Today Production and cost in the Short Run Print out slides #31 & #32 full-sized for easier work.
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Transcript of Today Production and cost in the Short Run Print out slides #31 & #32 full-sized for easier work.
Today Production and cost in the Short
Run Print out slides #31 & #32 full-
sized for easier work.
How Costs Vary with Output
Recall: Short-Run & Long-Run Short run: When an economic
agent can adjust somewhat (but not completely) to an event.
Long run: When an agent has fully adjusted to an event.
SR & LR for a Firm Short run: Period of time during which
some important input or inputs is fixed or limited in quantity. The firm can stop producing but can’t close down.
Long run: Period of time needed so that all inputs are variable in quantity. Everything can be adjusted. The firm could close down, liquidating resources.
Example: Pizza Parlor Pizza parlor sees increased demand &
decides to sell 20% more pizzas. SR: cannot increase the size of the
building, # of ovens. May hire more workers per shift, use more ingredients, or expand the hours of business.
LR: add ovens, floor space, kitchen space. May take several months to a year.
A Note on SR & LR These are not set periods of time:
their length will depend on the type of firm or industry.
We can think of them as response times.
“Production in the SR” . . . refers to how the firm is able
to vary its level of output while some input (or inputs) is fixed in quantity.
Pizza Parlor In the short run, assume the following is
fixed: restaurant size # of ovens # of tables workspace
Variable inputs in short run labor ingredients (will not focus on these)
Adding more labor to fixed inputs # Workers Total Product
0 01 102 223 324 385 36
What can you notice about the relation between workers and total product?
Definition of Marginal Product Marginal Product of Labor (MPL) =
TP/L.
Add MP to the Table L TP MP
0 0 n/a 1 10 10 2 22 12 3 32 10 4 38 6 5 36 -2
Graphing Marginal Product L MP
0 n/a
1 102 123 104 65 -2
L
MP
1 2 3 4 5
2
468
MP
10
-2
The Pattern of MP In this example, MP increases at first.
Represents increased division of labor. Can separate cooking from serving
functions. MP then decreases.
Represents the effects of crowding. More people trying to use limited space,
equipment. MP negative: extreme crowding.
Law of Diminishing Marginal Returns Holding some important inputs (or
inputs) constant and increasing the use of another input by equal increments will eventually result in a decreasing marginal product.
Notes on the Law of Diminishing Marginal Returns A physical law (doesn’t involve
prices). Allows for increasing MP at initial
levels of output. Applies to SR situations only
(why?)
What the LDMR implies for costs Beyond some point, adding
additional labor leads to a falling Marginal Product.
This implies that beyond that same point, it will cost more and more to produce an extra unit of output.
Let’s make this idea more formal.
Definitions of TC, TFC, TVC Total cost (TC): the economic cost of
producing a given level of output. Total Fixed Cost (TFC): Costs which do
not vary with changes in output, given a particular short run situation. (Overhead)
Total Variable Cost (TVC): Costs which do vary as output changes.
TC = TFC + TVC
Ex: Producing Cheese in the Short Run Fixed factors in the
SR: Size of factory Machinery Manager
Fixed Costs (in $1,000)
Rent on factory-$6 Rent on machinery-$2 Manager salary-$2 TFC = $10
Variable factors in the SR:
Labor Raw materials such as
milk, rennet. Variable Costs
Wages of production workers
Cost of raw materials. TVC depends on Q
Ex: TVC, TFC, TC Why is TFC equal
to 10 for every Q? Where does TC
come from? Note: Q is the
same thing as TP.
Q TVC TFC TC
0 0 10 10
1 3 10 13
2 5 10 15
3 8 10 18
4 12 10 22
5 17 10 27
6 23 10 33
Definitions of ATC, AVC, AFC Average Total Cost: TC/Q, where Q
= quantity of goods produced. Average Variable Cost: TVC/Q Average Fixed Cost: TFC/Q
Table: AVC, ATC Do you
see where the values in the AVC and ATC columns come from?
Q TVC AVC TC ATC
0 0 n/a 10 n/a
1 3 3.0 13 13.0
2 5 2.5 15 7.5
3 8 2.7 18 6.0
4 12 3.0 22 5.5
5 17 3.4 27 5.4
6 23 3.8 33 5.5
Graph of AVC, ATC ATC and AVC
both are U-shaped.
AVC lies everywhere below ATC. Why?
$/Q
Q
AVC
ATC
2 4 6
4
8
12
2
6
10
14
Notes on ATC and AVC How can you see AFC on this
graph? Why do ATC and AVC grow closer
together as Q rises? The minimum of AVC occurs at a
lower level of output than for ATC. Why?
Marginal Cost Marginal Cost (MC): The change in
total cost associated with increasing output by one unit.
MC = TC Q What are marginal fixed costs equal
to? Is MC the same thing as MVC?
Table: MC Do you
see where the values in the MC column come from?
Q TVC MCMC AVC TC ATC
0 0 n/an/a n/a 10 n/a
1 3 33 3.0 13 13.0
2 5 22 2.5 15 7.5
3 8 33 2.7 18 6.0
4 12 44 3.0 22 5.5
5 17 55 3.4 27 5.4
6 23 66 3.8 33 5.5
Graph of MC Graph MC
half-way between the old & new Q for greater accuracy.
$/Q
Q
AVC
ATC
2 4 6
4
8
12
2
6
10
14
MC
Notes on MC MC must eventually rise due to the
Law of Diminishing Marginal Returns. If each successive laborer has a lower
MP, then the MC of producing one more unit is rising.
MC cuts ATC and AVC and their lowest points. Why?
The Relation between Marginal and Average When marginal cost is below average
cost, average cost will be falling. When marginal cost is above average
cost, average cost will be rising. This relationship between “marginal”
and “average” applies to all variables.
Coming Up Shift in SR cost curves Production and cost in the Long
Run Group Work
Table & Graph of firm’s costs.
Cost Curves of the Firm Fill in the blanks in the table. Use
your class notes to understand the abbreviations. Use the number of decimal places already shown in each column.
Use your answers to graph ATC, AVC, and MC onto the graph.
Table of Firm Costs in the SRQ TVC MC AVC TFC TC ATC
0 0 undef undef 3 undef
1 3 3 3.00 3 6
2 4 3 7 3.50
3 7 3 2.33 3 3.33
4 4 2.75 14 3.50
5 16 5 3 19 3.80
6 22 3.67 3 25 4.17
7 29 7 4.14 3 4.57
8 8 4.63 40 5.00
9 46 9 5.11 3 49
10 56 10 5.60 3 59
Graph of Firm Costs in the SR
0 1 2
2
1
4
6
8
10
12
6 5 4 3 7 8 9 10
0
Quantity
$/q
ATC, AVC, MC
3
5
7
9
11
Questions MC cut AVC between ___1/2 and ___1/2
units. While your graph may be slightly off, what do we know must be happening to AVC at the point where MC cuts it?
MC cut ATC between ___1/2 and ___1/2 units. While your graph may be slightly off, what do we know must be happening to AVC at the point where MC cuts it?
More Questions How should we interpret the
vertical distance between ATC and AVC on the graph?
Why does this distance shrink as quantity increases?