Chapter 10

OUTPUT &
COSTS
THINK LIKE A PRODUCER

• A firm is an institution that hires factors of production and organizes them to

produce and sell goods and services
• A firm's fundamental goal is to maximize profit
• A producer makes several decisions to achieve its goal
• Two different time frames a firm faces for decision-making in terms of output
production & cost:
o Short run
o Long run

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SHORT RUN

• The short run is a time frame in which the quantity of one or more inputs
used in production is fixed or cannot be changed instantaneously
• Short run decisions are easily reversed
• For most firms, inputs such as the land, capital, called the firm's factory,
technology are fixed in the short run
• The cost of the fixed inputs are known as fixed costs (FC)
• Other inputs used by the firms (such as labour etc) can be changed in the
short run
•Sample
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LONG RUN

• The long run is a time frame in which the quantities of all the inputs/ resources
can be changed
• Long run decisions are not easily reversible
• In the long run, fixed costs can change

We’re going to study costs firms face in the short run and the long run

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SHORT RUN TECHNOLOGY CONSTRAINT

• To increase output in the short run, a firm must increase the quantity of labour
employed
• The relationship between output and the quantity of labour can be described
using three concepts:
• Total product
• Marginal product
• Average product

We will look into product schedules or product curves to understand these concepts.

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PRODUCT SCHEDULE

• A product schedule shows the total product, marginal product & average product of
a firm
• Total product is the maximum output that a given quantity of labour can produce
• The marginal product of labour is the change in total product resulting from a one-
unit increase in the quantity of labour employed, while all other inputs remain same
MP= Change in TP / Change in labour
• The average product of labour is equal to total product divided by the quantity of
labour employed
AP= Total Product / Total Labour

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PRODUCT SCHEDULE

The table tell us how Neat Knits’

production of jumper changes as
more workers are employed, for a
fixed level of plant and machines.
They also tell us about the
productivity of Neat Knits’ labour
force.

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PRODUCT CURVES

• The product curves are graphs of the relationships between employment and
the three product concepts you’ve just studied
• They show how total product, marginal product and average product change as
employment changes
• They also show the relationships among the three concepts

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TOTAL PRODUCT

• Production of jumper per day increases

as employment increases
• Similar to PPF
• Points inside the curve are attainable
but inefficient
• The steepness of the curve increases till
point C, then it keeps reducing
• The steeper the curve the greater is
the marginal product
• Slope of the TP curve= Marginal Product

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 MARGINAL
PRODUCT

• MP shows the
output from an
additional unit
of labour​

• Labour can be
measured in • The shape of the product curve represents:
person, hours or
- Increasing marginal returns initially
event minutes
- Diminishing marginal returns eventually

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LAW OF
DIMINISHING
RETURNS

As a firm uses more of a

variable input, with a
given quantity of fixed
inputs, the marginal
product of the variable
input eventually
diminishes.

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AVERAGE
PRODUCT
• Average product is largest at the
point where MP=AP
• AP increases at the points where MP
is higher than AP
• AP decreases at the points where AP
is higher than MP

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SHORT RUN COST

• To increase output in the short run, the number of labours employed needs to
increase
• With the increase in labour, cost incurred by the firm also increases
• The relationship between output & cost can be described using three concepts:
o Total cost
o Marginal cost
o Average cost

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TOTAL COST

• Total cost is the sum of the cost of all the factors of production/ inputs used by a
firm
• Total Cost (TC) is divided in two part:
o Total Fixed Cost (TFC)
o Total Variable Cost (TVC)
TC= TFC+TVC

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TOTAL COST

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MARGINAL COST

• A firm’s marginal cost is the change in total cost resulting from a one-unit
increase in output

• Marginal cost curve shows how much cost changes as output changes
• MC decrease at low level of outputs
• MC increases at higher level of outputs because of law of diminishing returns

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AVERAGE COST

• Average Cost (AC) is the cost per unit output

• Average Cost is divided in three part:
o Average Fixed Cost (AFC) is the total fixed cost per unit output
o Average Variable Cost (AVC) is the total variable cost per unit output
o Average Total Cost (ATC) is the total cost per unit output

ATC = AVC + AFC

OR,

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MARGINAL COST &
AVERAGE COSTS
• The AFC slopes downward. As output
increases, the same constant fixed
cost is spread over a larger output.
• The vertical distance between the
ATC & AVC curves is equal to AFC – as
indicated by the arrows.
• The MC curve intersects the AVC
curve and the ATC curve at their
minimum point.

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WHY IS THE ATC CURVE U-SHAPED

• The shape of the ATC combines the shape of the AFC & AVC
• The U-shape of the ATC arises from the two factors:
o Spreading fixed cost over a larger output
o Eventually diminishing returns

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COST CURVES & PRODUCT CURVES

• A firm’s marginal product curve is linked to its marginal cost curve

o If marginal product rises, marginal cost falls.
o If marginal product is a maximum, marginal cost is a minimum.
o If marginal product diminishes, marginal cost rises.

• A firms' average product curve is linked to tis Average Variable Cost curve
o If average product rises, average variable cost falls.
o If average product is a maximum, average variable cost is a minimum.
o If average product diminishes, average variable cost rises.

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LONG RUN COST

• In the short run, a firm can vary the quantity of labour but the quantity of
capital is fixed.
• In the long run, the firm can vary both the quantity of labour and the quantity of
capital.
• We are now going to study the firm’s costs in the long run, when all costs are
variable costs and when the quantity of labour and capital vary.

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PRODUCTION
FUNCTION
• The table shows Neat Knits’
production function. The table lists
the total product for four different
quantities of capital.
• Diminishing returns occur in all
four plants as the labour input
increases.
• Diminishing Marginal Product of
Capital

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SHORT RUN COST
ON FOUR
DIFFERENT PLANTS
• The figure shows short-run
average total cost curves for
four different quantities of
capital.
• Two things stand out:
o Each short-run ATC curve is
U-shaped.
o For each short-run ATC curve,
the larger the plant, the
greater is the output at which
ATC is a minimum.

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LONG RUN AVERAGE COSTS

• The plant size determines the short-run average cost curve on which Neat Knits
operates
• The plant size is determined by the owner. The owner's choice of plant size depends
on the output he/ she plans to produce.
• The average total cost of producing a given output depends on the plant size.
Example: suppose that Sam plans to produce 13 jumpers a day. Check graph.
• In the long run, Neat Knits chooses the plant size that minimizes average total cost.
• For a given output, a firm operates on its long-run average cost curve.
• The long-run average cost curve is the relationship between the lowest attainable
average total cost and output when both the plant size and labour are varied.

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LONG RUN
AVERAGE COST
CURVE
• When economies of scale
are present, the LRAC curve
slopes downward
• If economies of scale are
present, when a firm
doubles all inputs, its output
will more than double, and
so average costs fall
• When diseconomies of scale
are present, the LRAC curve
slopes upward

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