Changes

In general, MP rises as your initial employees are hired, eventually reaches a maximum at some point and then falling back towards zero for each additional employee.  It is an upside-down oval, beginning at MP=0 for 0 employees and returning to MP=0 for a large number “n” of employees.  The value of “n” depends on the business.   

In general, MP rises as your initial employees are hired, eventually reaches a maximum at some point and then falling back towards zero for each additional employee.  It is an upside-down oval, beginning at MP=0 for 0 employees and returning to MP=0 for a large number “n” of employees.  The value of “n” depends on the business.   

The optimal number of employees for an NBA basketball team, when MP is its maximum, is about only ten players.  The optimal number of employees for Wal-Mart, when MP is its maximum, is over 1 million employees.  So determining the optimal number of employees depends on what the firm is producing.

The optimal number of employees for an NBA basketball team, when MP is its maximum, is about only a dozen players.  The optimal number of employees for Wal-Mart, when MP is its maximum, is over 1 million employees.  So determining the optimal number of employees depends on what the firm is producing.

Can we can find the marginal cost (MC) of making that extra widget based on (i) the wages we have to pay the extra employee and (ii) his marginal productivity (MP)?  If it costs us $100 to hire one more employee, and he enables us to make 10 more widgets, then our marginal cost (MC) is simply $100/10 = $10 per unit.  In other words, '''''MC = wage/MP''''' (wage divided by marginal product).

Can we can find the marginal cost (MC) of making that extra widget based on (i) the wages we have to pay the extra employee and (ii) his marginal productivity (MP)?  If it costs us $100 to hire one more employee, and he enables us to make 10 more widgets, then our marginal cost (MC) is simply $100/10 = $10 per unit.  In other words, '''''MC = wage/MP''''' (wage divided by marginal product).

We expect the output of a firm to increase in proportion to an increase in scale.  As President, 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, 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?  Our first impression would be 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 scale) and “decreasing returns to scale” (output goes up by a smaller percentage than the increase in scale).  '''''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.'''''

The 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.

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

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

Do not confuse decreasing returns to scale with diminishing returns.  '''''Diminishing returns are something that occurs in the short run''''': it is the decline in marginal productivity as you keep increasing a variable input while all other inputs remain constant.  For example, asking one employee to work more and more overtime is going to have diminishing returns.  He is going to become so tired that he will not work as efficiently as when he is rested.  And even if he did not tire, the added benefit of the worker to your company by himself is going to decline without adding other workers or facilities to support him.  The entirely different concept of decreasing returns to scale refers to long term economic changes due to big modifications to your company.  Diminishing returns are always expected; decreasing returns to scale are not.

Do not confuse decreasing returns to scale with diminishing returns.  '''''Diminishing returns are something that occurs in the short run: the decline in marginal productivity as you keep increasing a variable input while all other inputs remain constant.''''' For example, asking one employee to work more and more overtime is going to have diminishing returns.  He is going to become so tired that he will not work as efficiently as when he is rested.  And even if he did not tire, the added benefit of the worker to your company by himself is going to decline without adding other workers or facilities to support him.  The '''''different''''' concept of decreasing returns to scale refers to long term economic changes due to big modifications to your company.  Diminishing returns are always expected; decreasing returns to scale are not.

A typical firm can initially expect average unit costs to decline as it increases inputs (workers, facilities, etc.) from zero.  This is an increasing return to scale.  But at some point, call it when input = X, those increasing returns disappear and the company can only obtain constant returns to scale.  It has attained its “minimum efficient scale” at that point.  It can continue to increase its inputs, but its output only increases by the same amount as its input.  Ultimately, the company will find that increasing inputs further does not even increase output much.  It has too many workers or facilities at that point, and it begins to have decreasing returns to scale.

A typical firm can initially expect average unit costs to decline as it increases inputs (workers, facilities, etc.) from zero.  This is an increasing return to scale.  But at some point, call it when input = X, those increasing returns disappear and the company can obtain only constant returns to scale.  It has attained its “minimum efficient scale” at that point.  It can continue to increase its inputs, but its output increases by only the same amount as its input.  Ultimately, the company will find that increasing inputs further does not even increase output much.  It has too many workers or facilities at that point, and it begins to have decreasing returns to scale.

====Division of Labor====

====Division of Labor====

The key to increasing returns to scale, which is what every firm owner wants, is '''''division of labor'''''.  Train your employees to become specialists at certain functions so that they can be performed more efficiently.  Henry Ford was a master at this, training his workforce in a way that each employee was an expert at a particularized aspect of the assembly line.  The more specialized employees can become, the faster they can accomplish their task.  After a while, they could almost do their job in their sleep.  And that is a good thing, because doing the same task over and over puts one to sleep!   

The key to increasing returns to scale, which is what every firm owner wants, is '''''division of labor'''''.  Train your employees to become specialists at certain functions so that they can be performed more efficiently.  Henry Ford was a master at this, training his workforce in a way that each employee was an expert at a particularized aspect of the assembly line.  The more specialized employees can become, the faster they can accomplish their task.  After a while, they can almost do their job in their sleep.  And that is a good thing, because doing the same task over and over puts one to sleep!   

Charlie Chaplin mocked this division of labor in the mostly silent movie, “Modern Times,” made in 1936.  In it, he portrays a factory working toiling in a dehumanizing position under the pressure of a mean boss.  Charlie is just trying to earn a decent living and buy a house for his wife Paulette and himself, but bad luck keeps getting the way.  The theme of class struggle occurs repeatedly in politics to this day.  In 1988, Democratic presidential candidate Michael Dukakis emphasized the need for Americans to have good jobs, not just any job.  But Dukakis was unsuccessful with his promise; either not enough believed him, or not enough cared.

Charlie Chaplin mocked this division of labor in the mostly silent movie, “Modern Times,” made in 1936.  In it he portrays a factory working toiling in a dehumanizing position under the pressure of a mean boss.  Charlie is just trying to earn a decent living and buy a house for his wife Paulette and himself, but bad luck keeps getting the way.  The theme of class struggle occurs repeatedly in politics to this day.  In 1988, Democratic presidential candidate Michael Dukakis emphasized the need for Americans to have good jobs, not just any job.  But Dukakis was unsuccessful with his promise; either not enough believed him, or not enough cared because the economy was doing well at the time.

==Costs: Long Run Is Cheaper than Short Run==

==Costs: Long Run Is Cheaper than Short Run==

1.  Fixed costs can be easily identified by seeing what the total costs are when output is _______.

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.  The Lecture mentioned how a prior student in this course is working her way through college by working as a waitress in a fancy Manhattan restaurant.  Suppose her boss tells her one day, "We were profitable last month.  To double our profits this month, I'm going to doubt our number of waitresses so that we can be double the number of people we serve!"  But our former 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.  The Lecture mentioned how a prior student in this course is paying her way through college by working as a waitress in a fancy Manhattan restaurant.  Suppose her boss told her one day, "We were profitable last month.  To increase our profits next month, I'm going to doubt our number of waitresses so that we can serve more people!"  But our former economics student told him that his plan would fail because there is _____________ returns of scale in the restaurant, because more waitresses would result in more wasted time talking to each other and waitresses getting in the way of each other.

3.  Explain what "marginal product" is.

3.  Explain what "marginal product" is.

4. Suppose you own a mechanics' shop that fixes cars, and you have 4 employees whom you pay $12 per hour.  On average your 4th employee can fix 3 cars an hour.  What is your marginal product (MP) and marginal cost (MC), and what is the minimum on average that you need to charge customers (your marginal revenue) for fixing cars?  (Assume your only cost is labor, and the customer pays the cost of any parts.)

4. Suppose you own a mechanics' shop that fixes cars, and you have 4 employees whom you pay $12 per hour.  On average your 4th employee can fix 3 cars an hour.  What is your marginal product (MP) and marginal cost (MC), and what is the minimum on average that you need to charge customers (your marginal revenue) for fixing cars?  (Assume your only cost is labor, and the customer pays the cost of any parts.)

5.  Do you think the returns to scale from the world's population is increasing, constant or decreasing?  There is no correct answer but you will be graded on your explanation.

5.  Do you think the returns to scale from the world's population is increasing, constant or decreasing?  There is no correct answer but you will be graded on your explanation.

===Honors===

===Honors===

Answer questions 8 and 9, and then write a brief essay about one of the other questions.

Provide brief answers to '''''all''''' of these questions.

8.  Recall from the last Lecture that a firm increases its output as long as its marginal revenue exceeds its marginal cost.  Suppose there is an increase in market price for the firm's widget, such that its marginal revenue is greater than its marginal cost.  The firm will hire more employees to produce more output until the value of its marginal product of labor equals _____________.

8.  Suppose there is a sudden increase in the market price for a firm's widget, and that its only cost is labor.  The firm will hire more employees to produce more output until the point where the value of its marginal product of labor equals its _____________.

9.  Answer and discuss:  Your firm seeks to produce a certain level of output in the most efficient way (the lowest cost).  It should use its resources in which of the following ways:

9.  Explain the following from the lecture: if inflation is 10% per year for three years, but one particular good keeps the same price during those three years, then its opportunity cost and real price actually decreased.

 

 

 

12.  (Difficult, but try):  Your firm seeks to produce a certain level of output in the most efficient way (the lowest cost).  It should use its resources in which of the following ways:

(a) use materials that generate the highest marginal product

(a) use materials that generate the highest marginal product

<br>(c) use as much material as possible until there are diminishing returns

<br>(c) use as much material as possible until there are diminishing returns

<br>(d) use resources such that their marginal products per unit cost are equal

<br>(d) use resources such that their marginal products per unit cost are equal

=== Extra Credit for Anyone ===

=== Extra Credit for Anyone ===

13.  The most efficient division of labor in the world is ... traditional marriage between a man and woman.

13.  The most efficient "division of labor" in the world is ... traditional marriage between a man and woman.

== References ==

== References ==