6355 Lecture Notes - Lecture 4: Average Cost, Average Variable Cost, Opportunity Cost
5 Jun 2018
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Technology, Production and Costs
Some Economic Definitions
• Firm: An organisation that comes into being when a person or a group of people decides to
produce a good or service to meet a perceived demand.
• Technology: the processes a firm uses to turn inputs into outputs of goods and services.
• Technological change: a change in the ability of a firm to produce a given level of output when
a given quantity of inputs.
• Production function: the relationship between the inputs employed by the firm and the
maximum output it can produce with those inputs.
The Behaviour of Profit Maximising Firms
• All firms must make several basic decisions to achieve what we assume to be their primary
objective - maximum profit.
1. How much output to supply
2. Which production technology to use
3. How much of each input to demand
Short Run versus Long Run
• Economists distinguish between the short-run and the long-run.
o Short run:
• A period of time where there is at least one fixed input.
o Long run:
• A sufficient period of time to allow all inputs to be varied.
• There is not single answer to the length of time that defines the difference between the short
run and the long run. It depends on the industry.
Fixed and Variable Inputs
• A fixed input is:
o Any resource where the quantity used cannot change during a specific period of time.
• A variable input is:
o Any resource for which the quantity used can change during a specific period of time.
Marginal Product and the Law of Diminishing Returns
• Marginal product:
o The additional output that can be produced by adding one more unit of a specific input,
ceteris paribus
• Law of diminishing returns:
o 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.
Shape of the Marginal Product Curve
• Increasing Marginal Returns
o Arises from increased specialisation and division of labour as the first few workers are
hired.
• Decreasing Marginal Returns
o More and more workers are using the same equipment and work area, so while the total
number of copies still increases as the 4th & 5th worker is hired, the rate of increase is
slowing.
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Document Summary
Marginal product and the law of diminishing returns: marginal product, the additional output that can be produced by adding one more unit of a specific input, ceteris paribus. Law of diminishing returns: diminishing returns always apply in the short run, and in the short run every firm will face diminishing returns. This means that every firm finds is progressively more difficult to increase its output as it approaches capacity production. Marginal product and average product: average product, the total output produced by a firm divided by the number of workers, or, output per worker, average product of labour = total output / number of workers. If the marginal is above the average, the average increases. If the marginal is below the average, the average falls: the marginal is equal to the average when the latter is at its maximum. If the technology improves, and/or the fixed resources increase, it is likely the total output curves rises.
