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total product on the y-axis, is upward sloping until it reaches its maximum,
after which it becomes downward sloping.
D. Marginal Product
Marginal product (MP) is the change in total product that results from a oneunit increase in the quantity of labor employed. The marginal product curve is
upward sloping, reaches a maximum, and then declines.
1. Increasing Marginal Returns
Increasing marginal returns occur when the marginal product of an
additional worker exceeds the marginal product of the previous worker.
Most production processes experience increasing marginal returns initially.
2. Decreasing marginal returns occur when the marginal product of an
additional worker is less than the marginal product of the previous worker..
a. The law of decreasing returns states that as a firm uses more of a
variable input, with a given quantity of fixed inputs, the marginal product
of the variable input eventually decreases.
E. Average Product
The average product (AP) is the total product divided by the quantity of an
input. The average product of labor is total product divided by the quantity of
labor employed. The average product curve is upward sloping, reaches a
maximum, and then declines. The marginal product curve intersects the
average product curve at the AP curves maximum point.
1. Marginal Grade and Grade Point Average
The relationship between the marginal grade and grade point average is the
same a the relationship between marginal product and average product:
a. When the marginal product is greater than the average product, the
average product is increasing.
b. When the marginal product is less than the average product, the average
product is decreasing.
I2.3 Short-Run Cost
A. Total Cost
There are three total cost concepts:
1. Total cost (TC) is the cost of all the factors of production used by a firm.
Total cost divides into two parts: total fixed cost and total variable cost.
2. Total fixed cost (TFC) is the cost of the fixed factors of production used by
a firmthe cost of land, capital, and entrepreneurship.
3. Total variable cost (TVC) is the cost of the variable factor of production
used by a firmthe cost of labor.
4. Total cost = total fixed cost + total variable cost.
B. Marginal Cost
Marginal cost (MC) is the change in total cost that results from a one-unit
increase in output.
C. Average Cost
There are three average cost concepts:
1. Average fixed cost (AFC) is total fixed cost per unit of output. AFC = TFC
Q. The AFC curve is downward sloping.
2. Average variable cost (AVC) is total variable cost per unit of output. AVC
= TVC Q. The AVC curve is U-shaped.
3. Average total cost (ATC) is total cost per unit of output, which equals
average fixed cost plus average variable cost. The ATC curve is U-shaped
and lies above the AVC curve. The vertical distance between the ATC and
AVC curves is average fixed cost.
4. The MC curve intersects the ATC curve and the AVC curve at their minimum
points.
D. Why the Average Total Cost Curve is U-Shaped
The ATC curve is U-shaped because ATC is the sum of AFC and AVC. The Ushape reflects the factors that determine the shapes of those two curves:
1. The AFC curve is downward sloping because as output increases, the firm
spreads its fixed costs over larger and larger amounts of output.
2. The AVC curve is U-shaped because of decreasing marginal returns.
E. Cost Curves and Product Curves
The cost curves and product curves are linked.
1. In the range of employment and output over which the AP curve is upward
sloping, the AVC curve is downward sloping, and in the range over which
the AP curve is downward sloping, the AVC curve is upward sloping.
2. In the range of employment and output over which the MP curve is upward
sloping, the MC curve is downward sloping, and in the range over which the
MP curve is downward sloping, the MC curve is upward sloping.
F. Shifts in the Cost Curves
Cost curves shift in response to changes in two factors:
1. Technology.
A technological change that increases productivity shifts the product curves
upward and the cost curves downward. If a technological change results in
the firm using more capital, the average fixed cost curve shifts upward and
at low levels of output, the average total cost curve may shift upward. At
large output levels, average total cost decreases.
2. Prices of factors of production.
An increase in the price of a factor of production increases costs and shifts
the cost curves upward. An increase in fixed cost does not affect the
variable cost or marginal cost curves (TVC, AVC, and MC curves). An
increase in variable cost does not affect the fixed cost curves (TFC and
AFC). The total cost curves (TC and ATC curves) are affected by a price
change for any factor of production.
I2.4 Long-Run Cost
In the long run, the firm can vary both the quantity of labor and the quantity of
capital.
A. Plant Size and Cost
When a firm changes its plant size, the firms scale changes and its cost of
producing a given output changes. When a firm changes the size of its plant, it
might experience:
1. Economies of Scale
Economies of scale is a condition in which, when a firm increases its plant
size and labor employed by the same percentage, its output increases by a
larger percentage and its average total cost decreases.
a. Economies of scale result from the specialization of labor and capital.
2. Diseconomies of Scale
Diseconomies of scale is a condition in which, when a firm increases its
plant size and labor employed by the same percentage, its output increases
by a smaller percentage and its average total cost increases.
3. Constant Returns to Scale
Constant returns to scale is a condition in which, when a firm increases
its plant size and labor employed by the same percentage, its output
increases by the same percentage and its average total cost remains
constant.
B. The Long-Run Average Cost Curve
The long-run average cost curve (LRAC) is a curve that shows the lowest
average cost at which it is possible to produce each output when the firm has
had sufficient time to change both its plant size and labor employed.
1. Economies and Diseconomies of Scale
The LRAC is divided into segments reflecting the three types of scale: