The Theory behind the Supply Curve. Production and Costs
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1 The Theory behind the Supply Curve Production and Costs
2 Production Firms convert inputs (factors of production) into output Fixed Resource resources that DON T change with when output increases ex. a business license, factory space, machinery Variable Resource resources that DO change as output increases ex. materials, workers
3 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
4 Production in the Short-Run
5 The Links Factory Overview A firm is going to hire one more worker every round. There will be 7 rounds and each round lasts 1 min Inputs: 1 scissor, 1 table, 1 roll of tape, paper, and Rules workers Workers cannotcut 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
6 The Links Factory Number of Workers (inputs) Total Product (per round) Total Product(Q) - total output produced
7 The Links Factory Number of Workers (inputs) Total Product (per round) Marginal Product Average Product Total (Physical) Producttotal output produced Marginal Product- the additional output generated by additional inputs (workers) MP= Change in Total Product Change in Inputs Average Product - the output per unit of input AP= Total Product Units of Labor
8 The Links Factory Number of Workers (inputs) Total Product (per round) Marginal Product Average Product
9 Simulation Debrief 1. What happened to the number of 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?
10 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: Each successive unit of an input will raise production by less than the last if the quantity of all other inputs is held fixed.
11 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 14
12 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 15
13 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 16
14 Typically, a firm s production function will flatten as the quantity of input increases, displaying the property of diminishing marginal product.
15 Cost Curves
16 Different Economic Costs Total Costs TFC = Total Fixed Costs TVC = Total Variable Costs TC = Total Costs = TFC + TVC Per Unit Costs MC = Marginal Costs = TC/ Q ATC = Average Total Costs = TC/Q AFC = Average Fixed Costs = FC/Q AVC = Average Variable Costs = VC/Q
17 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
18 Costs in $s TC VC FC TFC is constant at all quantity levels. TVC increases as output increases since the firm will require increasing amounts of variable resources (workers, materials) as it increases production. Initially TVC will be steep since specialization cannot occur without enough workers. It will then become less steep due increasing marginal returns. It will eventually become steep again due to diminishing marginal returns TC is the sum of TFC and TVC. Since TFC is constant, TC has the same slope as TVC Quantity (chairs per hour) FC=Fixed Cost VC=Variable Cost TC=Total Cost
19 Total Cost Curve Slopes upward due to the increasing variable costs As output increases, the curve becomes steeper due to diminishing marginal returns.
20 Total Fixed, Total Variable, and Total Costs What is the TOTAL COST, FC, and VC for producing 4 units?
21 Costs in $s TC VC TC=Total Cost VC=Variable Cost What is the total cost of 5 units? Fixed cost? Quantity (chairs per hour)
22 Average Total Cost ATC= U-shape Total Costs Quantity As the quantity of output increases, the AVC first falls and then rises. Increasing output has two opposing effects on the ATC: Spreading Effect the larger the output, the greater quantity of output over which the fixed cost is spread, leading to a lower AFC. The Diminishing Returns Effect - the larger the output, the greater amount of variable inputs is required, leading to a higher AVC. AFC
23 Relationship between Production and Cost Costs Marginal Product Quantity of labor MP MC MP and MC are mirror images of each other. 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. Quantity of output
24 Marginal Cost MC is the cost of producing the next unit. MC= Total Cost Output A swoosh shape (sometimes drawn as just upward sloping) A higher marginal cost means a steeper slope.
25 Minimum Average Total Cost At min average total 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
26 THINK GPA If you get a B in economics, how will that change 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
27 You produce widgets. Currently you produce 4 widgets at a total cost of $40. What is your average total cost? $40/4 = $10 Suppose you could produce one more (the fifth) widget at a marginal cost of $5. If you do produce that fifth widget, what will your average total cost be? Has your average total cost increased or decreased? Why? $40 + $5 = $45 $45/5 = $9 ATC decreases when MC < ATC Suppose instead that you could produce one more (the fifth) widget at a marginal cost of $20. If you do produce that fifth widget, what will your average total cost be? Has your average total cost increased or decreased? Why? $40 + $20 = $60 $60/5 = $12 ATC increases when MC > ATC
28
29 MC ATC MC crosses ATC at its minimum AFC slopes down due to the spreading effect
30 Costs (dollars) Per-Unit Costs MC ATC AVC AFC MC of the 11 th unit? ATC of the 11 th unit? AVC of the 11 th unit? Min ATC? TC of 11 units? Quantity
31 (C) $6 (ATC) x 20 = 120 TC = 120 $6 (ATC) - $5 (AVC) = $1 x 20 TFC= 20
32 TC VC FC At output Q, what area represents: 0CDQ 0BEQ 0AFQ or BCDE
33 Shifting Cost Curves
34 Shifting Costs Curves TP VC FC TC MC AVC AFC ATC What if fixed costs increase to $
35 Shifting Costs Curves TP VC FC TC MC AVC AFC ATC
36 Shifting Costs Curves TP VC FC TC MC AVC AFC ATC
37 Shifting Costs Curves TP VC FC TC MC AVC AFC ATC Which Per Unit Cost Curves Change? 44
38 Shifting Costs Curves TP VC FC TC MC AVC AFC ATC ONLY AFC and ATC Increase! 45
39 Shifting Costs Curves TP VC FC TC MC AVC AFC ATC ONLY AFC and ATC Increase! 46
40 Shifting Costs Curves If fixed costs change ONLYAFC and ATC Change! TP VC FC TC MC AVC AFC ATC MC and AVC DON T change! 47
41 Shift from an increase in a Fixed Cost MC ATC 1 Costs (dollars) ATC AVC AFC 1 AFC Quantity 48
42 Shifting Costs Curves TP VC FC TC MC AVC AFC ATC What if the cost for variable resources increase
43 Shifting Costs Curves TP VC FC TC MC AVC AFC ATC
44 Shifting Costs Curves TP VC FC TC MC AVC AFC ATC
45 Shifting Costs Curves TP VC FC TC MC AVC AFC ATC Which Per Unit Cost Curves Change? 52
46 Shifting Costs Curves TP VC FC TC MC AVC AFC ATC MC, AVC, and ATC Change! 53
47 Shifting Costs Curves TP VC FC TC MC AVC AFC ATC MC, AVC, and ATC Change! 54
48 Shifting Costs Curves If variable costs change MC, AVC, and ATC Change! TP VC FC TC MC AVC AFC ATC
49 Shift from an increase in a Variable Costs MC1 MC Costs (dollars) ATC 1 AVC 1 ATC AVC AFC 56 Quantity
50 When productivity growth is positive, what happens to AFC, AVC, ATC, and MC? AVC, ATC and MC will shift downward. AFC does not change.
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