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Graphing Exercise: Production and Costs In making payments for its resources, the firm incurs costs of production. In the short run, a time frame over which capital is fixed, the total cost of any given level of output can be broken into fixed cost and variable cost. On a per unit basis, these can be expressed as average fixed cost and average variable cost, which together sum to average total cost. Marginal cost refers to the extra cost of producing one additional unit. Obviously, these short-run costs reflect both the costs and the productivity of the inputs.Click here to explore the relationship between input prices, productivity, and costs. The excercise will open in a new browser window. Familiarise yourself with the graph and then complete the questions below. If you have clicked on the link above and cannot see the interactive exercise, you may need to install a free Java plugin for you internet browser. Click here for the plugin. In making payments for its resources, the firm incurs costs of production. In the short run, a time frame over which capital is fixed, the total cost of any given level of output can be broken into fixed cost and variable cost. On a per unit basis, these can be expressed as average fixed cost and average variable cost, which together sum to average total cost. Marginal cost refers to the extra cost of producing one additional unit. Obviously, these short-run costs reflect both the costs and the productivity of the inputs. The graph contains productivity data - the physical relationship between inputs and output - for a hypothetical firm. Total product, the relationship between labor input and output, is graphed on the upper panel, while marginal and average product are graphed below. Clicking and dragging the Productivity Index slider to the right allows you to increase the productivity of labor by any amount up to 25 percent. By clicking on the Production/Costs button, the applet toggles to the graphical portrayal of the firm’s cost curves: Variable Cost, Fixed Cost, and Total Cost are in the upper graph, while the lower panel contains the corresponding Marginal and Average-Total-Cost curves. You can change the wage rate and fixed cost by clicking on the corresponding bold values below the tabular productivity data. In either the production or the cost mode, clicking Reset restores all values to their initial levels. 1. How are the positions of the production graphs affected by an increase in labor productivity? AnswerClick and drag the Productivity slider to the right. Labor’s total product increases, as do average and marginal product. 2. Over what range of labor input are there increasing marginal returns to labor? Over what range are there decreasing marginal returns to labor? AnswerIncreasing marginal returns are reflected by increases in labor’s marginal product; decreases in marginal product indicate decreasing marginal returns. From the table and the graph, marginal product increases through the addition of the fourth worker. Decreasing marginal returns begin with the addition of the fifth worker. As is apparent from the lower production panel, average product - output per worker - continues to rise as long as marginal product exceeds average product. If marginal product is below average product, average product is decreasing. 3. Reset productivity to its original level. Over what range of output does marginal cost decrease? Over what range does it increase? How do these ranges correspond to labor productivity? AnswerDrag the Productivity slider all the way to the left then click on the Production/Cost toggle button to display the firm’s cost curves. Marginal cost declines through the production of the 200th unit. This corresponds exactly to the range of increasing marginal returns to labor. Marginal cost is increasing beyond this point, corresponding to the range of decreasing marginal returns to labor. 4. When the wage is $20 and fixed cost is $100, what is the marginal cost of the 420th unit of output? How is this affected by a decrease in fixed cost? How is it affected by an increase in the wage? How is it affected by an increase in labor productivity? AnswerReading either from the table or the graph, the marginal cost associated with an output of 420 is £.50. To check the impact of an increase in fixed cost, click on the Fixed Cost button and enter a new value. Marginal cost is unaffected, although average total cost rises. Next, click on the Wage Rate button and enter a value of £40. Marginal cost doubles, from £.50 to £1.00 with a doubling of the wage rate. Finally, drag the Productivity slider all the way to the right. Marginal cost decreases. 5. Experiment on your own. Considering the three factors investigated in the applet - fixed cost, wage rate, and productivity - which factor(s) will increase marginal cost? How will these same factors affect average total cost? Can average total cost increase without an increase in marginal cost? AnswerMarginal cost will increase with an increase in the wage rate or a decrease in productivity. Both of these will increase average total cost as well. An increase in fixed cost has no impact on marginal cost, but will increase average total cost. |