Economics - Micro - Output and Costs

Start 12:30 PM

Output and Costs

Short run and long run

• Short run is where quantities of some resources are fixed
• Technology of production is fixed in short run, thus a constraint
• Labor and raw materials are typically short run
• Decisions easier to reverse
• In long run you can adjust quantities, production methods, plant size
• Once spent, typically a sunk cost

Products of Labor

• Total product - total output of shirts
• Production possibilities frontier - Graph of total product
• Marginal product - number of shirts added by each additional unit of labor
• Decreases as production increases
• Average product - total output divided by total workers
• Average product will max at a point where marginal product intersects it from above
• Usually marginal will start higher than average, then intersect, then lower

Costs

• Total cost = all costs associated with generation of output, fixed + variable
• Total fixed cost - PP&E plus normal profit (value of ability of owners) - independent of firm output
• Total variable cost - increase as output increases - i.e. labor and materials
• Total cost should increase at increasing rate due to increasing marginal cost
• Marginal cost = change in total cost / change in output
• Average cost - fixed, total, or fixed plus total, each divided by number of units

Properties of costs

• AFC (avg fixed cost) decreases
• Vertical distance from ATC to AVC = AFC
• MC declines initially, then increases - first you have scale economies, but then diminishing returns
• MC intersects ATV and AVC at their minimum points
• ATV and AVC are U shaped because diminishing returns set in

Relation between product and cost curve

• MP reaches a max when MC is at a min
• As labor continues to increase, AP reaches a max and AVC reaches a min
• MP is declining and MC is increasing
• After this point, MP and AP both decrease, and MC and AVC both increase

Production function

• This is the relation between inputs (K+L) and quantity produced
• Law of Diminishing Returns - at some point, output continues to increase but at a decreasing rate
• Marginal Product of Capital - increase in output from one additional unit of capital, holding labor constant
• At some point adding capital still increases production but at a decreasing rate

Short Run and Long Run Costs

• Short run curves apply to a plant of a given size
• In long run, even plant size is variable - these curves are called 'planning curves'
• Inherent tradeoff between size of firm and unit costs - unit costs may decline:
• Savings due to mass production
• Specialization of labor/machinery
• Experience
• Long-run average total cost curve is U-shaped
• Economies of scale in first part, diseconomies thereafter
• Diseconomies = bureaucracy, problems motivating large force, principal agent problems, and greater barriers to innovation

End of reading

1:15 pm

0.75 hrs