Chapter 14: Behind the Supply Curve: Inputs and Costs

Chapter 14: Behind the Supply Curve: Inputs and Costs

1. The Firm's Goal

• Maximizing Profits: The fundamental goal of any firm is to maximize profits, which can be calculated using the formula:

  • Profit = Total Revenue (TR) - Total Cost (TC)

2. Introduction to Farmer Jack

• Example: Farmer Jack produces wheat utilizing two main inputs: labor and land.

• Production Definition: The process of converting inputs into outputs.

3. Inputs and Their Classification

3.1 Fixed and Variable Inputs

• Fixed Inputs: Inputs that remain constant and cannot be varied in the short term.

  • Example: For Farmer Jack, land rental at $1,000/month is a fixed cost, commonly referred to as overhead cost.

• Variable Inputs: Inputs whose quantities can change at any time.

  • Example: Labor, which Farmer Jack hires at $2,000/month per laborer.

4. Time Periods in Production

• Long Run: A timeframe in which all inputs can be varied.

• Short Run: A period where at least one input is fixed.

• Total Product Curve: Illustrates the relationship between the quantity of output and the variable input used, holding fixed inputs constant.

5. Understanding the Production Function

• Production Function: The relationship between the amount of variable inputs and the resulting quantity of output. It can be expressed via tables, equations, or graphs (total product curves).

• Attributes: While different firms may have unique production functions, they share crucial characteristics.

6. Example: Farmer Jack’s Production Function

• Graph Analysis: Displays the number of workers against the quantity of wheat produced.

• Marginal Product (MP): The increase in output from adding an additional unit of input, with all other inputs held constant.

  • Marginal Product of Labor (MPL) Formula: MPL = ∆Q/∆L.

7. Diminishing Marginal Product

• Concept: As more of a variable input (like labor) is added, the marginal product usually starts to increase, then diminishes.

• Explanation: If Farmer Jack increases workers without expanding land, each additional worker has less land to manage, leading to decreased productivity.

8. Cost Types

8.1 Fixed and Variable Costs

• Fixed Costs (FC): Do not vary with production levels.

  • Example: Land rental at $1,000.

• Variable Costs (VC): Change with production output.

  • Example: Wage costs for labor.

• Total Cost (TC): TC = FC + VC.

9. Visualization of Costs

• Total Cost Curve: Reveals that TC increases as output (Q) rises, driven by the principles of diminishing marginal product.

10. Marginal Cost (MC)

• MC Definition: The additional cost incurred from producing one more unit of output.

  • Formula: MC = ∆TC/∆Q.

• Upward Sloping Nature: The marginal cost curve typically rises, linked to diminishing returns.

11. Examples and Analyses of Costs

11.1 Pizza Company Example

• Simplified scenario focusing on labor as the variable input to produce pizzas per hour. Fixed costs relate to equipment that is constant.

12. Average Costs

12.1 Varieties of Average Costs

• Average Fixed Cost (AFC): A decrease as output increases due to fixed costs spread over more units.

• Average Variable Cost (AVC): The variable cost associated with each unit produced. The AVC curve initially decreases, reaches a minimum, and then increases.

• Average Total Cost (ATC) is derived from adding the AFC and AVC.

13. Cost Curves Insights

• TC Curve: Steeper with more output due to increasing costs of variable inputs.

• Shape of Cost Curves: U-shaped due to the interplay of economies of scale and capacity limits.

14. Marginal-Average Cost Relationship

• The Rule: If marginal cost exceeds average total cost, average will rise; if below, the average will fall.

15. Long Run vs. Short Run Costs

• Cost Structures: In the short run, some inputs are fixed; in the long run, all can be adjusted, impacting average costs based on operational efficiency.

16. Conclusion

• Understanding various cost concepts is crucial for business decisions in production, pricing, and hiring.

• Future discussions will explore profit maximization within different market structures.