CHAPTER 22
Unemployment and Employment
CHAPTER OVERVIEW
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TEACHING OBJECTIVES
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Managers of all forms of business firms (proprietorships, partnerships, and corporations) must make
many decisions over short-run and long-run periods of time. These include but are not limited to the
number of units to produce; the size of the enterprise; whether to operate at a loss or shut down; and
whether to acquire new operating units, close, expand new units, or spin off existing units. This chapter
addresses these and other issues by presenting a model of the costs of production of a business. All
costs of production are derived and their interrelationships are developed. A continuous theme is that
costs are related to the current knowledge of technology through the production function. After
presenting the cost functions, the revenue side of business decisions is introduced in order to identify
profitable levels of production or levels associated with losses that may result in shutting down
operations. Finally, these issues are considered over the long run, the period over which plant capacity
can be altered. Economies of scale, acquisitions, mergers, spin-offs, and related topics are discussed.
Cover the costs of production. Total cost, average cost, marginal cost, and their interrelationship
should be included. This discussion should also include the use of inputs over the short and long
run.
2.
Use the costs of production and revenue to determine the level of production that maximizes
profits. Cover profits, losses, shutdown, and breakeven.
3.
Discuss the behavior of costs and production over the long run. Develop the long-run average cost
curve.
4.
Discuss economies of scale.
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1.
KEY TERMS
short run
long run
average total cost (ATC)
average variable cost (AVC)
average fixed cost (AFC)
average product of labor
breakeven point
shutdown point
long-run average total cost curve
economies of scale
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different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.
Chapter 22: Unemployment and Employment
173
diseconomies of scale
constant returns to scale
minimum efficient scale
TEACHING TAYLOR AND WEERAPANA 'S ECONOMICS
This chapter continues the use of marginal analysis in an examination of the output decisions of an
individual business over the short and long runs. Total and per-unit cost curves are developed for the
short and long runs. The importance of information in efficient business decision-making is stressed in
a discussion of the problems of managing multidivisional firms over the long run.
LECTURE OUTLINE AND TEACHING TIPS
Costs for an Individual Firm
A. Total costs are the sum of variable costs (VC) and fixed costs (FC). The short run is a period
of time where at least one input is fixed. In the long run, there are no fixed inputs. Use
Figure 2. The per-unit view of costs includes average total cost (ATC), average variable cost
(AVC), average fixed cost (AFC), and marginal cost (MC). Use Table 1 in the text to show
the definition and derivation of each.
B. Costs are related to a firm's production function.
C. The number of variable inputs hired in the short run determines the level of variable cost.
But the amount hired depends on the amount required to produce the desired level of output.
The technical relationship between inputs and output is depicted in the production function.
This is seen in Figure 3 and Table 2.
D. The production function tells managers how output changes when there is a change in
variable input—the marginal product.
E. The behavior of marginal product over additional input is described by the law of
diminishing returns. When marginal product rises, marginal cost falls.
Teaching Tip
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I.
II.
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Once you link marginal product with marginal cost, you may wish to return to Table 1 to link marginal
product to the behavior of VC. The link between marginal product and marginal cost is very important.
All other costs logically follow from this original connection.
Cost Curves
A. The ATC and the AVC are U-shaped. ATC and AVC get closer together as production
increases because AFC declines with increase in output.
B. The marginal cost (MC) curve cuts AVC and ATC from below at the lowest points of ATC
and AVC. This is shown in Figures 4 and 5.
Teaching Tip
To help students understand the mathematical relationship between marginal and average costs, talk
about the effect of a baseball player's batting average for one game on the player's average for the
season. Going four for four in one game will cause the player's season average to rise.
Teaching Tip
Stress that all forms of businesses have fixed and variable inputs. They also have production functions
in which the marginal product diminishes. Therefore, the cost curves of all businesses look very similar.
Cost curves are generic: All firms in all economies look this way. See Figure 5.
© 2010 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be
different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.
174
Chapter 22: Unemployment and Employment
III. The Production Decision in the Short Run
A. Profits are equal to total revenue minus total cost. This can be seen in the per-unit picture
(ATC, AVC, MC) by adding a line for the market price (P).
B. Market price is shown in Figure 6 as a horizontal line. This depiction is based on the
assumption that the firm is selling its output on a competitive market.
C. Profit-maximizing output is found where P = MC . Total profits grow (or total losses fall) if
units are produced that add more to revenue than they add to costs.
D. Total cost is equal to the desired quantity (found where P = MC ) multiplied by ATC. Total
revenue is equal to the desired output (found where P = MC ) multiplied by the market
price. Because total cost and total revenue are based on the same quantity (found where
P = MC ), profits occur when P exceeds ATC, losses when P is less than ATC, and
breakeven when P equals ATC. This is seen in Figures 7, 8, and 9.
Teaching Tip
Profit maximization is a rule to determine the best, or optimum, quantity to produce (P = MC ) . Profits
and losses are determined by comparing P and ATC. Distinguish between making profits and
maximizing profits.
If losses are unavoidable, P < ATC where P = MC , then a manager must determine
whether to produce or shut down. This determination is arrived at by comparing P and AVC
at P = MC . It is shown in Figure 10.
Teaching Tip
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E.
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This is a good time to stress the role of fixed inputs in the short run; this gives you a transition into the
next section.
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IV. Costs and Production: The Long Run
A. The long run is a period of time over which there are no fixed inputs. The addition of fixed
inputs raises fixed costs but also lowers variable costs. This is due to the increase in the
marginal product of labor associated with the increase in capacity. Use Figure 11. At low
levels of output, TC is higher than before, but it is lower with higher levels of output.
B. These changes also affect ATC. For each level of fixed input there will be a new ATC.
Changes in capital shifts short-run ATC. Use Figure 12.
C. A tracing of the pattern made by shifts in short-run ATC is the long-run average total cost
curve. The resulting shape may be downward-sloping, upward-sloping, horizontal, or a
combination of all three. Use Figure 13.
Teaching Tip
Link the decision to expand to profit maximization. Stress that profit maximization is the rule that
economists use to motivate business decisions. This also influences the use of different capital/labor
ratios over the long run.
V.
Economies of Scale
A. Over the long run, all inputs can be changed. Thus, the scale changes. Scale is related to the
shape of the long-run ATC.
B. If a doubling of inputs more than doubles output, then long-run ATC must fall. This is
referred to as economies of scale. Diseconomies of scale occur if the long-run average total
cost curve rises as the scale of the firm increases. If the long-run average total cost curve
neither rises nor falls, it is called constant returns to scale. Use Figure 14. Most firms
experience all forms of economies of scale. This is shown by Figure 15. The minimum
efficient scale is found at the lowest point in this figure.
© 2010 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be
different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.
Chapter 22: Unemployment and Employment
175
Teaching Tip
The response of changes in output to changes to input is found in the production function. Relate the
long run to the knowledge of production technology. Make the point that long-run behavioral
foundations and short-run behavioral foundations are the same.
C.
Mergers can reduce ATC. Combining different types of firms to reduce costs or create new
products is called economies of scope.
DISCUSSION TOPICS
Show how a household could be described as a business firm. Households take market goods
(food), capital (ovens), and labor (parental time) and produce output (dinner). Thus, the
production of dinner by a household is done in competition with profit-seeking restaurants.
Extend the discussion to child care.
2.
One of the topics addressed in this chapter is the evolution that business firms experience. A
discussion of Apple Computer would clearly show this evolution. It started in a garage and
evolved into a major player in the computer market, although many of the original entrepreneurs
are no longer with the company. Discuss whether entrepreneurs can be successful day-to-day
managers. Each job requires special talents that may not be complementary.
3.
Generally, students have very little experience drawing graphs. They may benefit by graphing the
information in Table 1. Although this is done in Figures 2 and 4 of the text, the physical exercise
will help students see (and feel) the relationship between all the cost curves.
4.
Stress the difference between profit maximization and making profit. One is a rule to guide
behavior and the other is an accounting relationship. Can a firm maximize profits and suffer a
loss?
5.
Spend class time comparing Wal-Mart’s success with the principles of Adam Smith’s pin factory.
Bring out the importance of the division of labor.
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1.
© 2010 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be
different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.
SOLUTIONS TO END-OF-CHAPTER PROBLEMS
Figure 22.2 shows the various cost curves for a competitive firm.
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1.
Figure 22.2
Marginal cost is greater than ATC at the profit-making quantity.
d.
Fixed costs are unchanged as the market price decreases. Variable costs increase as the
market price increases.
Yes, there are economies of scale in teaching introductory economics. For example, an instructor
can teach 20 students in a classroom with 20 seats and one blackboard and one instructor's
computer. To teach 40 students, the number of seats would need to be doubled, but only 1
instructor, 1 blackboard and 1 computer would be needed. However, increasing the number of
students to 400 would require additional resources in the form of teaching assistants, larger
overhead projectors, etc. to deliver the same quality of learning experience.
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2.
c.
3.
Quantity
Total
Cost
Fixed
Cost
Variable
Cost
ATC
AVC
MC
0
1
2
3
4
5
18
27
32
33
40
60
18
18
18
18
18
18
0
9
14
15
22
42
18
27
16
11
10
12
0
9
7
5
5.5
8.4
0
9
5
1
7
20
© 2010 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be
different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.
4.
Figure 22.4 is a plot of the data given in the table in the text. The minimum efficient scale is 3
units.
$
$
50
45
40
35
30
25
20
Economies
of Scale
15
Constant
Returns
Diseconomies
of Scale
5
0
1
2
3
4
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0
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10
5
6
7
Q
Figure 22.4
5.
TC
FC
VC
C
Q
0
1
2
3
4
5
8
12
14
20
30
50
8
8
8
8
8
8
0
4
6
12
22
42
ATC
AVC
MC
12
7
6.67
7.5
10
4
3
4
5.5
8.4
4
2
6
10
20
© 2010 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be
different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.
6.
Figure 22.3 is a plot of the information in the question.
The long-run average total cost curve is shown.
Figure 22.3
Figure 22.1 is a graph of average and marginal ages. As the marginal is below the average and
falling, the new average will fall. The average will fall to 35.25.
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7.
Figure 22.1
8.
a.
At Q = 4 , the firm makes the maximum amount of profit. Equally acceptable, 4 is the
highest output level such that MR > MC.
b.
Profit = TR - TC = 12
c.
No, the market is not in long-run equilibrium since the firm is making positive economic
profits. Over time, other firms will enter the market and price will be driven down to the
level of minimum ATC, at which profits are zero.
d.
At P = 10 , the firm breaks even since the minimum ATC equals 10. At P = 5 , the firm
shuts down since the minimum value of AVC is 5.
© 2010 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be
different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.
Chapter 22: Unemployment and Employment
179
9.
a.
The average will rise as the marginal grade is greater than the average of all the grades.
b.
The average will fall.
c.
This shows that averages will follow the marginal. Alternatively, the behavior of an average
depends on the marginal.
a.
4 units.
b.
Yes, economic profits equal to $30 are earned.
c.
$6.67 is the breakeven price.
d.
$3 is the shutdown price.
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10.
© 2010 Cengage Learning. All Rights Reserved. This edition is intended for use outside of the U.S. only, with content that may be
different from the U.S. Edition. May not be scanned, copied, duplicated, or posted to a publicly accessible website, in whole or in part.