2.4. Production and Costs in the Short Run Flashcards
Production definition
the process of converting factor inputs (FOPs) into output (goods and services)
Time periods short run
1) short run
at least one FOP (usually capital) is fixed (quantity does not change).
2) long run
all FOPs are variable (quantity of all FOPs can change)
3) very long run
change in the state of technology (technology advances)
Total product
the total amount of output produced by all the inputs.
Marginal product
change in total product from an additional variable input (labour)
ΔTP / ΔQ(L)
Average product
output per unit of variable input (labour)
TP / Q(L)
Law of Diminishing Marginal Returns (Law of Variable Proportions)
As additional units of the variable input (e.g. labour) are combined with a fixed input (e.g. capital), eventually the marginal product of the the variable input (e.g. labour) will fall.
- begins at the peak of the MP curve and continues as the curve slopes downwards
Relationships between Total Production curve and Marginal Production curve (DRAW DIAGRAMS)
1) When MP = 0, TP is maximised.
2) When MP is maximised, TP rises at steepest gradient.
3) MP cuts through the top of AP because:
a. When MP > AP, AP rises.
b. When MP < AP, AP falls.
c. Therefore, MP cuts through top of AP.
Why does diminishing returns occur?
- it all relates to the fact that for any fixed quantity of capital, there will be an optimal number of workers to operate the capital most efficiency
- If a firm employs too few workers, capital will not be full utilized. Each worker may struggle to make effective use of machinery. Marginal product of the extra worker will be low and therefore average product also be low
- As more workers are hired, workers may begin to cooperate. Each is able to specialise (division of labor) and the business will operate more efficiently. Marginal product will start to rise (increasing marginal returns) and therefore the average product will also rise (increasing average returns)
- If a firm employs too many workers, this means that each worker, on average, has fewer machines and less equipment to work with. Marginal product starts to fall and therefore average product will eventually fall too. When this happens diminishing returns (marginal and average) have set in
- Eventually the firm will become so crowded and become less productive. If the firm continues to supply more labour, marginal product may become negative
Fixed Costs
costs that do not change with output.
Variable Costs
costs that change with output.
Total Costs
sum of fixed costs and variable costs.
- TC = FC + VC
- When output is zero, VC = 0 therefore TC = FC
Fixed Cost (FC), Variable Cost (VC), Total Cost (TC) (DRAW DIAGRAM)
- distance between TC and VC is the same distance as fixed cost
- fixed cost is horizontal
Marginal Costs
the change in total cost from the production of an additional unit of output.
ΔTC / ΔOutput
Marginal Cost and Marginal Product
The graphs are mirror images of each other
- MC curve - like a tick shape
- MP curve - like a mountain
- diminishing marginal returns starts at the peak of the MP curve and trough of the MC curve
Average Fixed Cost (AFC)
fixed cost per unit of output.
AFC = FC / Output
