Prices & Markets Chapter 7

In the short run, the firm’s technology and physical plant are fixed, but other inputs (such as labour and raw materials) are variable.

Costs of fixed inputs are fixed costs and the costs of variable inputs are variable costs.

Time period is too short to change the quantity of one of the input.

In the long run, the firm can vary the quantities of all inputs, adopt new technology and change the size of its physical plant.

A long-run average cost curve shows the lowest cost at which the firm is able to produce a given quantity of output in the long run, when no inputs are fixed.

Total Cost (TC) =Fixed Cost (FC) +Variable Cost (VC)

Implicit costs: Non-monetary opportunity costs.

Explicit cost: When a firm spends money

• Production function: Relationship between the inputs employed by the firm and the maximum
• output it can produce with those inputs

• Average total cost (ATC) = Total cost /
• Quantity of output produced (TC/Q).

• As production increases from low levels, ATC falls. ATC will rise as output increases further at higher levels of production (once the firm is producing more output than its plant was designed
• to produce).

In the short run, adding more and more of a variable input, such as labour, to the same amount of a fixed input, such as capital, will eventually cause the marginal product of labour to decline.

The law of diminishing returns is the principle that, at some point, adding more of a variable input, such as labour, to the same amount of a fixed input, such as capital, will cause the marginal product of the variable input to decline.

The increases in marginal product of labour that occur at low rates of output result from specialisation and the division of labour.

Adding a second or third worker, for example, reduces the time the workers spend moving from one activity to the next and allows them to be more specialised at their tasks.

Marginal product of labour is the change in output that results from change in variable (changing the number of workers hired).

Average product of labour equals total output / total number of workers hired.

Average product increases.

Average product of labour decreases.

Marginal cost (MC) is the change in total cost from producing one more unit of output.

MC = Change in total cost / Change in Quantity

When the marginal product of the variable factor increases (i.e. workers' product), marginal cost decreases (i.e. cost of producing 1 unit), and when the marginal product of the variable factor decreases, marginal cost increases.

• Marginal product increase = Marginal cost decrease
• Marginal product decrease = Marginal cost increase

In other words:

When the output of workers increase, the cost of producting one product decreases.

Average total cost (ATC) = total cost divided by total output (TC/Q).

Average fixed cost (AFC) = total fixed cost divided by total output (FC/Q).

AVC = total variable cost divided by total output (VC/Q).

ATC = AFC + AVC

When MC is less than ATC (or AVC), ATC (AVC) decreases.

When MC is greater than ATC (AVC) increases.

MC curve intersects both the ATC and AVC curves at their lowest points.

• Economies of scale means long run ATC
• falls as output increases.

Constant returns to scale occur when long run ATC is unchanged as output increases.

Diseconomies of scale exist when long run ATC rises as output increases.

Positive technological change results in the production of more output using the same quantities of inputs or production of the same amount of output with lower quantities of inputs. Positive technological change can result from the installation of faster machinery or equipment.

Negative technological change can result from damage to machinery or equipment from a hurricane. Negative technological change results in less output produced from the same quantity of inputs.

The short run is a time period during which at least one of the firm’s inputs is fixed so that changes in the rate of output result from varying the use of other variable inputs.

In the long run, the firm changes the rate of output by varying all inputs. In the long run, there are no fixed inputs.

The marginal product of labour is the additional output produced by a firm by hiring one more worker.

• The average product of labour equals total output produced by a firm divided by the number of
• its workers.

When the marginal product of labour is greater than the average product of labour, the average product increases.

When the marginal product of labour is less than the average product of labour, the average product decreases.

Marginal cost is the change in total cost caused by producing one more unit of output.

Average total cost equals total cost divided by total output.

When marginal cost is greater than average total cost, average total cost increases.

When marginal cost is less than average total cost, average total cost decreases.

• 
• The average fixed cost curve declines continuously as output increases.

The average total cost curve and the average variable cost curve are U-shaped.

The marginal cost curve crosses both of these curves from below at their lowest points.

The distance between the average total cost curve and the average variable cost curve equals average fixed cost.

The long run average total cost curve shows the lowest cost at which a firm can produce a given amount of output in the long run.

This curve shows the impact on cost of expanding output by, for example, building a larger factory or store.