Chapter 21 How Cost of Production Affects Price

I. Defining Cost Types
II. Understanding Labor Productivity
III. Determining Production Costs
IV. Graphing Production Costs 
V. Productivity Affects Costs
VI. Total Variable Costs

VII. Long Run Costs
VIII. Robot Revolution

IX. Political Economy Book Summaries
X. 2016 Presidential Issues
Discussion Questions & ans.
Homework Questions & ans.

Other Micro Chapters

19) Elasticity of Demand Affects Total Revenue
20) Consumer Behavior and Demand Theory
22) Analyzing Profit

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I. Defining Cost Types
A. Introduction
       1. The last two chapters were an in-depth exploration of demand.
         2. This chapter will explore costs, the key determinate of supply.
         3. Math Review is a short dynamic review of basic math skills for 
                    microeconomics from R. L. Reynolds of Boise St. University.
     B. Costs are the dollars paid for the factors of production.
     C. Opportunity cost is the value of the best alternate use, e.g., 
          the opportunity cost of labor is the value that 
          could have been received from using capital.
     D. Explicit costs versus implicit costs
          1. Explicit costs require an out-of-pocket expenditure, e.g., wages, 
             materials, and overhead.
          2. Implicit costs do not require an outlay, e.g., forgone interest on 
              invested capital, forgone rent a company could receive by renting
              a facility used in the business, forgone wages for uncompensated
              efforts by family members in a family-operated business, forgone
              entrepreneurial income you could earn by managing another
              business. Included a normal return on investment, which is the
              minimum amount required to keep resources employed at their
              current use. 


     E. Short run versus long run costs  
          1. In the short run costs are both fixed and variable.
              a. Fixed costs do not vary with production, e.g., plant and equipment,
                  property taxes, most overhead, etc.
              b. Variable costs vary directly with production, e.g., labor and materials 
              c. Marginal cost is the change in total costs which results from making
                  one more unit.
          2. In the long run all costs are variable as fixed costs may increase. 
     F. Diminishing returns:  
         1. Adding a variable resource (labor) to a fixed resource (capital) will increase
             production for a while.
         2. At some point the rate of increase declines and eventually becomes negative. 
         3. Diminishing returns affect both the production of labor and cost of production.
         4. Example: When eating at my mother's house I would say using three people
             to do the dishes didn't make sense because the third person just got in the
             way. She agreed so me and my sisters did the dishes.
         5. Diminishing returns - Wikipedia has additional information.
         6. Econ in 60 Seconds Video Law of Diminishing Marginal Returns   
            reviews diminishing returns and previews section III on labor productivity.
     G. Accounting profits versus economic profits
         1. Accounting profit is revenue minus explicit costs.
         2. Economic profit is revenue minus explicit plus implicit costs.
            3. Since implicit cost includes a payment for the risk factor part of  interest and
             payment for entrepreneurial skill.
         4. This means
 a.  Normal Profit is a cost  to economists and paid for as an explicit cost.
              b. In the long run competition causes economic profit to be zero.




II. Understanding Labor Productivity

Total product of labor (TPL) measures total production occurring as more workers are added to a production process containing fixed resources.

Marginal product of labor
measures the change in the TPL which occurs as more workers are added to a production process containing fixed resources.

Average product of labor
measures the average production of all workers as additional workers are added to a production process containing fixed resources.

Note: MPL should be plotted at the mid-point on the x-axis.

Educating the Class of 2034.htm applies productivity  theory to education.

Number of  
Total Product of Labor (TPL) Marginal Product of Labor (MPL) Average
0 0 0 0
1 6 6 6
2 14 8 7
3 24 10 8
  Stage 1 Increasing marginal returns to scale (getting bigger) because of worker specialization.

Stage 2 Decrease marginal
returns to scale because of fixed resources.

Stage 3 Negative marginal returns to scale because workers are in the way of each other.  

4 32 8 8
5 35 3 7
6 35 0 5.83
7 28 -7 4

II. Determining Production Costs
        A. Econ Concepts in 60 Second Video on  Per Unit Costs Curves MC, ATC, AVC a dynamic demonstration.
      B. Static demonstration

Total Fixed 
Total Variable Costs
Marginal Costs is change in TC
per unit
Average Fixed Costs
Average Variable Costs
Average Total Costs (2+3)/1
0 500 0 500 NA      
1 500 500 1000 500 500 500 1000
2 500 900 1400 400 250 450 700
3 500 1200 1700 300 167 400 567
4 500 1500 2000 300 125 375 500
5 500 1900 2400 400 100 380 480
6 500 2400 2900 500 83 400 483
7 500 3000 3500 600 71 429 500

IV. Graphing Production Costs 






V. Productivity Affects Costs 

Note that AV is the mirror image of AP and MC is the mirror image of MP.


At low quantities MP is above AP so AP is rising. As MP starts to fall AP flattens but continues to rise because MP is still higher. When MP drops below AP, AP immediately begins to decrease indicating the intersection must be AP's highest point.

At low quantities MC is below AVC so AVC is falling. As MC starts to rise AVC flattens but continues to decrease because MC is still lower. When MC rises above AVC, AVC immediately begins to rise indicating the intersection must be AVC's lowest point.

U.S. and Germany Lead the Way 
The Economist Magazine 5/4/13


VI. Total Variable Costs
A. Not a straight line but an S-shaped curve
   B. Economies and diseconomies of scale
Start-up costs cause the curve to rise quickly at low levels of production.   Examples include Incorporating, legal and accounting, Licenses and permits, Remodeling, Rent, Security Deposit or Real Estate Purchase, Signage and marketing materials, Initial inventory Supplies, Furniture and Equipment.

Economies of scale make production very efficient causing the curve to flatten out over a considerable range of production. Examples include labor/management specialization, volume discounts, and use of by-product. Those wanting additional reading see Economies of scale - wiki

Diseconomies of scale cause production to be inefficient and result in the curve rising sharply as maximum capacity is approached. Examples include Bureaucracy and diminishing returns. Japanese flexible production techniques enhance economies of scale and stretched out the low point on the AVC line. These techniques have been adopted by manufacturers around the world. see  Diseconomy of scaleWikipedia, the free encyclopedia.



Video for lucille ball cartoon

Economies of scale for all manufacturing.
From 1950 t0 2004 manufacturing workers dropped from 35 percent of the labor force to 13 percent. Yet production went up dramatically.







VII. Long run costs by industry, a dynamic models
        A. constant-cost industry from amosweb, a leader in
            economics education

        B. decreasing-cost industry  

        C. increasing-cost industry

        D. Productivity increases make overall cost decreasing

        E. Hiring more part-time less productive workers has
            not lowered productivity


F. Business Are Doing More With  Less Workers as hiring has not com back after the last three recessions

G. Fracking, which lowers cost, could a Game Changer for U.S. Manufacturing Until Russia Entered the Supply Market.



 H. Incremental cost of labor

Asset heavy ITO players losing share

Source Click





VIII. Robot Revolution
        A. Robot Revolution Arrives World Changes
        B. MRPL VS MRPC
For more information about the robot revolution

(a)  Economists and others grapple with these issues (this section will be updated):

  1. “Is America facing an increase in structural unemployment?“, brief answers from a range of economists, 23 July 2010
  2. “Identifying Cyclical vs. Structural Unemployment“, Brad DeLong (Prof Economics, Berkeley), 24 August 2010
  3. “A curious unemployment picture gets more curious“, Federal Reserve Bank of Atlanta, 16 July 2010
  4. “Labor Force Participation and the Future Path of Unemployment“, Joyce Kwok et al, Federal Reserve Bank of San Francisco, 13 September 2010
  5. “Armies of Expensive Lawyers, Replaced by Cheaper Software“, New York Times, 4 March 2011
  6. “Companies Spend on Equipment, Not Workers“, New York Times, 9 June 2011
  7. “How would robotic prostitutes change the sex tourism industry?“, published by i09, 15 April 2012 — This describes the gated article “Robots Men and Sex Tourism”, Ian Yeoman and Michelle Mars (Victoria Management School, Victoria U of Wellington), Futures, May 2012
  8. “Paleofuture: The Disco-Blasting Robot Waiters of 1980s Pasadena“, Smithsonian, 19 April 2012 — Premature technology, but they’re coming.

(b)  Martin Ford has some answers to these questions:

Ford wrote The Lights in the Tunnel: Automation, Accelerating Technology and the Economy of the Future (2009); the ebook is free. 

  1. The Economic Implications of Intelligent Machines, 26 October 2009
  2. The Average Worker and the Average Machine, 1 July 2010
  3. Structural Unemployment: The Economists Just Don’t Get It, 4 August 2010
  4. Econometrics and Technological Unemployment — Some Questions, 6 August 2010
  5. Outsourcing Jobs…that Can’t be Outsourced, 27 August 2010
  6. Healthcare Robotics, 14 September 2010

(c)  Posts about the robot revolution:

  1. The coming big increase in structural unemployment, 7 August 2010
  2. The coming Robotic Nation, 28 August 2010
  3. The coming of the robots, reshaping our society in ways difficult to foresee, 22 September 2010
  4. Economists grapple with the first stage of the robot revolution, 23 September 2012
  5. The Robot Revolution arrives, and the world changes, 20 September 12

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