Chapter 6 (behind the supply curve: inputs and costs)

production function

(the quantity of output a firm produces depends on the quantity of inputs) the relationship between the quantity of inputs a firm uses and the quantity of output it produces.

fixed input

an input whose quantity is fixed for a period of time and cannot be varied. (ie land)

variable input

an input whose quantity the firm can vary at any time.

long run

the time period in which all inputs can be varied.

short run

the time period in which at least one input is fixed.

total product curve

shows how the quantity of output depends on the quantity of the variable input, for a given quantity of the fixed input.

change in the quantity output

called marginal product of labor (MPL) where one unit of labor is equal to one worker)

Marginal Product

the additional quantity of output that is produced by using one more unit of that input.

MPL equation

MPL= change in quantity of output / change in quantity of labor

Diminishing returns to an input

when an increase in the quantity of that input, holding the levels of all other inputs fixed, leads to a decline in the marginal product of that input.

Other things equal assumption

each successive unit of an input will raise production by less than the last if the quantity of all other inputs is held fixed.

Fixed cost

a cost that does not depend on the quantity of output produced. It is the cost of the fixed input.

Variable cost

A cost that depends on the quantity of output produced. It is the cost of the variable input.

Total cost

the sum of the fixed cost and variable cost of producing that quantity of output.

(TC=FC +VC)

Total cost curves

shows how total cost depends on the quantity of output.

Marginal cost

the change in total cost generated by producing one more unit of output

(MC = change in total cost / change in quantity of output) ie rise over run (slope)

tells producer how much more one unit of output costs to produce.

Average total cost

ATC = TC/Q

tells how much the average or typical unit of output costs to produce

U shaped average total cost

falls at low levels of output, then rises at higher levels

Average fixed cost

fixed cost per unit of output

Average variable cost

is variable cost per unit of output

Why ATC is a U-shape

at low levels of output, average total cost falls because the spreading effect of falling average fixed cost dominates the diminishing returns effect of rising average variable cost. At high levels of output, the opposite is true and total cost rises.

Spreading effect

The larger the output, the greater the quantity of output over which fixed cost is spread, leading to lower average fixed cost

Diminishing returns effect

The larger the output, the greater the amount of variable input required to produce additional units, leading to higher average variable cost.

Marginal cost curve

slopes upward — the result of diminishing returns affect that makes an additional unit of output more costly to produce than the one before.

Average variable cost curve

Slopes upward — due to diminishing returns (flatter than MC) This is because the higher cost of an additional unit of output is averaged across all units, not just the additional units, ni the average variable cost measure.

AFC curve

slopes downward — because of spreading effect

Three general principles that are always true about a firms ATC and MC curves

1. at minimum-cost output, average total cost is equal to marginal cost

2. At output less than the minimum-cost output, the marginal cost is less than average total cost and average total cost is falling.

3. At output greater than the minimum-cost output, the marginal cost is greater than average total cost and average total cost is rising.

Long run average total cost curve

shows the relationship between the output and average total cost when fixed cost has been chosen to minimize average total cost for each level of output.

Increasing returns to scale

when long-run average total cost declines as output increases.

decreasing returns to scale

when long-run average total cost increases as output increases.