CHAPTER 5 SECTION 2 Costs of Production I

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CHAPTER 5 SECTION 2 Costs of Production

CHAPTER 5 SECTION 2 Costs of Production

I. LABOR AND OUTPUT ▶ A. Number of workers ▶ 1. Must decide how

I. LABOR AND OUTPUT ▶ A. Number of workers ▶ 1. Must decide how many people to hire ▶ 2. Must look at how it will affect the total output

Labor (# of Workers) Output (amount produced/hour) 1 4 2 10 3 17 4

Labor (# of Workers) Output (amount produced/hour) 1 4 2 10 3 17 4 23 5 28 6 31 7 32 8 31

▶ B. Marginal Product of Labor: change in output from hiring one additional unit

▶ B. Marginal Product of Labor: change in output from hiring one additional unit of labor ▶ 1. It’s the amount the additional worker added in production

Labor Output Marginal Product of Labor 1 4 4 2 10 6 3 17

Labor Output Marginal Product of Labor 1 4 4 2 10 6 3 17 7 4 23 5 28 6 31 7 32 8 31 -1

▶ C. Increasing Marginal Returns: a level of production in which the marginal product

▶ C. Increasing Marginal Returns: a level of production in which the marginal product of labor increases as the number of workers increase ▶ 1. Specialization increases output per worker ▶ Allows you to not waste time switching tasks ▶ Become more skillful at the task you are doing ▶ EX: One person stuffs bean bag, one cuts cloth, one sews cloth in correct shape, one sews cloth shut…

Labor Output Marginal Product of Labor Increasing 1 4 4 Increasing 2 10 6

Labor Output Marginal Product of Labor Increasing 1 4 4 Increasing 2 10 6 Increasing 3 17 7 Increasing 4 23 6 5 28 5 6 31 3 7 32 1 8 31 -1

▶ D. Diminishing Marginal Returns: level of production in which the marginal product of

▶ D. Diminishing Marginal Returns: level of production in which the marginal product of labor decreases as the number of workers increase ▶ 1. After there is a person for each task the marginal product of labor will start to decrease ▶ 2. Usually happens when there is a limited amount of capital ▶ Not enough sewing machines, people have to wait, not being productive

Labor Output Marginal Product of Labor Increase/Decrea se 1 4 4 Increasing 2 10

Labor Output Marginal Product of Labor Increase/Decrea se 1 4 4 Increasing 2 10 6 Increasing 3 17 7 Increasing 4 23 6 Decreasing 5 28 5 Decreasing 6 31 3 Decreasing 7 32 1 Decreasing 8 31 -1 Negative

▶ E. Negative Marginal Returns ▶ 1. Happens when workers are getting in each

▶ E. Negative Marginal Returns ▶ 1. Happens when workers are getting in each others way and disrupt the production process

II. PRODUCTION COSTS ▶ A. Fixed Costs: a cost that does not change, no

II. PRODUCTION COSTS ▶ A. Fixed Costs: a cost that does not change, no matter how much of a good is produced ▶ 1. Rent for a building, property taxes, salaries ▶ B. Variable Costs: Costs that rises or falls depending on how much is produced ▶ 1. Costs of raw materials and some labor ▶ Electricity/heating ▶ Costs of beans and cloth

▶ C. Total Cost: fixed costs plus variable costs ▶ 1. Add the two

▶ C. Total Cost: fixed costs plus variable costs ▶ 1. Add the two types of costs together ▶ D. Marginal Cost: the cost of producing one more unit of a good ▶ 1. Marginal costs falls as output increases ▶ 2. Eventually the marginal cost will start to rise reflecting the diminishing returns of labor

Beanbag s/hour Fixed Cost Variable Cost Total Cost (Fixed + Variable) Marginal Cost 0

Beanbag s/hour Fixed Cost Variable Cost Total Cost (Fixed + Variable) Marginal Cost 0 $36 $0 $36 - 1 $36 $8 $44 $8 2 $36 $12 $48 $4 3 $36 $15 $51 $3 4 $36 $20 5 $36 $27 6 $36 7 $36 $48 8 $36 $63 9 $36 $82 10 $36 $106 11 $36 $136 $5

III. SETTING OUTPUT ▶ A. Firms want to maximize profits ▶ 1. Profit: total

III. SETTING OUTPUT ▶ A. Firms want to maximize profits ▶ 1. Profit: total revenue minus total cost ▶ 2. Total revenue: is equal to the price of each good multiplied by the number of goods sold ▶ 3. Want the level of output with the highest profit ▶ Look for the biggest gap between total revenue and total cost

▶ B. Marginal Revenue and Marginal Cost ▶ 1. Marginal Revenue: the additional income

▶ B. Marginal Revenue and Marginal Cost ▶ 1. Marginal Revenue: the additional income from selling one more unit of a good ▶ 2. Want to find the output level where marginal revenue is equal to marginal cost

Beanbag s/hour Fixed Cost Variable Total Cost (Fixed + Variable) 0 $36 $0 $36

Beanbag s/hour Fixed Cost Variable Total Cost (Fixed + Variable) 0 $36 $0 $36 1 $36 $8 $44 2 $36 $12 3 $36 4 Marginal Total Profit Cost Revenue (total (Price) revenue -total Cost) - $24 $0 $-36 $8 $24 $-20 $48 $4 $24 $48 $0 $15 $51 $3 $24 $72 $21 $36 $20 $56 $5 $24 $96 $40 5 $36 $27 $63 $7 $24 $120 $57 6 $36 $72 $9 $24 $144 $72 7 $36 $48 $84 $12 $24 $168 $84 8 $36 $63 $99 $15 $24 $192 $93 9 $36 $82 $118 $19 $24 $216 $98 10 $36 $106 $142 $24 $240 $98 11 $36 $172 $30 $24 $264 $92 12 $36 $173 $209 $37 $24 $288 $79

IV. SHUT DOWN DECISION ▶ A. When do you shut down a factory? ▶

IV. SHUT DOWN DECISION ▶ A. When do you shut down a factory? ▶ 1. If you are at the most profitable level of output, however the market price is so low that the factory’s total revenue is less then its total cost: firm is losing money

▶ 2. Need to consider the operating cost ▶ 1. Operating cost: the cost

▶ 2. Need to consider the operating cost ▶ 1. Operating cost: the cost of operating a facility ▶ Just the variable costs not the fixed costs ▶ 2. If the total revenue of the factory is greater than the variable costs you should stay in business ▶ If you shut down you still have to pay all of the fixed costs ▶ Both situation you are losing money, but one you don’t lose as much