Changes

===The Short Run: Marginal Product===

===The Short Run: Marginal Product===

Imagine yourself as the President of a company making widgets, our imaginary good.  If it costs you a total of $200 to make 10 widgets, and a total of $205 to make 11 widgets, then what is your marginal cost (MC) of the 11th unit?  It is only $5.  What is its average cost?  Nearly $19 ($205 total cost divided by 11 total units).  '''''Average cost is often greater than the marginal cost'''''.  This makes sense, because once you pay for your factory and workers, you do not have much additional cost to produce an extra unit.  This is called '''''economies of scale: the bigger your operation, the cheaper you can make one more unit'''''.

Imagine yourself as the president of a company making widgets, our imaginary good.  If it costs you a total of $200 to make 10 widgets, and a total of $205 to make 11 widgets, then what is your marginal cost (MC) of the 11th unit?  It is only $5.  What is its average cost?  Nearly $19 ($205 total cost divided by 11 total units).  '''''Average cost is often greater than the marginal cost'''''.  This makes sense, because once you pay for your factory and workers, you do not have much additional cost to produce an extra unit.  This is called '''''economies of scale: the bigger your operation, the cheaper you can make one more unit'''''.

Think of a baking some bread.  It requires some time and effort to bake one loaf of bread, and the expense of heating the oven.  But there is not as much extra effort and expense to stick a second loaf in the oven at the same time.  After all, the oven expense is the same for two loaves as it is for one.

Think of a baking some bread.  It requires some time and effort to bake one loaf of bread, and the expense of heating the oven.  But there is not as much extra effort and expense to stick a second loaf in the oven at the same time.  After all, the oven expense is the same for two loaves as it is for one.

Or imagine going to a baseball game.  The cost for one person to go is the ticket price plus the cost of gas and parking and wear and tear on the car.  The cost for a second person to go with the first person is just the price of the extra ticket.  There is no extra gas or parking or wear and tear on the car for a second person to ride along.  So the marginal cost for the second person is less than for the first person.

Or imagine going to a baseball game.  The cost for one person to go is the ticket price plus the cost of gas and parking and wear and tear on the car.  The cost for a second person to go with the first person is just the price of the extra ticket.  There is no extra gas or parking or wear and tear on the car for a second person to ride along.  So the marginal cost for the second person is less than for the first person.

Now let’s return to your role as President of the widget company.  You are deciding how many employees to hire.  You have an assembly line that needs workers.  Each additional employee whom you hire to work on that assembly line increases the '''''“marginal product of labor,” which is the increase in output for each additional unit of labor.  It is often called “MP”'''''.   

Suppose as president of the widget company, you are deciding how many employees to hire.  You have an assembly line that needs workers.  Each additional employee whom you hire to work on that assembly line increases the '''''“marginal product of labor,” which is the increase in output for each additional unit of labor.  It is often called “MP”'''''.   

Let’s explain MP in a different way to make sure you understand it.  The more workers you hire, the more goods your company can produce.  Suppose you can make 1000 widgets a week with 10 employees.  Then you hire one more employee, and your output increases to 1015 widgets.  What is the “marginal product of labor,” or MP, for your 11th employee?  It is 1015-1000=15.  Note that this is less than the '''''average''''' product of labor, which 1015/11 = 92.3 for 11 employees.   

Let’s explain MP in a different way to make sure you understand it.  The more workers you hire, the more goods your company can produce.  Suppose you can make 1000 widgets a week with 10 employees.  Then you hire one more employee, and your output increases to 1015 widgets.  What is the “marginal product of labor,” or MP, for your 11th employee?  It is 1015-1000=15.  Note that this is less than the '''''average''''' product of labor, which 1015/11 = 92.3 for 11 employees.   

There is a "long run" in most businesses also.  When you are doing business with a supplier you want to be confident it will still be there a year or five years later.  You want to set up your firm so that it is efficient for the long run.  Quick fixes are typically short-lived and inefficient, and long run planning is crucial to long run success.  People who become doctors or lawyers go through more education at short-term expense, in order to succeed in the long run afterward.

There is a "long run" in most businesses also.  When you are doing business with a supplier you want to be confident it will still be there a year or five years later.  You want to set up your firm so that it is efficient for the long run.  Quick fixes are typically short-lived and inefficient, and long run planning is crucial to long run success.  People who become doctors or lawyers go through more education at short-term expense, in order to succeed in the long run afterward.

Efficiency is maximized by focusing on the long run.  As President of your widget company, you want to maximize the efficiency of your company.  You want the lowest total cost per unit.  You do not want idle workers or equipment.  You do not want wasted inventory.

Efficiency is maximized by focusing on the long run.  As president of your widget company, you want to maximize the efficiency of your company.  You want the lowest total cost per unit.  You do not want idle workers or equipment.  You do not want wasted inventory.

The changes you make to your company in the long run will be designed to maximize efficiency.  You want to reduce overtime, and you want loyal workers at a relatively low wages.  You want manufacturing facilities that are utilizing close to 100% of their capacity for production.  If demand is increasing, then that means building new facilities.  If demand is decreasing, then that means selling facilities that you already have.

The changes you make to your company in the long run will be designed to maximize efficiency.  You want to reduce overtime, and you want loyal workers at a relatively low wages.  You want manufacturing facilities that are utilizing close to 100% of their capacity for production.  If demand is increasing, then that means building new facilities.  If demand is decreasing, then that means selling facilities that you already have.

There is a concept for the long run known as “scale”.  '''''"Scale" refers to the total amount of inputs (workers, facilities, equipment, etc.) that a company has.'''''  The “large scale” means large facilities and number of workers.  The “small scale” means small facilities and number of workers.

There is a concept for the long run known as “scale”.  '''''"Scale" refers to the total amount of inputs (workers, facilities, equipment, etc.) that a company has.'''''  The “large scale” means large facilities and number of workers.  The “small scale” means small facilities and number of workers.

We expect the output of a firm to increase in proportion to an increase in scale.  As President of your company, you may think that doubling everything (facilities, workers, etc.) will double your output.  Often that is true.  '''''When output increases on a one-to-one basis with input, this is called “constant returns to scale.”'''''  When scale increases by a factor of ‘x’, then output also increases by the same factor of ‘x’.

We expect the output of a firm to increase in proportion to an increase in scale.  As president of your company, you may think that doubling everything (facilities, workers, etc.) will double your output.  Often that is true.  '''''When output increases on a one-to-one basis with input, this is called “constant returns to scale.”'''''  When scale increases by a factor of ‘x’, then output also increases by the same factor of ‘x’.

An assembly line is perhaps the best example of this.  Suppose one assembly line produces 1000 widgets a month.  How much would two assembly lines, with double the workers, produce?  We would expect about twice the output, or 2000 widgets a month.

An assembly line is perhaps the best example of this.  Suppose one assembly line produces 1000 widgets a month.  How much would two assembly lines, with double the workers, produce?  We would expect about twice the output, or 2000 widgets a month.

But equally important are situations where there are “increasing returns to scale” (output goes up by a greater percentage than the increase in input) and “decreasing returns to scale” (output goes up by a smaller percentage than the increase in input).  '''''The popular term “economies of scale” refers to “increasing returns to scale,” which are what one often sees in a well-managed company.'''''

But equally important are situations where there are “increasing returns to scale” (output goes up by a greater percentage than the increase in input) and “decreasing returns to scale” (output goes up by a smaller percentage than the increase in input).  '''''The popular term “economies of scale” refers to “increasing returns to scale,” which are what one often sees in a well-managed company.'''''

Our example of the assembly line may yield slightly increasing returns to scale.  When we double the assembly line, we may not have to double the number of administrative workers like managers, clerks, phone operators, etc.  We won’t need two Presidents, for example.  So we can double our output without doubling our workforce.  Perhaps we can even squeeze the second assembly line into our existing manufacturing plant.  We would still need twice the materials for the goods produced, but not twice the labor and facilities.  In this case we have increasing returns to scale: output doubles when inputs increased by less than 100%.

Our example of the assembly line may yield slightly increasing returns to scale.  When we double the assembly line, we may not have to double the number of administrative workers like managers, clerks, phone operators, etc.  We won’t need two presidents, for example.  So we can double our output without doubling our workforce.  Perhaps we can even squeeze the second assembly line into our existing manufacturing plant.  We would still need twice the materials for the goods produced, but not twice the labor and facilities.  In this case we have increasing returns to scale: output doubles when inputs increased by less than 100%.

When would a firm have decreasing returns to scale?  How could it be that we can double our workers and facilities and not produce at least twice the output?  The reason is that inefficiencies creep in.  Workers may spend more time talking with each other than doing productive work.  Managers and other workers may fight each other for power rather than doing what is best for the company.  People may call in sick more often, knowing that others are there to fill in for them.  Waste could spiral out of control as more purchases are made.  Each employee will feel less needed, and may become less motivated.

When would a firm have decreasing returns to scale?  How could it be that we can double our workers and facilities and not produce at least twice the output?  The reason is that inefficiencies creep in.  Workers may spend more time talking with each other than doing productive work.  Managers and other workers may fight each other for power rather than doing what is best for the company.  People may call in sick more often, knowing that others are there to fill in for them.  Waste could spiral out of control as more purchases are made.  Each employee will feel less needed, and may become less motivated.

As President of your company, think before you make long-run changes to increase output: do you have increasing, constant, or decreasing returns to scale?   

As president of your company, think before you make long-run changes to increase output: do you have increasing, constant, or decreasing returns to scale?   

====Diminishing Returns v. Returns to Scale====

====Diminishing Returns v. Returns to Scale====

Occasionally a major firm will suddenly declare itself to be broke and will ask the government for a “bailout” to save its jobs, as General Motors has done.  The car maker Chrysler also did this about 30 years ago.  The federal government, despite substantial criticism, provided cheap loans to Chrysler to keep it out of bankruptcy.  So many jobs were at stake that there was political benefit to some officials for doing this.  But don’t expect the government ever to save '''''your firm''''' from going bankrupt.   

Occasionally a major firm will suddenly declare itself to be broke and will ask the government for a “bailout” to save its jobs, as General Motors has done.  The car maker Chrysler also did this about 30 years ago.  The federal government, despite substantial criticism, provided cheap loans to Chrysler to keep it out of bankruptcy.  So many jobs were at stake that there was political benefit to some officials for doing this.  But don’t expect the government ever to save '''''your firm''''' from going bankrupt.   

==Assignment==

==Assignment==

1.  Fixed costs can be easily identified by seeing what the total costs are when output is _______.  Separately, give an example of a variable cost.

1.  Fixed costs can be easily identified by seeing what the total costs are when output is _______.  Separately, give an example of a variable cost.

2.  Suppose the owner of a restaurant decides, "We were profitable last month.  To increase our profits next month, I'm going to double our number of waitresses so that we can serve more people!"  But an economics student told him that his plan would fail because there is _____________ returns of scale in the restaurant: more waitresses would result in more wasted time talking to each other and waitresses getting in the way of each other.

2.  There are _____________ returns of scale in restaurants with respect to doubling or tripling the number of waitresses.  Explain briefly.

3.  Give an example of a "short run" cost for a firm, and give an example of a "long run" cost.  This can refer to any type of firm, from a grocery store to a baseball team to homeschooling.

3.  Give an example of a "short run" cost for a firm, and give an example of a "long run" cost.  This can refer to any type of firm, from a grocery store to a baseball team to homeschooling.