Marginal CostMarginal Cost (MC) Is the increase in Total Cost from producing one more unit:MC = (Δ TC) / (Δ Q)Look at example 1 in notes to find MCit cost x to produce additional bushel of wheat in that certain range.MC usually rises as Q rises, due to diminishing marginal product.Sometimes (as in example 2), MC falls before rising.the fish hook, more typical MCin other examples, MC may be constant***when plotting this, the points are between the quantities on the horizontal axisSomething produces on an assembly line?Why MC is ImportantFarmer Jack is rational and wants to maximize his profit. To increase profit, should he produce more or less wheat?To find the answer, Farmer Jack needs to “think at the margin”If the cost of additional wheat (MC) is less than the revenue he would get from selling it, then Jack’s profits rise if he produces more.We use MC to maximize product.AFC is always going downATC is always aboveMC will hit ATC at its lowest pointLook at examples in bookExample: Why ATC is usually U-shapedAs Q rises:initially falling AFC pulls ATC downEventually rising AVC pulls ATC upEfficient scale: the quantity that minimizes ATCThe minimum of ATCExample 2: ATC and MCMC will cross ATC at its lowest pointWhen MC < ATC, ATC is fallingWhen MC > ATC, ATC is risingThe MC curve crosses the ATC curve at the ATC curve’s minimumCosts in the Short Run and Long RunShort run is 1-2 yearsshort run:some inputs are fixes (e.g., factories, land). The costs of these inputs are FCat least one input is fixed99% of the time, capitol is the input that is fixedlong run:all inputs are variable (e.g., firms can build more factories, or sell existing ones).Not measures in timeIn the long run, ATC at any Q is cost per unit using the most efficient mix of inputs for that Q (e.g., the factory size with the lowest ATC)Example 3: LRATC with 3 factory sizesFirm can choose from 3 factory sizes: S,M,LEach size has its own SRATC curveLook at graph in notesThe firm can change to a different factory size in the long run, but not in the short runTo produce less than Qa, firm will choose size S in the long runTo produce between Qa and Qb, firm will choose size M in the long runTo produce more than Qb, firm will choose size L in the long runLRATC connects the all the ATC curves***SRATC curve is the same at ATC curveA Typical LRATC curve (long run only)in the real world, factories come in many sizes, eachthe shape of the LRATC is important bc it tells us the economies of scaleEconomies of scale: ATC falls as Q increases (GOOD) (want this rather than constant)Constant returns to scale: ATC stays the same as Q increases (OKAY)Diseconomies of scale: ATC rises as Q increases (BAD)How ATC changes as the Scale of Production changesEconomies of scale occur when increasing production allows greater specialization: workers more efficient when focusing on a narrow taskMore common when Q is lowDiseconomies of scale are due to coordination problems in large organizationsE.g., management becomes stretched, cant control costsOct 21,2013Econ Notes: Chapter 13Total Revenue, Total Cost, Profit- We assume that the firm’s goal is to maximize profit.- Profit=Total Revenue- Total Costo Total Revenue: the amount a firm receives from the sales of its output.o Total Cost: the market value of the inputs a firm uses in production. Costs: Explicit vs. Implicit- Explicit Cost require an outlay of money, e.g., paying wages to workers- Implicit costs do not require a cash outlay, e.g., the opportunity cost of the owner’s time- Remember one of the Ten Principles:o The cost of something is what you give up to get it.- This is true whether the costs are implicit or explicit. Both matter for firms’ decisions. Economic Profit vs. Accounting Profit- Accounting profito = total revenue minus total explicit- Economic profito = total revenue minus total costs (including explicit and implicit costs)- Accounting profit ignores implicit costs, so it’s higher than economic profit. Production Function- A production function shows the relationship between the quantity of inputs used to produce a good and the quantity of output of that good.- It can be represented by a table, equation, or graph.- Ex 1o Farmer Jack grows wheato He has 5 acres of lando He can hire as many workers as he wants. Marginal Product- If Jack hires one more worker, his output rises by the marginal product of labor- The marginal product of any input is the increase in output arising from an additional unit of that input, holding all other inputs constant.o Change in output as you hire or use another unit of an input - Notation:o Δ Delta=”change in…”- Examples: Δ Q: change in output, Δ L= change in labor- Marginal product of labor (MPL)= Δ Q/ Δ LOct 21,2013o MPL equals the slop of the production function.o *Notice MPL diminishes as L increases. o This explains why the production function gets flatter as L increases. Why MPL is Important-Recall one of the Ten Princniples:o Rational people think at the margin- When farmer Jack hires an extra worker,o His cost rise by the wage he pays the workero His output rises by MPL- Comparing them helps Jack decide whether he would benefit from hiring the worker. Why MPL Diminishes - Farmer Jack’s output rises by a smaller and smaller amount for each additional worker. Why?- As Jack adds workers, the average worker has less land to work with and will be less productive- In general, MPL diminishes as L rises whether the fixed input is land or capital (equipment, machines, etc.)- Diminishing marginal product: the marginal product of an input declines as the quantity of the input increases (other things equal)Fixed and Variable Costs- Fixed costs (FC) do not vary with quantity of output producedo For Farmer Jack, FC=1000 for his lando Other examples: cost of equipment, loan payments, rent Straight line - Variable costs (VC) vary with the quantity produced.o For Farmer Jack VC= wages he pays workerso Other examples: cost of materials Something is always Zero?- Total Cost (TC)= FC+VCo Above fixed cost’- Average fixed cost (AFC) is fixed cost divided by the quantity of output:o AFC=FC/Qo Always fall, never reaches zeroo Notice the AFC falls as Q rises: The firm is spreading its fixed costs over a larger and larger number of units. - Average variable cost (AVC) is variable cost divided by the quantity of output:- AVC=VC/QOct 21,2013- As Q rises, AVC may fall initially. In most cases, AVC will eventually rise as output