CHAPTER 9 BUSINESSES AND THE COSTS OF PRODUCTION

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CHAPTER 9 BUSINESSES AND THE COSTS OF PRODUCTION

Long Run Production Costs

Diseconomies of scale

Shirking

Worker alienaton

Communication problems

control and coordination problems

Economies of scale: Labor specialization Managerial specialization Efficient capital Other factors Constant returns to scale

1. The firm can change all input amounts, including plant size. 2. All costs are variable in the long run. 3. Long run ATC: Now consider costs in term of average total costs.

Short run production costs

Total cost (TC): 1. Sum of TFC and TVC 2. TC = TFC + TVC

Variable costs (TVC): 1. Costs that do vary with output. 2. Examples: Variable cost: payments for materials , fuel, power, transportation services, labor.

Fixed costs (TFC): 1. Costs that do not vary with output. 2. Examples: rental payments, insurance premiums, interest payments (on loans).

Short-Run Production Functions

Average product (AP) Refers to the average output produced by all variable inputs Also called the average productivity of labor AP = TP / L

Marginal product (MP) Refers to additional outputs produced by additional variable input MP = Change in TP / Change in L

Total product (TP) Refers to total outputs produced

NEGATIVE MARGINAL RETURNS TP falls and MP becomes negative. Additional worker reduces total outputs. Too many workers are hired.

Long Run (Variable Plant)

In the long run, it would be more desirable to build a new factory that could better handle the increased production.

1. All inputs are variable (including factory size) 2. Firms can adjust plant size as well as enter and exit industry.

Time period long enough for firm to adjust plant capacity and enter/leave industry

Short Run (Fixed Plant)

In the short run, a battery factory would purchase more inputs and hire more employees to produce more batteries.

1. Some variable inputs (e.g.: labor) 2. Fixed plant (capacity, e.g:capital: machines, factory size)

Time period too short to change plant capacity (size of operation)

Law of Diminishing Returns

1. As variable resources (such as labor) are continuously added to fixed resources (such as machines), 2. At some point, additional output (marginal product, MP) will fall.

The principle that as successive increments of a variable resource are added to a fixed resource, the marginal product of the variable resource will eventually decrease.

INCREASING MARGINAL RETURNS TP is rising at an increasing rate, so MP is positive and getting larger-increasing marginal returns.

DECREASING MARGINAL RETURNS TP continues to increase, but by smaller and smaller amounts - diminishing marginal returns. TP is still positive and rising, but it is now rising at a slower rate. Factory is overcrowded by workers.