11 OUTPUT AND COSTS

After studying this chapter, you will be able to:

 Distinguish between short run and long run
 Explain and illustrate a firm’s short-run product curves
 Explain and derive a firm’s short-run cost curves
 Explain and derive a firm’s long-run average cost curve

© 2019 Pearson Education

 Decision Time Frames

The firm makes many decisions to achieve its main

objective: profit maximization.
Some decisions are critical to the survival of the firm.
Some decisions are irreversible (or very costly to reverse).
Other decisions are easily reversed and are less critical to
the survival of the firm, but still influence profit.
All decisions can be placed in two time frames:
 The short run
 The long run

© 2019 Pearson Education

 Decision Time Frames

The Short Run

The short run is a time frame in which the quantity of one
or more resources used in production is fixed.
For most firms, the capital, called the firm’s plant, is fixed
in the short run.
Other resources used by the firm (such as labor, raw
materials, and energy) can be changed in the short run.
Short-run decisions are easily reversed.

© 2019 Pearson Education

 Decision Time Frames

The Long Run

The long run is a time frame in which the quantities of all
resources—including the plant size—can be varied.
Long-run decisions are not easily reversed.
A sunk cost is a cost incurred by the firm and cannot be
changed.
If a firm’s plant has no resale value, the amount paid for it
is a sunk cost.
Sunk costs are irrelevant to a firm’s current decisions.

© 2019 Pearson Education

 Short-Run Technology Constraint

To increase output in the short run, a firm must increase

the amount of labor employed.
Three concepts describe the relationship between output
and the quantity of labor employed:
1. Total product
2. Marginal product = the change in TP/ the change in Q
3. Average product = TP/Q

© 2019 Pearson Education

 Short-Run Technology Constraint

Product Schedules
Total product is the total output produced in a given
period.
The marginal product of labor is the change in total
product that results from a one-unit increase in the
quantity of labor employed, with all other inputs remaining
the same.
The average product of labor is equal to total product
divided by the quantity of labor employed.

© 2019 Pearson Education

 Short-Run Technology Constraint

Table 11.1 shows a firm’s Labor TP MP AP

product schedules.
0 0
As the quantity of labor
employed increases: 1 4

 Total product increases. 2 10

 Marginal product increases 3 13

initially …
4 15
but eventually decreases.
 Average product decreases. 5 16

© 2019 Pearson Education

© 2019 Pearson Education
 Short-Run Technology Constraint

Product Curves
Product curves show how the firm’s total product, marginal
product, and average product change as the firm varies
the quantity of labor employed.

© 2019 Pearson Education

 Short-Run Technology Constraint

Total Product Curve

Figure 11.1 shows a total
product curve.
The total product curve
shows how total product
changes with the quantity
of labor employed.

© 2019 Pearson Education

 Short-Run Technology Constraint

To make a graph of the

marginal product of labor,
we can stack the bars in
the previous graph side by
side.
The marginal product of
labor curve passes
through the mid-points of
these bars.

© 2019 Pearson Education

 Short-Run Technology Constraint

Increasing marginal returns arise from increased

specialization and division of labor.
Diminishing marginal returns arises because each
additional worker has less access to capital and less
space in which to work.
Diminishing marginal returns are so pervasive that they
are elevated to the status of a “law.”
The law of diminishing returns states that:
As a firm uses more of a variable input with a given
quantity of fixed inputs, the marginal product of the
variable input eventually diminishes.
© 2019 Pearson Education
 Short-Run Technology Constraint

Average Product Curve

Figure 11.3 shows the
average product curve
and its relationship with
the marginal product
curve.
When marginal product
exceeds average product,
average product
increases.

© 2019 Pearson Education

 Short-Run Technology Constraint

When marginal product is

below average product,
average product
decreases.
When marginal product
equals average product,
average product is at its
maximum.

© 2019 Pearson Education

 Short-Run Cost

To produce more output in the short run, the firm must

employ more labor, which means that it must increase its
costs.
Three cost concepts and three types of cost curves are
 Total cost = TFC + TVC
 Marginal cost = the change in TC/ the change in TP
= the change in TVC/ the change in TP
 Average cost = TC/TP

© 2019 Pearson Education

 Short-Run Cost

Total Cost
A firm’s total cost (TC) is the cost of all resources used.
Total fixed cost (TFC) is the cost of the firm’s fixed inputs.
Fixed costs do not change with output.
Total variable cost (TVC) is the cost of the firm’s variable
inputs. Variable costs do change with output.
Total cost equals total fixed cost plus total variable cost.
That is:
TC = TFC + TVC

© 2019 Pearson Education

 Short-Run Cost

Figure 11.4 shows a

firm’s total cost curves.
Total fixed cost is the
same at each output
level.
Total variable cost
increases as output
increases.
Total cost, which is the
sum of TFC and TVC
also increases as output
increases.
© 2019 Pearson Education
 Short-Run Cost

Marginal Cost
Marginal cost (MC) is the increase in total cost that
results from a one-unit increase in total product.
Over the output range with increasing marginal returns,
marginal cost falls as output increases.
Over the output range with diminishing marginal returns,
marginal cost rises as output increases.

© 2019 Pearson Education

 Short-Run Cost

Average Cost
Average cost measures can be derived from each of the
total cost measures:
Average fixed cost (AFC) is total fixed cost per unit of
output.
Average variable cost (AVC) is total variable cost per unit
of output.
Average total cost (ATC) is total cost per unit of output.
ATC = AFC + AVC.

© 2019 Pearson Education

 Short-Run Cost

Figure 11.5 shows the MC,

AFC, AVC, and ATC curves.
The AFC curve shows that
average fixed cost falls as
output increases.
The AVC curve is U-shaped.
As output increases,
average variable cost falls to
a minimum and then
increases.

© 2019 Pearson Education

 Short-Run Cost

The ATC curve is also

U-shaped.
The MC curve is very
special.
For outputs over which AVC
is falling, MC is below AVC.
For outputs over which AVC
is rising, MC is above AVC.
For the output at minimum
AVC, MC equals AVC.

© 2019 Pearson Education

 Short-Run Cost

Similarly, for the outputs

over which ATC is falling,
MC is below ATC.
For the outputs over which
ATC is rising, MC is above
ATC.
For the output at minimum
ATC, MC equals ATC.

© 2019 Pearson Education

 Short-Run Cost

Cost Curves and Product Curves

The shapes of a firm’s cost curves are determined by the
technology it uses.
We’ll look first at the link between total cost and total
product and then …
at the links between the average and marginal product and
cost curves.

© 2019 Pearson Education

 Short-Run Cost

Average and Marginal Product and Cost

The firm’s cost curves are linked to its product curves.
 MC is at its minimum at the same output level at which
MP is at its maximum.
 When MP is rising, MC is falling.
 AVC is at its minimum at the same output level at which
AP is at its maximum.
 When AP is rising, AVC is falling.

© 2019 Pearson Education

 Short-Run Cost

Figure 11.7 shows these

relationships.

© 2019 Pearson Education

 Question: Fill in the table
Total Total Total Fixed Total Variable Marginal Average Total Avg. Fixed Avg. Variable
Output Cost Cost Cost Cost Cost Cost Cost

0 30
1 35
2 60
3 110
4 200
5 320
6 600

a) Complete the above table.

b) Draw marginal cost curve, average total cost curve, and average variable cost
curve on the same graph in excel.

© 2019 Pearson Education

 Question
Charlie’s Chocolates total product Labor Output
schedule is in the table. (workers per day) (boxes per day)

a. Draw the total product curve.

b. Calculate the average product of
labor and draw the average 1 12
product curve.
c. Calculate the marginal product of 2 24
labor and draw the marginal 3 48
product curve.
d. What is the relationship between 4 84

the average product and marginal 5 121

product when Charlie’s Chocolates
produces (i) less than 276 boxes a 6 192
day and (ii) more than 276 boxes a 7 240
day?
8 276
2. In problem 1, the price of labor is
$50 per day, and total fixed costs 9 300
are $50 per day. 10 312
a. Calculate total cost, total variable
cost, and total fixed costs for each
level of output and draw the short-
run total cost curves.
b. Calculate average total cost, © 2019 Pearson Education
 Answers
Labor Output
MP AP TFC TVC TC MC AFC AVC ATC

1 12
12 50 50 100 4.166667 4.166667 8.333333
2 24
12 12 50 100 150 4.166667 2.083333 4.166667 6.25
3 48
24 16 50 150 200 2.083333 1.041667 3.125 4.166667
4 84
36 21 50 200 250 1.388889 0.595238 2.380952 2.97619
5 121
37 24.2 50 250 300 1.351351 0.413223 2.066116 2.479339
6 192
71 32 50 300 350 0.704225 0.260417 1.5625 1.822917
7 240
48 34.28571 50 350 400 1.041667 0.208333 1.458333 1.666667
8 276
36 34.5 50 400 450 1.388889 0.181159 1.449275 1.630435
9 300
24 33.33333 50 450 500 2.083333 0.166667 1.5 1.666667
10 312
12 31.2 50 500 550 4.166667 0.160256 1.602564 1.762821

© 2019 Pearson Education

 Long-Run Cost

In the long run, all inputs are variable and all costs are
variable.
The Production Function
The behavior of long-run cost depends upon the firm’s
production function.
The firm’s production function is the relationship between
the maximum output attainable and the quantities of both
capital and labor.

© 2019 Pearson Education

 Long-Run Cost

Table 11.3 shows a

firm’s production
function.
As the size of the plant
increases, the output
that a given quantity of
labor can produce
increases.
But for each plant, as
the quantity of labor
increases, diminishing
returns occur.
© 2019 Pearson Education
 Long-Run Cost

Diminishing Marginal Product of Capital

The marginal product of capital is the increase in output
resulting from a one-unit increase in the amount of capital
employed, holding constant the amount of labor employed.
A firm’s production function exhibits:
 Diminishing marginal returns to labor (for a given plant)
 Diminishing marginal returns to capital (for a quantity of
labor).
For each plant, diminishing marginal product of labor
creates a set of short run, U-shaped cost curves for MC,
AVC, and ATC.
© 2019 Pearson Education
 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.
The larger the plant, the greater is the output at which
ATC is at a minimum.
The firm has 4 different plants: 1, 2, 3, or 4 knitting
machines.
Each plant has a short-run ATC curve.
The firm can compare the ATC for each output at
different plants.

© 2019 Pearson Education

 Long-Run Cost

ATC1 is the ATC curve for a plant with 1 knitting machine.

© 2019 Pearson Education

 Long-Run Cost

ATC2 is the ATC curve for a plant with 2 knitting machines.

© 2019 Pearson Education

 Long-Run Cost

ATC3 is the ATC curve for a plant with 3 knitting machines.

© 2019 Pearson Education

 Long-Run Cost

ATC4 is the ATC curve for a plant with 4 knitting machines.

© 2019 Pearson Education

 Long-Run Cost

The long-run average cost curve is made up from the

lowest ATC for each output level.
We need to decide which plant has the lowest cost for
producing each output level.
Suppose that the firm wants to produce 13 sweaters a day.
What is the least-cost way of producing 13 sweaters a
day?

© 2019 Pearson Education

 Long-Run Cost

The 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 and labor are varied.
The LRAC curve is a planning curve that tells the firm the
plant that minimizes the cost of producing a given output.
Once the firm has chosen its plant, the firm incurs the
costs that correspond to the ATC curve for that plant.

© 2019 Pearson Education

 Long-Run Cost

Figure 11.9 illustrates the LRAC curve.

© 2019 Pearson Education

© 2019 Pearson Education
 Long-Run Cost

Economies and Diseconomies of Scale

Economies of scale are features of a firm’s technology
that lead to falling long-run average cost as output
increases.
Diseconomies of scale are features of a firm’s
technology that lead to rising long-run average cost as
output increases.
Constant returns to scale are features of a firm’s
technology that lead to constant long-run average cost as
output increases.

© 2019 Pearson Education

 Long-Run Cost

Figure 11.9 illustrates economies and diseconomies of scale.

© 2019 Pearson Education

 Long-Run Cost

Minimum Efficient Scale

A firm experiences economies of scale up to some output
level.
Beyond that output level, it moves into constant returns to
scale or diseconomies of scale.
Minimum efficient scale is the smallest quantity of output
at which the long-run average cost reaches its lowest
level.
If the LRAC curve is U-shaped, the minimum point
identifies the minimum efficient scale output level.

© 2019 Pearson Education

 Long-Run Cost

Figure 11.9 illustrates the minimum efficient scale.

© 2019 Pearson Education

 Question

The table shows the Labor Output

(workers (pizzas per day)
production function of per day)
Mario’s Pizza-to-Go. Mario
must pay $100 a day for Plant 1 Plant 2 Plant 3 Plant 4
each oven he rents and $75
a day for each kitchen hand 1 4 8 11 13
he hires
2 8 12 15 17
a. Find and graph the
average total cost curve 3 11 15 18 20
for each plant size.
b. Draw Mario’s long- 4 13 17 20 22

run average cost curve.

Ovens 1 2 3 4
c.Over what output range
does Mario experience
economies of scale?
d. Explain how Mario
uses his long-run average
cost curve to decide how
© 2019 Pearson Education
 Answers

Labor Output

Plant 1 Plant 2 Plant 3 Plant 4 TC1 TC2 TC3 TC4 ATC1 ATC2 ATC3 ATC4

1 4 8 11 13 175 275 375 475 43.75 34.38 34.09 36.54

2 8 12 15 17 250 350 450 550 31.25 29.17 30.00 32.35

3 11 15 18 20 325 425 525 625 29.55 28.33 29.17 31.25

4 13 17 20 22 400 500 600 700 30.77 29.41 30.00 31.82

Ovens 1 2 3 4

© 2019 Pearson Education