The theory behind the Supply curve
Production and Costs
Production
Firms convert inputs (factors of production) into output
Fixed Resource - resources that DON’T change with
when output levels change
ex. a business license,
retail space, machinery
Variable Resource– resources that DO change as as
output levels change
ex. raw materials, workers
Short-run vs. Long-run
• Short-run is NOT a set
amount of time.
• The short-run is a period in
which at least one resource
is fixed.
– Plant capacity/size is NOT
changeable
• In the long-run ALL resources
are variable
– NO fixed resources
– Plant capacity/size is
changeable
Production in the Short-Run
The Links
Factory
Overview
• Each firm is going to hire one more worker every
round.
• There will be 7 rounds and each round lasts 1 min
Resources: 1 scissor, 1 table, tape and paper
Rules
•
Workers cannot cut more than one strip of paper at a time. You can
only cut your strips, no tearing.
•
Workers cannot cut more than one strip of tape at a time. You can only
cut your tape, no tearing.
•
Anything that is cut CANNOT be carried over to the next round.
•
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 count
The Links Factory
Number of
Workers (inputs)
1
2
3
4
5
6
7
Total Product
(output) for
each round
Total (Physical) Product total output produced
The Links Factory
Number of
Workers (inputs)
1
Total Product
(output) for
each round
Marginal
Product
Total (Physical) Product total output produced
Average
Product
Marginal Product- the
additional output generated
by additional inputs (workers)
2
MP=
Change in Inputs
3
4
5
6
7
Change in Total Product
Average Product - the
output per unit of input
AP=
Total Product
Units of Labor
The Links Factory
Number of
Workers (inputs)
1
2
3
4
5
6
7
Total Product
(output) for
each round
Marginal
Product
Average
Product
Simulation
Debrief
1. What happened to the number on links
produced as more workers were hired?
2. Why was the second worker able to
generate more additional links than the lone
worker?
3. Why did the additional output for each
worker eventually start to fall or even go
negative?
4. What would happen to total output if every
student in the room tried to make links given
the supplied resources?
What happened?
The Law of Diminishing Marginal Returns
If one factor of production (number of workers) is increased while other
factors (machines and workspace) are held constant, the output per unit
of the variable factor will eventually diminish.
The
Production
Function
shows the
relationship
between
quantity of
inputs used
to make a
good and the
quantity of
output of that
good.
Read more: http://www.businessdictionary.com/definition/law-of-diminishing-returns.html
Each successive unit of an input will raise production by less than
the last if the quantity of all other inputs is held fixed.
Three Stages of Returns
Stage I: Increasing Marginal Returns
MP rising. TP increasing at an increasing rate.
Why? Specialization.
Total
Product
Total
Product
Quantity of Labor
Marginal and
Average
Product
Marginal Product
Quantity of Labor
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Three Stages of Returns
Stage II: Decreasing Marginal Returns
MP Falling. TP increasing at a decreasing rate.
Why? Fixed Resources. Each worker adds less and less.
Total
Product
Total
Product
Quantity of Labor
Marginal and
Average
Product
Average Product
Marginal Product
Quantity of Labor
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Three Stages of Returns
Stage III: Negative Marginal Returns
MP is negative. TP decreasing.
Workers get in each others way
Total
Product
Total
Product
Quantity of Labor
Marginal and
Average
Product
Average Product
Marginal Product
Quantity of Labor
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Cost Curves
Different Economic Costs
Total Costs
TFC = Total Fixed Costs
TVC = Total Variable Costs
TC = Total Costs
Per Unit Costs
MC = Marginal Costs
ATC = Average Total Costs
AFC = Average Fixed Costs
AVC = Average Variable Costs
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Production Costs
•
Total Fixed Cost – a cost that does not
change, no matter how much is produced
(overhead costs)
Average Fixed Costs =
Fixed Costs
Quantity
•
Total Variable Cost – costs that change
depending on how much is produced.
Average Variable Costs =
Variable Costs
Quantity
•
Total Cost = fixed cost + variable costs
Total cost curve
• Slopes upward due to the
increasing variable costs
• As output increases, the curve
becomes steeper due to
diminishing marginal returns.
Total Fixed, Total Variable, and Total Costs
What is the TOTAL COST, FC, and VC for producing 4 units?
Marginal Cost
• MC is the cost of
producing the next
unit.
Change in Total Costs
MC=
Change in Output
• Is equal to the slope
of the total cost curve
and thus a higher
marginal cost means
a steeper slope.
• A swoosh shape
(sometimes drawn as
just upward sloping)
Marginal Product
Relationship between Production and Cost
MP and MC are mirror images of
each other.
MP
Quantity of labor
Costs
MC
Quantity of output
Due to diminishing marginal
returns, as output increases, the
marginal product of the variable
input declines. Thus more and more
of a variable input must be used to
produce additional units, thus
increasing marginal cost.
Average Total Cost
Total Costs
ATC=
Quantity
• U-shape
• As the quantity of output increases,
the AVC first falls and then rises.
• Increasing output has two opposing
effects on the ATC:
• The diminishing returns effect the larger the output, the greater
amount of variable inputs is
required, leading to a higher AVC
• Spreading effect – the larger the
output, the greater quantity of output
over which the fixed cost is spread,
leading to a lower AFC
Average Minimum Total Cost
• At average minimum cost,
ATC = MC
WHY?
• At output less than the
average min. cost,
MC<ATC and ATC is
falling.
• At output greater than
average min. cost,
MC>ATC and ATC is
rising.
• THINK GPA
THINK GPA
If you get a B in economics, how will
that effect your GPA?
It depends….
• If you GPA (ATC) was higher than a
3.00, a B (MC) in economics will pull
down your grade.
• If your GPA (ATC) was lower than a
3.00, a B (MC) in economics will
bring up your grade.
• If you GPA was a 3.00 then a B in
economics would keep it at a 3.00
Different Economic Costs
Total Costs
TFC = Total Fixed Costs
TVC = Total Variable Costs
TC = Total Costs
Per Unit Costs
ATC = Average Total Costs
AFC = Average Fixed Costs
AVC = Average Variable Costs
MC = Marginal Costs
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