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Economics 111.3 Winter 14
March 10th, 2014
Lecture 21
Ch. 11: Output and costs
Test 3
• Friday, March 14th, 2014
• 8:30 – 9:20 Room 200 STM
• Chapters to be tested: 9, 10 (up to p. 231)
and 11 (short-run costs only)
• Format: Multiple-Choice Questions (MCQ):
30 questions – 100% of Test mark
Time – 50 minutes
Short-Run Production Relationship: a recap
Average product (the same as
labour productivity) is calculated by
dividing total output
by the number of workers who produced it.
The Law of Diminishing Marginal
Productivity (Diminishing Returns)
• The law of diminishing marginal productivity
states that as more and more of a variable
input is added to an existing fixed input, after
some point the additional output obtained
from the additional input will fall.
• This law is also called the flowerpot law,
because it if did not hold true, the world’s
entire food supply could be grown in a single
flower pot.
units of
labour
0
1
2
3
4
5
6
7
8
TP
0
10
25
45
60
70
75
75
70
MP
AP=
10
15
20
15
10
5
0
-5
AP
total product
total labour input
10.00
12.50
15.00
15.00
14.00
12.50
10.71
8.75
Marginal & Average Values
• If the average value is
rising, the marginal
value must be ABOVE
the average value
• If the average value is
falling, the marginal
value must be BELOW
the average value
Profit = Total revenue – Economic cost
Costs of
production in
the short run are:
Fixed Costs,
Variable Costs,
and Total Costs.
Fixed Costs
• Fixed costs are those that are spent and cannot be
changed in the period of time under consideration.
• Fixed costs do not vary with changes in output (e.g.,
firm’s debt, rental payments, interest, insurance
premiums)
• In the long run there are no fixed costs since all costs
are variable.
• Sunk costs – a subset of fixed costs that are not
recoverable if a firm goes out of business. Examples:
advertising expenditures, purchasing the advice of a
management consultant, market research
Variable Costs
• Variable costs are costs that change
as output changes, such as the costs
of labour and materials.
• NB! The increases in variable costs
associated with succeeding one-unit
increase in output are not equal
Total Costs
• The sum of the
variable and fixed
costs are total
costs:
TC = FC + VC
Average Cost
Average fixed cost (AFC) is total fixed
cost per unit of output.
Average variable cost (AVC) is total
variable cost per unit of output.
Average total cost (ATC) is total cost
per unit of output.
Average Cost
How are the average cost curves
related to each other?
TC  TFC  TVC
TC TFC TVC


Q
Q
Q
OR
ATC  AFC  AVC
Q
0
1
2
3
4
5
6
7
8
9
10
TFC
100
100
100
100
100
100
100
100
100
100
100
TVC
0
90
170
240
300
370
450
540
650
780
930
TC
AFC
AVC
ATC
AFC=TFC / Q
100
190 100
270
50
340 33.33
25
400
20
470
550 16.67
640 14.29
750 12.50
880 11.11
1030 10
MC
Q
0
1
2
3
4
5
6
7
8
9
10
TFC
TVC
TC
AFC
100
0
AVC=TVC
/100
Q
100
90
190 100
100
170
270
50
100
240
340 33.33
25
100
300
400
100
370
20
470
100
450
550 16.67
100
540
640 14.29
100
650
750 12.50
100
780
880 11.11
100
930 1030
10
AVC
90
85
80
75
74
75
77.14
81.25
86.67
93
ATC
MC
Q
0
1
2
3
4
5
6
7
8
9
10
TFC
TVC
100
0
ATC=TC
100
90
100
170
100
240
100
300
100
370
100
450
100
540
100
650
100
780
100
930
TC
AFC
/ 100
Q
190 100
270
50
340 33.33
25
400
20
470
550 16.67
640 14.29
750 12.50
880 11.11
1030 10
AVC
ATC
90
85
80
190
135
75
74
75
113.33
100
94
77.14
91.67
91.43
81.25
93.75
86.67
97.78
93
103
MC
Marginal cost (MC) is the increase in total
cost that results from a one-unit increase
in output.
It equals the increase in total cost divided by the
increase in output.
Marginal cost decreases at low outputs because
of the gains from specialization, but eventually
increases due to the law of diminishing
returns.
Q
0
1
2
3
4
5
6
7
8
9
10
TFC
100
100
100
100
100
100
100
100
100
100
100
TVC
0
90
170
240
300
370
450
540
650
780
930
TC
AFC
AVC
MC=
TC
100
190 100
270
50
340 33.33
25
400
20
470
550 16.67
640 14.29
750 12.50
880 11.11
1030 10
90
85
80
75
74
75
/ ATC
Q
190
135
113.33
100
94
77.14
91.67
91.43
81.25
93.75
86.67
97.78
93
103
MC
90
80
70
60
70
80
90
110
130
150
• Average fixed cost declines continuously as output
increases
• Average-Variable-Cost and Average-Total-Cost
curves are U-shaped, reflecting increasing and then
diminishing returns
• The Marginal-Cost curve falls when marginal
returns increase, and rises when marginal returns
diminish.
• The Marginal-Cost curve intersects both the
Average-Variable- and Average-Total Cost curves at
their minimum points.
Cost (dollars per sweater)
Marginal Cost and Average
Costs
15
ATC = AFC + AVC
MC
ATC
AVC
10
5
AFC
0
5
10
15
Output (sweaters per day)
b) “At the current output level, this factory is
subject to diminishing returns. Therefore, the
firm is operating along the upward-sloping
portion of its short-run average total cost
curve”.
b) “At the current output level, this factory is
subject to diminishing returns. Therefore, the
firm is operating along the upward-sloping
portion of its short-run average total cost
curve”.