Econ 2113: Principles of Microeconomics Spring 2009 ECU
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Econ 2113: Principles of Microeconomics
Spring 2009 ECU
Production and Cost
Chapters 9 and 10
Profit Maximization
Is profit maximization really the goal of all firms?
What about firms that produce eco-friendly products?
What about firms that want to provide good working conditions for their employees?
Two Sides of Profit Maximization
1. Costs: How much it costs a firm to produce something.
• Relates to the production technology for the firm.
2. Revenues: How much a firm can get from selling something.
• Relates to the market structure. • In this course we consider perfectly competitive
markets and monopoly.
Time Horizon
The short run: Period of time sufficiently short so that at least some of the firm’s factors of production are fixed.
The long run: Period of time sufficiently long that all of the firm’s factors of production are variable.
Production in the Short Run
Total product: total quantity produced at a given level of inputs.
Marginal product: increase in total product given a one-unit increase in a given input.
Average product: total product divided by the quantity of the input used. (output per unit of input)
Example: Bakery The bakery has 2 ovens
Labor (Bakers)
Total Product (Loaves of
Bread)
Marginal Product (Loaves per
Additional Baker)
Average Product (Loaves per
Baker)
0 0
1 15 15 15
2 40 25 20
3 63 23 21
4 70 7 17.5
5 75 5 15
Some Patterns
Marginal Product: Initially increases: specialization Eventually decreases: diminishing marginal returns Law of diminishing marginal returns: As a firm uses
more of a variable input with a given quantity of fixed inputs, the marginal product of the variable input eventually declines.
In the example, we add bakers but keep the number of ovens fixed
Average Product: Initially increases Eventually decreases
Product Curves Output on y-axis Variable input on x-axis
Shape of Total Product Curve slope steepens at first, then flattens
Shape of Marginal Product Curve it is increasing at first, then decreasing
Shape of Average Product Curve increasing, and then decreasing
Product Curves
TP MP
Labor Labor
MPL
APL
TP
Average-marginal relationship: Average Age Game New Student’s Age Average Age in Class Average Up or
Down? 20 20 -- 30 25 U 40 30 U 50 35 U 40 36 U 30 35 D
- When the marginal is greater than the average, then the average is increasing
- When the marginal is less that the average, then the average is decreasing
- “GPA theorem”
Costs in the Short Run
Fixed cost (FC): the sum of all payments made to the firm’s fixed factors of production.
Variable cost (VC): the sum of all payments made to the firm’s variable factors of production.
Total cost (TC=FC+VC): the sum of all payments made to the firm’s fixed and variable factors of production.
Costs in the Short Run, Graphically
Costs in the Short Run Average fixed cost: fixed cost divided by total output.
AFC=FC/Q Always decreases as output goes up.
Average variable cost: variable cost divided by total output. AVC=VC/Q Initially decreasing and eventually increasing as output goes up.
Average total cost: total cost divided by total output. ATC=TC/Q Notice that ATC = AFC + AVC
Marginal cost: the cost associated with a one-unit increase in output.
Cost Curves Costs on y-axis Output on x-axis
- Where AVC is rising, MC is above AVC.
- At the minimum AVC, MC equals AVC.
- Where AVC is falling, MC is below AVC.
- ATC curve is U-shaped.
- Remember the “GPA theorem”
Short-Run Cost
- Similarly, where ATC is falling, MC is below ATC.
- Where ATC is rising, MC is above ATC.
- At the minimum ATC, MC equals ATC.
The relationship between marginal product and marginal cost (SR)
Marginal product and marginal cost are related in the following way: When marginal product is increasing, marginal cost is
decreasing. When marginal product is decreasing, marginal cost is
increasing.
Same relation is true for AP and AC
Product Curves and Cost Curves (SR)
AP, MP
AC, MC MC
AC
AP
MP
Labor
Output
Factors that Move the Short-Run Cost Curve
The position of a firm’s short-run cost curves is determined by two factors:
Technology Technological innovations typically increase
productivity. Thus, they reduce MC, AVC and ATC.
Prices of productive resources Increases in input prices increase MC, AVC
and ATC.
Short-Run Cost
Technology Technological change influences both the
productivity curves and the cost curves.
An increase in productivity shifts the average and marginal product curves upward and the average and marginal cost curves downward.
Short-Run Cost
Prices of Factors of Production An increase in the price of a factor of
production increases costs and shifts the cost curves.
An increase in a fixed cost shifts the total cost (TC ) and average total cost (ATC ) curves upward but does not shift the marginal cost (MC ) curve.
An increase in a variable cost shifts the total cost (TC ), average total cost (ATC ), and marginal cost (MC ) curves upward.
Long-Run Costs
All factors of production are variable in the long run.
Again, the shape of the firm’s cost curves depends on the production technology.
Long-Run Cost
Short-Run Cost and Long-Run Cost The average cost of producing a given output varies and
depends on the firm’s plant size. The larger the plant size, the greater is the output at which
ATC is at a minimum. Example: There are 4 possible plant sizes: 1, 2, 3, or 4
knitting machines. Each plant has a short-run ATC curve. The firm can compare the ATC for each given output at
different plant sizes.
Short Run Cost Curves
ATC1 is the ATC curve for a plant with 1 knitting machines.
ATC2 is the ATC curve for a plant with 2 knitting machines.
ATC3 is the ATC curve for a plant with 3 knitting machines.
ATC4 is the ATC curve for a plant with 4 knitting machines.
Long-Run Cost
The long-run average cost curve is made up from the lowest ATC for each output level.
So, we want to decide which plant has the lowest cost for producing each output level.
Let’s find the least-costly way of producing a given output level.
Suppose that we want to produce 13 sweaters a day.
Long-Run Cost • 13 sweaters a day cost $6.80 each on ATC2. • This is the least-cost way of producing 13 sweaters a day.
Long-Run Cost
Long-Run Average Cost Curve The long-run average cost curve is the
relationship between the lowest attainable average total cost and output when both the plant size and labor are varied.
Long-Run Cost
Returns to Scale
A firm’s scale: if a firm increases its scale by, say 100%, it means it’s increasing its use of ALL productive resources by 100%.
Constant returns to scale: An increase in the firm’s scale increases output proportionately. For example, doubling inputs exactly doubles outputs.
Economies of scale: An increase in the firm’s scale increases output more than proportionately. For example, doubling inputs more than doubles output.
Diseconomies of scale: An increase in the firm’s scale increases output less than proportionately. For example, doubling inputs less than doubles output.
Long-Run Cost
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