – If a firm expects the price to increase, they will store goods now in order to sell them in the future. They reduce the amount available for purchase immediately. Expectations of lower prices has the opposite effect.

Number of suppliers – As firms enter the market, supply will shift right. As firms exit a market, supply shifts left.

50 100 150 200 250 300 350 400$0.00

$0.50

$1.00

$1.50

$2.00

$2.50

$3.00

$3.50

Individual Supply Curve

Decrease in Supply

Increase in Supply

Shifts in Supply

Will the following cause an increase or decrease in supply of American-made backpacks? The government raises the minimum wage of

backpack workers to $40 an hour Decrease – marginal cost increases

A new regulation requires firms to make backpacks out of expensive clear plastic Decrease – price of resources has increased

An engineer invents a machine that can sew ten backpacks a minute, speeding up production Increase – technology lowers production cost

On your own

Read through your notes Circle key terms Underline main ideas Put a star by important information Write your questions in the left-hand

column Summarize your notes (answer the

essential question)