Chapter 5
Section 2: Costs of
Production
Labor & Output
 How
many workers to hire?
Owners have to consider how
the number of workers they hire
will affect their total production
A Firm’s Labor Decisions
Marginal Product of Labor
 marginal
product of labor
is the change in
output from
hiring one
additional unit
of labor, or
worker.
Labor
(number of
Output
(beanbags
Marginal
product
workers)
per hour)
of labor
0
0
—
1
4
4
2
10
6
3
17
7
4
23
6
5
28
5
6
31
3
7
32
1
8
31
–1
Increasing marginal
returns occur when
marginal production
levels increase with
new investment.
Increasing, Diminishing, and
Negative Marginal Returns
8
7
Increasing
marginal
returns
Diminishing
marginal
returns
6
Marginal Product of labor
(beanbags per hour)
Marginal Returns
5
4
3
Negative
marginal
returns
2
1
0
4
–1
5
6
7
–2
Specialization
increases worker
output
–3
1
2
3
Labor
(number of workers)
8
9
Diminishing marginal returns occur
when marginal production levels
decrease with new investment.
-Benefits of specialization ends, at that
point, adding one more worker
increases output, but at a decreasing
rate
-Produce less & less output from each
additional worker because working
with limited amount of capital
Negative marginal returns occur
when the marginal product of
labor becomes negative.
-Workers get in each other’s
way & disrupt production
-Rare
Production Costs
A
fixed cost is a cost that does
not change, regardless of how
much of a good is produced.
Examples: rent, salaries,
property taxes, & machinery
repairs
 Variable
costs are costs that rise or
fall depending on how much is
produced.
Examples: costs of raw materials,
some labor costs, electricity, & heat
 The total cost equals fixed costs plus
variable costs.
 The
marginal cost is the cost of
producing one more unit of a good.
Each additional unit is cheaper to
make because of increasing
marginal returns with specialization
(to a point)
Setting Output
 Marginal
Revenue & Marginal Cost
Marginal revenue is the additional
income from selling one more unit of a
good.
It is usually equal to price (most
profitable)
If a firm has no control over the market
price, marginal revenue equals market
price
–Profit is available anytime the
company receives more for the last
unit than it cost to produce it
Responding to Price Changes
 Law
of supply
The Shutdown Decision
 Factory
that is losing money
 Market price is so low that total
revenue is less than cost
 There
are times to remain open
If the total revenue is greater than
the cost of keeping it open
Must look at the operating costonly looks at variable costs
Fixed costs are paid regardless