Costs of Production

How much to produce?

Labor and Output

• How the number of workers affects total production?

Labor and Output

• Does more workers = greater productivity?– To a point. Adding

workers will increase production…but at some point, production will begin to decrease.

Marginal product of labor

• Marginal product of labor – the change in output from hiring one more worker.

• Measures the change in output at the margin – where the last worker was hired or fired.

Increasing marginal returns

• Increasing marginal returns – A level of production in which the marginal product of labor increases as the number of workers increases.

Diminishing marginal returns

• Diminishing marginal returns – A level of production in which the marginal product of labor decreases as the number of workers increases.

Negative marginal returns

• Negative marginal returns – When adding an additional worker, actually decreases output. Added workers disrupt production.

Production Costs

• Production costs are divided into two categories:

• Fixed cost – a cost that does not change, no matter how much of a good is produced.

• Variable cost – costs that rise and fall depending on quantity produced.

Production Costs

• Total cost – fixed costs + variable costs

• Marginal cost – the additional cost of producing one more unit

Setting Output

• How do firms set output to maximize profit?

Setting Output

• One way – look for the largest gap between total cost and total revenue at a certain level of output.

Setting Output

• Another way – find the output level were marginal revenue (the additional income from selling one more unit of a good; sometimes equal to price) is equal to marginal cost.

Setting Output

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

• Includes the variable costs that keep the factory producing but not the fixed costs which must be paid whether the factory produced or not.

• Helps determine if a firm should continue operate if it’s costs exceed its revenue.