Unit 3: Production and Output

Decisions
Lecture 5: Short Run Production and
Output

1 MBA Business Economics Lecture 5, Dr Dawid Trzeciakiewicz

 Average and Marginal Product
𝑂𝑢𝑡𝑝𝑢𝑡
• Define average product: Marginal
𝑇𝑜𝑡𝑎𝑙 𝑃𝑟𝑜𝑑𝑢𝑐𝑡 Product Falls
𝐴𝑣𝑔 𝑃𝑟𝑜𝑑𝑢𝑐𝑡 =
𝑁𝑜 𝑜𝑓 𝑊𝑜𝑟𝑘𝑒𝑟𝑠
• Marginal product is the 𝐴𝑃
output produced by adding
an extra worker
• Appropriate law of
diminishing marginal
returns applies here – why?
• Graph shows this average
product (𝐴𝑃) curve
𝐿𝑎𝑏𝑜𝑢𝑟

2 MBA Business Economics Lecture 5, Dr Dawid Trzeciakiewicz

 Average and Marginal Product 2
𝑂𝑢𝑡𝑝𝑢𝑡
• Because of the benefits of
experience we may see an
early increase in the
marginal product, but this
will soon fall.
• Lines will always cross at the
maximum point of AP
• Why do the curves take this
shape? 𝐴𝑃
• Are workers really as good
and hard working as each 𝑀𝑃
other?
𝐿𝑎𝑏𝑜𝑢𝑟

3 MBA Business Economics Lecture 5, Dr Dawid Trzeciakiewicz

 Definitions of Costs
• Split costs under two
headings, fixed and variable Fixed Variable
• Construct “average” costs by •Factories •Commission
dividing by the output •Machines •Power
produced: •Land •Raw
𝑇𝑜𝑡𝑎𝑙 𝐶𝑜𝑠𝑡𝑠 •Salaries materials
𝐴𝑇𝐶 =
𝑂𝑢𝑡𝑝𝑢𝑡 •Depreciation •Wages
𝑇𝑜𝑡𝑎𝑙 𝐹𝑖𝑥𝑒𝑑 𝐶𝑜𝑠𝑡𝑠 •Packaging
𝐴𝐹𝐶 = •Display
𝑂𝑢𝑡𝑝𝑢𝑡
𝑇𝑜𝑡𝑎𝑙 𝑉𝑎𝑟𝑖𝑎𝑏𝑙𝑒 𝐶𝑜𝑠𝑡𝑠
𝐴𝑉𝐶 =
𝑂𝑢𝑡𝑝𝑢𝑡

4 MBA Business Economics Lecture 5, Dr Dawid Trzeciakiewicz

 Average Cost and Marginal Cost
• Analogous to marginal 𝐶 𝑀𝐶
product and average product
discussion
• Marginal cost curve crosses 𝐴𝐶
through the average cost
curve from below
• Always crosses through at
the lowest point (just as
marginal product crosses
through average product at
the maximum)

5 MBA Business Economics Lecture 5, Dr Dawid Trzeciakiewicz

 Short Run Shut Down Point
• Firms can operate provided they are making a contribution to fixed
costs, that is their revenues are greater than their variable costs.
• Over the long term everything can be altered – firms can identify
ways to make savings and make a greater contribution to fixed
costs
• If it is still not possible to cover the total costs in the long run then
the business should shut down, this creates a long run shut down
point
• This discussion is integral to the supply curve discussion which
follows in Lecture 6.

6 MBA Business Economics Lecture 5, Dr Dawid Trzeciakiewicz

 Summary
• Costs come from many sources, and may be fixed or variable with
respect to output
• Marginal product of labour can rise but as output increases it
obeys an appropriate law of diminishing marginal returns
• Marginal product crosses the average product at its maximum
• Marginal cost crosses average cost at its minimum
• Firms should aim to make contributions to their fixed costs, that is
they should have higher average variable costs than their average
revenue.
• In the long term firms can look to change all of their processes and
inputs to address the inability to repay fixed costs as well.

7 MBA Business Economics Lecture 5, Dr Dawid Trzeciakiewicz