Key Concepts

LOS 17.a

The short run is the period in which quantities of some productive inputs are fixed and a firm cannot change its production methods or plant size. In the long run, a firm can adjust its inputs, production methods, and plant and equipment.

A firm's short-run decisions are easier to reverse than its long-run decisions.

LOS 17.b

Total product of labor is the number of units of output produced for a given amount of labor input.

Marginal product of labor is the increase in the total product of labor from using one additional unit of labor, holding the quantities of other inputs fixed.

Average product of labor is total product of labor divided by the units of labor used.

Marginal product increases at first as more labor is added to a fixed amount of capital assets (increasing marginal returns) but eventually decreases as more labor is added (diminishing marginal returns). The marginal product of labor curve intersects the average product of labor curve at its maximum.

LOS 17.c

Total cost is the sum of total fixed cost (e.g. plant and equipment), which does not vary with output, and total variable cost (e.g., labor, raw materials), which increases as output is increased.

Marginal cost is the increase in total cost for a one unit increase in output.

Average fixed cost (AFC) is fixed cost per unit of output. Average variable cost (AVC) is variable cost per unit of output. Average total cost (ATC) is total cost per unit of output. ATC = AFC + AVC.

AFC slopes downward in the short run because fixed costs are constant, but are averaged over an increasing quantity of output. The vertical distance between the ATC and AVC curves is equal to AFC.

The marginal cost curve intersects the AVC and ATC curves from below at their minimum points.

The AVC curve is U-shaped, declining at first due to efficiency gains, but eventually increasing due to diminishing returns. The ATC curve is U-shaped because it is the sum of the decreasing-to-flat AFC curve and the U-shaped AVC curve.

LOS 17.d

A production function illustrates the relationship between a firm's labor and capital inputs and its quantity of output.

The law of diminishing returns states that, at some point, using more of a variable input (holding other input quantities constant) increases output at a decreasing rate.

Diminishing marginal product of capital means that for a constant quantity of labor, output increases at a decreasing rate as more capital is employed.

Short-run cost curves are specific to a given plant size. Long-run average cost curves show minimum average unit costs based on the optimal plant size (scale of operations) for each level of output.

Economics of scale are present when unit costs fall as plant size increases. Diseconomies of scale are present when costs rise as plant size increases, often arising from the bureaucratic inefficiencies that occur with larger firms.

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