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Fall 2010
Herriges (ISU)
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Outline
Herriges (ISU)
Overview
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To guide the firm over the next several years, manager must use the
long-run view
To determine what the firm should do next week, the short run view
is best.
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Fixed inputs
- These are inputs whose quantity is constant for some period of time
(regardless of how much output is produced).
- Typically, fixed inputs will include land and machinery, though they can
also include certain types of labor (due to contracts).
Variable inputs
- These are inputs whose quantity the firm can vary, even in the short
run.
- Examples of variable inputs often include labor, energy, fuel, etc.
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Total Product
To fix ideas, suppose we have a firm whose only variable input is labor
All other inputs (capital, land, raw materials, etc.) we will assume for
now are fixed.
Total product is the maximum quantity of output that can be
produced from a given combination of inputs.
The total product curve shows how the quantity of output depends on
the quantity of variable input, for a given quantity of the fixed input.
We would generally expect the total product curve to be increasing;
i.e., as the quantity of the variable input increases, we would expect
total output to increase.
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Units of Labor
0
1
2
3
4
5
6
7
8
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Total Product
0
10
35
80
160
193
218
239
257
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Herriges (ISU)
Marginal Product
Notice that the Total Product curve is always increasing in this case,
but that its slope is not the same throughout.
- Initial the slope is increasing
- but eventually it starts to flatten out.
Tells us the rise in output produced when one more worker is hired
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Units of Labor
0
Total Product
0
Marginal Product
10
10
25
35
45
80
80
160
33
193
25
218
21
239
18
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This pattern of MPL (and for other inputs) is thought to hold for
most industries.
Consider the problem of a woodworking shop.
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Total Fixed costs (TFC): These are costs that do not depend upon the
quantity of output produced.
- These costs are typically associated with fixed inputs.
- Examples of fixed costs might be the rent paid for the firms building or
equipment rentals.
Total Variable costs (TVC): These are costs that depend on the
quantity output produced.
- As the name suggests, these are costs associated with the variable
inputs.
- In the case of Johns Woodworking shop, the TVC = w L where w
denotes the wage rate.
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Herriges (ISU)
Total
Output
0
10
35
80
160
193
218
239
257
Total Fixed
Cost (TFC)
$5000
$5000
$5000
$5000
$5000
$5000
$5000
$5000
$5000
Total Variable
Costs (TVC)
$0
$1200
$2400
$3600
$4800
$6000
$7200
$8400
$9600
Total
Costs (TC)
$5000
$6200
$7400
$8600
$9800
$11000
$12200
$13400
$14600
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While the breakdown of Total Cost into Total Fixed and Total
Variable Costs is helpful, two other measures of cost will be even
more useful:
1
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Average Costs
There are three types of average costs
1 Average Fixed Costs (AFC) = Total Fixed Costs divided by Output
TFC
AFC =
(1)
Q
Since the numerator is fixed, AFC will decline as output increases.
2 Average Variable Costs (AVC) = Total Variable Costs divided by
Output
TVC
AVC =
(2)
Q
- Since TVC is initial slowing down as output increases (with increasing
returns to labor), AVC will initially fall as output increases.
- As TVC starts to increase more rapidly with output (with diminishing
returns to labor), AVC will start to increase with output.
3
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Units of Labor
1
2
3
4
5
6
7
8
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Total Product
10
35
80
160
193
218
239
257
AFC
$500.00
$142.86
$62.50
$31.25
$25.91
$22.94
$20.92
$19.46
AVC
$120.00
$68.57
$45.00
$30.00
$31.09
$33.03
$35.15
$37.35
ATC
$620.00
$211.43
$107.50
$61.25
$56.99
$55.96
$56.07
$56.81
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Marginal Costs
Another way of looking at the firms cost structure is to look at its
Marginal Costs; i.e., how its costs increase as output increases.
Formally:
TC
MC =
(4)
Q
If we look at Johns Woodworking Shop we have
Output
0
10
35
80
160
193
218
239
257
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Total Cost
5000
6200
7400
8600
9800
11000
12200
13400
14600
TC
MC
10
25
45
80
33
25
21
18
1200
1200
1200
1200
1200
1200
1200
1200
120
48
27
15
36
48
57
67
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Labor
Units of Labor
0
1
2
3
4
5
6
7
8
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Units of Capital
Capital = 1 Capital = 2 Capital = 3
0
0
0
10
10
10
35
39
39
80
92
101
160
184
202
193
284
314
218
397
439
239
443
571
257
478
709
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Returns to Scale
LRATC curves for industries usually exhibit three basic phases:
1
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