S U P P L Y

Cost of ProductionChapter 5 Section 2

S U P P L Y• Objectives:

– Explain how firms decide how much labor to hire to produce a certain level of output.

– Analyze the production costs of a firm.– Understand how a firm chooses to set output.– Explain how a firm decides to shut down an

unprofitable business.

Section 1 Review1. What is Supply?2. What is the Law of Supply?3. What are the 4 parts of a Supply Graph?4. What is a Market Period?5. What is a Short Run Period?6. What is the Long Run Period?7. What is Elastic?8. What is Inelastic?

S U P P L Y• Producers respond to a price change just

like consumers did in Demand.• As price goes up…suppliers will produce

more product.• This section is dedicated to learning how

much a supplier will produce with a price change.

S U P P L Y• One of the basic questions that a

business has to answer…how many workers to hire.

• Owners consider how the number of workers they hire will affect their total production.

S U P P L Y• Example…

– 1 worker is hired… produces 4 beanbags/hour– 2 workers…produces 10 beanbags/hour– 3 workers…produces 17 beanbags/hour

• As new workers join the company, total output increases. – 11 workers…produces 32 beanbags/hour– 12 workers…produces 31 beanbags/hour

• WHY the decrease at 12 workers????

S U P P L Y• There is a relationship between labor,

measured by the number of workers in the factory, and the number of beanbags produced.

• Economists look at Marginal Product of a company adding additional labor to work in the factory.

• M.P. = the change in output from hiring one additional unit of labor.

S U P P L Y• Labor Output Marginal Product

• 0 0 ---• 1 4 4• 2 10 6• 3 17 7• 4 23 6• 5 28 5• 6 31 3• 7 32 1• 8 31 - 1

S U P P L Y• When we look at the schedule, we see

that MP increases for the 3 workers.• It then decreases when we hire a 4th

worker.• It continues to decrease until we have

hired an 8th worker and it becomes a minus number.

• W H Y ???

S U P P L Y• The MP of labor increases for the first 3 workers

because thee are three tasks involved in making beanbags. {cut and sew cloth into the shape; stuff the bag; and sew the bag closed}

• It is hard for a single worker to perform all three tasks and be able to produce a whole lot.

• Adding a 2nd worker would allow each worker to specialize in 1 or 2 tasks.

• Specialization increases output per worker. 3 workers would allow each one to specialize in a single task and become much more efficient.

S U P P L Y• Increasing Marginal Returns… a level of

production in which the marginal product of labor increases as the number of workers increase.

• Diminishing Marginal Returns…a level of production in which the marginal

product of labor decreases as the number of workers increase.

S U P P L Y• Diminishing Marginal Product occurs at the 4th

worker being hired. Continues until we get to 7th worker.

• This happens when workers have to work with limited amount of capital.

• Capital is any human-made resources that is used to produce other goods.

• Capital in this example is a single pair of scissors and a single sewing machine.

S U P P L Y• This problem gets worse as more workers are

hired. {Wasted time waiting for a machine}• Negative Marginal Returns…occurs when

workers get in each other’s way and disrupt the production process. At this point, overall output decreases.

S U P P L Y• Production Costs:

– Paying workers and purchasing capital are costs of producing goods.

– 2 categories…• Fixed Costs - the cost that does not change no

matter how much of a good is produced.• Variable Costs - a cost that rises or falls depending

on how much is produced.

S U P P L Y• Fixed Costs include…

– Rent– Machinery Repairs– Property Taxes– Salaried Workers

S U P P L Y• Variable Costs include…

– Cost of Raw Materials– Hourly Workers (Labor)– Electricity/Heating Bills

S U P P L Y• Total Cost = fixed costs + variable costs.• Marginal Costs - the cost of producing

one more unit of a good.• Marginal Revenue - the additional income

from selling one more unit of a good• Total Revenue = Price x Quantity • Profit = Total Revenue - Total Cost

S U P P L YFixed Variable Total Marginal Marginal Total

• Beanbags Costs Costs Cost Cost Revenue Rev. Profit

• 0 $ 36 $ 0 $ 36 ----- $ 00 $ 0 $ -36– 1 $ 36 $ 8 $ 44 $ 8 $ 24 $ 24 $ -20– 2 $ 36 $ 12 $ 48 $ 4 $ 24 $ 48 $ 00 - 3 $ 36 $ 15 $ 51 $ 3 $ 24 $ 72 $ 21– 4 $ 36 $ 20 $ 56 $ 5 $ 24 $ 96 $ 40– 5 $ 36 $ 27 $ 63 $ 7 $ 24 $120 $ 57– 6 $ 36 $ 36 $ 72 $ 9 $ 24 $144 $ 72– 7 $ 36 $ 48 $ 84 $ 12 $ 24 $168 $ 84– 8 $ 36 $ 63 $ 99 $ 15 $ 24 $192 $ 93– 9 $ 36 $ 82 $ 118 $ 19 $ 24 $216 $ 98– 10 $ 36 $ 100 $ 136 $ 18 $ 24 $240 $104– 11 $ 36 $ 136 $ 172 $ 36 $ 24 $264 $ 92– 12 $ 36 $ 173 $ 209 $ 37 $ 24 $288 $ 79

• Each beanbag is going to sell for $ 24.00

S U P P L Y• Behind all of the decisions about how

many workers to hire is the firm’s basic goal: to Maximize Profits!

• Profit is defined as total revenue minus total cost.

• Total Revenue is the money a firm gets by selling their product.

S U P P L Y• Another way to find the best level of output is to

find the output level where Marginal Revenue = Marginal Cost.

• MR is additional income from selling one unit of a good.

• IF the firm has no control over the market price, MR = the market price.

• Operating Cost - the cost of operating a facility, such as a store or factory.

S U P P L Y• Operating Cost includes…

– Variable costs the owners must pay to keep the factory running.

– NOT Fixed Costs

S U P P L Y• Stage I - increasing returns as the number of

workers increase they better use of their time, machinery, and resources.

• Stage II - total production keeps growing, but by smaller and smaller amounts. The rate in increase in total production is starting to slow down. Each additional worker is making a diminishing contribution (although +)

• Stage III - too much input - total output decreases as input increases -MP is negative - total plant output decreases

S U P P L Y• Input Total Marginal• (# of workers) Product Product Stage

– 0 00 00 ----– 1 7 7 Stage I – 2 20 13 Stage I – 3 38 18 Stage I – 4 62 24 Stage I – 5 90 28 Stage I – 6 110 20 Stage II – 7 129 19 Stage II – 8 138 9 Stage II – 9 144 6 Stage II – 10 148 4 Stage II – 11 145 - 3 Stage III – 12 135 -10 Stage III