Costs of Production

1. Costs of Production Chapter 5 Section 2

2. Labor and Output • Marginal Product of Labor • The change in output from hiring one additional unit of labor • Increasing Marginal Returns • Workers increase, marginal production of labor increases • Diminishing Marginal Returns • Workers increase, marginal production of labor decreases

3. Labor and Output

4. Production Costs • Fixed Costs (FC) • A cost that does not change, no matter how much of a good is produced • Example: building, equipment, property taxes, salary of employees • Variable Costs (VC) • A cost that rises or falls depending on the quantity produced • Example: raw material; wages of employees; utility bills

5. Production Costs • Total Cost (TC) • The sum of fixed costs plus variable costs • Marginal Cost (MC) • Additional cost of producing one more unit

6. Setting Output • Marginal Revenue (MR) and Marginal Cost (MC) • Marginal Revenue • The additional income from selling on more unit of a good • BEST level of output is where Marginal Revenue is equal to Marginal Cost • MR=MC

7. Setting Output • Responding to Price Changes • If price of good changes, production will change accordingly • If a good’s price changes from $10 to $20, the firm would increase production so the marginal cost would equal the higher price

8. Setting Output • The Shutdown Decision • Firm produces at the most profitable level MR=MC • Market price is so low that total revenue is less than total cost • To shut down or not • Shutdown if Total Revenue (TR) is less than Variable Cost (VC) • Keep running is TR > VC • Why???????????

9. Some Equations • MC = New TC – Previous TC • TR = MR x amount of good • Profit = TR - TC