Unit 6: Production Decisions & Economic Profit

Econ Units Included: 2: Seller Choice

Total Product

max. quantity that can be produced with a given amount of labor, holding all other inputs the same

Marginal Product of Labor

change in output that results from increasing variable input by one unit

MP_L= Change in total product/change in Q of labor = Change in Q/change in L

Increasing Marginal Returns

occurs when MP of an additional unit of input exceeds the MP of a previous unit of input (specialization of labor)

Diminishing Marginal Returns

occurs when MP of an additional unit is less than the MP of the previous unit of input

Law of Diminishing Marginal Returns

as firm uses more of a variable factor of production with a given quantity of fixed factor of production, the MP of the variable factor will eventually diminish

Average Product of Labor (MP_L)

average amount of output per unit of labor

AP_L = total product/Q of labor = Q/L

Relationship between MP and AP

• When Avg. product is INC, MP_L>AP_L

• When Avg. product is DEC, MP_L<AP_L

• When Avg. product is neither INC or DEC, MP_L=AP_L

Fixed Costs

Costs that do not vary with output

Sunk vs. Avoidable fixed costs

Sunk (incurred regardless)

Avoidable (avoided if production halts)

Fixed costs in SR and LR

LR - fixed costs become avoidable

SR - cannot avoid fixed costs

Variable costs

costs that are directly dependent on the output, vary with level of output

Total Cost

TC = VC + FC

Marginal cost

change in the TC resulting from an INC in the production of one unit of output

MC = change in TC/Change in Q

MC = change in AVC/change in Q

How does diminishing marginal returns cause increasing marginal cost?

When marginal product of labor INC, MC must DEC

when MP of labor falls, MC must rise

Average Fixed Costs (AFC)

total fixed costs per unit of output

Average Variable Costs

total variable costs per output

Average total cost

total cost per output

ATC = AVC + AFC

Relationship between MC and AVC curves

MC < Avg. cost, avg. cost DEC

MC > Avg. cost, avg. cost INC

MC = avg. cost, avg. cost at MIN

Accounting Profit

TR-Explicit

Economic Profit

TR-(Explicit + Implicit)

Explicit Costs

costs that are out of pocket

ex. payments, wages, rent

Implicit Costs

cost of resources already owned by firm (opp. c)