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1 AGENDA Tues 10/6 QOD #20: Caution! Curves Ahead Law of Diminishing Marginal Returns Costs of Production (Review HW Q#1,2,5,6) Short & Long Run (Q # 8, 9, 10) Partner Practice Ch 7 P # 2&3 HW: Prep for Ch 6 & 7 Quiz/Assessment/ Opportunity for demonstrating understanding or areas of confusion

2 QOD #20: Caution! Curves Ahead Part 1: Calculate MP and AP Input of Labor Total Production Marginal Product Average Product

3 QOD #20: Caution! Curves Ahead Part 1: Calculate MP and AP Input of Labor Total Production Marginal Product Average Product

4 QOD #20: Caution! Curves Ahead Part 2: Draw the Total, Marginal and Average products graphs.

5 LO2 Marginal Product, MP Total Product, TP 7-5 The Law of Diminishing Returns 30 TP Increasing Marginal Returns Diminishing Marginal Returns Negative Marginal Returns 10 AP MP

6 QOD #20: Caution! Curves Ahead Part 3: Explain relationship between each pair of curves. Why does marginal product first rise, then decline, and ultimately become negative? What bearing does the law of diminishing returns have on short run costs? When marginal product is rising, marginal costs is falling and vice versa. Draw this graph.

7 QOD #20: Curves Solution MP is the slope (the rate of change) of the TP curve. When TP is rising at an increasing rate, MP is positive and rising. When TP is rising at a diminishing rate, MP is positive but falling. When TP is falling, MP is negative and falling.

8 QOD #20: Curves Solution AP rises when MP is above it; AP falls when MP is below it. MP first rises because workers specialize and the fixed capital is used more productively as added workers are employed. Each added worker contributes more to output than the previous worker because the firm is better able to use its fixed plant and equipment. As still more labor is added, the law of diminishing returns takes hold. Labor becomes so abundant, relative to the fixed capital, that congestion occurs and marginal product falls.

9 QOD #20: Curves Solution At the extreme, the addition of labor so overcrowds the plant that the marginal product of still more labor is negative, and total output falls. Because labor is the only variable input and its price (wage rate) is constant, MC is found by dividing the wage rate by MP. As illustrated by Figure 7.6 in the textbook, when MP is rising, MC is falling; when MP reaches its maximum, MC is at its minimum, and when MP is falling, MC is rising.

10 Cost (Dollars) Average Product and Marginal Product MC and Marginal Product Production Curves MP Quantity of Labor MC AP AVC LO3 Cost Curves Quantity of Output 7-10

11 LO3 Costs 7-11 Short-Run Production Costs \$ TC TVC Fixed Cost Total Cost Variable Cost 100 TFC Q

12 LO Per-Unit, or Average, Costs Average Fixed Costs AFC = TFC/Q Average Variable Costs AVC = TVC/Q Average Total Costs Marginal Costs ATC = TC/Q MC = ΔTC/ΔQ

13 LO3 Costs 7-13 Per-Unit, or Average, Costs \$ AFC ATC AVC 50 AVC AFC Q

14 LO3 Costs 7-14 Marginal Cost \$ MC 100 AFC ATC AVC 50 AVC AFC Q

15 LO Long-Run Production Costs The firm can change all input amounts, including plant size. All costs are variable in the long run. Long run ATC Different short run ATCs

16 LO4 Average Total Costs 7-16 The Long-Run Cost Curve ATC-1 ATC-5 ATC-2 ATC-3 ATC-4 Long-Run ATC Output

17 LO Economies and Diseconomies of Scale Economies of scale Labor specialization Managerial specialization Efficient capital Other factors Constant returns to scale

18 LO Economies and Diseconomies of Scale Diseconomies of scale Control and coordination problems Communication problems Worker alienation Shirking

19 LO MES and Industry Structure Minimum Efficient Scale (MES): Lowest level of output where longrun average costs are minimized Can determine the structure of the industry

20 LO4 Average Total Costs 7-20 MES and Industry Structure Economies Of Scale Constant Returns To Scale Diseconomies Of Scale Long-Run ATC q 1 q 2 Output

21 7-21 Don t Cry Over Sunk Costs Sunk costs Costs have already been incurred and thus are irrecoverable Rule: Do not engage in any activity where MB<MC Rule: Ignore sunk costs They are irrecoverable

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