Lecture 7: Behind Supply

Total/Marginal/Average Products, Total/Marginal/Average Costs, Short/Long Run

Inputs & Outputs

What are the 3 Factors of Production?

Factors of production are intermediate goods (also known as inputs); goods that will be used to create other goods & services. Such as raw materials, parts or unfinished goods!

  • Labour: All the physical & mental inputs of human beings.

Do animals count as labour?

  • Capital: Machines, tools, buildings & inventories. Any tool!

Does capital in this sense also mean investments and money?

  • Land: Raw materials such as the land used, water, air, etc. Anything from nature!

What is a Production Function?

A production function is the relationship between quantity of inputs (size of land, amount of equipment) and the quantity of outputs (number of goods produced) in a given time period.

What is Short Run?

A time period in which a firm has fixed inputs/costs/variables.

What is Long Run?

A time period long enough for all inputs/costs/variables to change. All costs are variable in the long run!

What is Marginal Product?

The change in output that results from increasing a variable input by one unit. It can be calculated by dividing the change in output by the change in labour (amount of employees), ceteris paribus.

What is the Law of (Eventually) Diminishing Marginal Returns?

The marginal product of an input will eventually decrease as only one input increases, while all other inputs are held constant. This happens because additional input has less of the fixed factor to work with. However, initially, an increase in input can cause an increase in marginal returns!

What is Average Product?

The average product of labour is the amount of total output divided by amount of employees, ceteris paribus. For example, it is the number of products each worker produces on average.

Average Product summarizes info but Marginal Product is more important for decision making!

Relationship Between Marginal & Average Product

When we put marginal & average product on a graph, we see that marginal product ‘pulls’ average product towards itself.

When marginal product is equal to average product, average product is at its maximum point!

Remember, ‘marginal product’ points on a graph are in between ‘average product’ points!

Costs & Outputs

3 Ways to Pay for Capital

  • Buy Outright: The cost of owning capital is the investment income the money could’ve earned.
  • Borrow Money: The cost is the interest paid each time period.
  • Leasing: The cost is the lease price.

What are Fixed Costs?

Total Fixed Cost is the cost of all the fixed inputs, and this cost does not vary as output changes.

What are Variable Costs?

Total Variable Costs are the costs of variable inputs. Variable inputs change as output changes.

What are Total Costs?

What are Marginal Costs?

Marginal cost is the cost of producing one more unit of output.

Remember, ‘marginal cost’ points are graphed at the midpoint between the quantities produced!

Diminishing Marginal Returns Causes Increasing Marginal Cost: Increasing one input, ceteris paribus, eventually causes a decrease in marginal product so the ratio of total cost over total output changes. A greater change in cost than output increases marginal costs.

What are Average Costs?

Average Costs & Marginal Costs Together

Marginal costs ‘pull’ average costs towards itself.

Average cost is at its minimum point when marginal costs & average costs are equal!

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