Total product is simply the output that is produced by all of the employed workers. Doing all of these tasks by himself, our first worker is able to produce three widgets. With one worker, the worker must fold the paper, staple it, and write the W. What will be the output level of widgets as more labor is added? With zero workers, nothing gets produced. Each round is a certain amount of time, say 40 seconds. The inputs are a stack of quarter sheets of paper, one stapler, one pen, and a 2’ x 3’ sheet of poster board which represents your factory wherein all production must take place. If you have a big family, you can do this as a Family Home Evening activity otherwise you can just read along to see the results. Our widget will be made taking a quarter sheet of paper, folding it in half twice then stapling it and writing the letter W on it. For demonstration purposes in economics, we often make widgets, which is really any hypothetical manufactured device. We can demonstrate the impact of adding more of a variable resource, say labor, to a fixed amount of capital and see what happens to output. What happens to output as more resources are employed? In order to produce, we must employ resources, i.e., land, labor, capital, and entrepreneurship. This section focuses on the second part of the equation, costs. Total revenue is equal to price times quantity and we examined their relationship in the elasticity section. Profits equal total revenue minus total costs. This is the most efficient quantity to produce, as the average total cost is minimized.We are now going to focus on the what is behind the supply curve. This results in a lower average total cost( $18.75). While the average variable cost is increasing ($12), it increases less than the average fixed cost decreases. As we learn, the average fixed costs decrease as the total quantity increase.Īt a quantity level of 8, we see that fixed costs have spread out across the total output( $13.5). The fixed cost equals $54 for the 1 unit of chocolate, the average fixed cost is $54. Similarly, we can see that the variable cost of 1 unit is $6, and the average variable cost increases with each additional unit of chocolate bar. Average Cost ExampleĪs the Willy Wonka chocolate firm produces more chocolate bars, the total costs are increasing as expected. In the below table, we have columns for the produced quantity, the total cost as well as the average variable cost, average fixed cost, and average total cost. Let's practice calculating the Average Cost and have a closer look at the example of the Willy Wonka chocolate firm. It is very important to understand how to calculate the Average Cost using the total fixed cost and average variable cost. At low levels of output, small increases in output cause large changes in average fixed cost. How do the spreading effect and diminishing returns effect cause the U-shape of the Average Cost Function? The relationship between these two affects the shape of the Average Cost Function.įor lower levels of output, the spreading effect dominates the diminishing returns effect, and for higher levels of output, the contrary holds. Since a greater amount of variable input would be necessary as the output increases, we have higher average variable costs for higher levels of produced outputs. This effect is called the diminishing returns effect. This effect is also known as diminishing returns to the variable input Each unit of output that the firm produced additionally adds more to the variable cost since a rising amount of variable input would be necessary to produce the additional unit. On the other hand, we see a rising average variable cost. The Average Variable Cost and the Diminishing Returns Effect Given a certain amount of fixed cost, the average fixed cost decreases as the output increases. This effect is called the spreading effect since the fixed cost is spread over the produced quantity. This is the reason why we have a falling average fixed cost curve in Figure 1 above. Since the total fixed cost is fixed, the more you produce, the average fixed cost per unit will decrease further. In other words, fixed costs equal the required investment you need to make to start producing. This includes, for instance, necessary machines, stands, and tables. You can think of the fixed cost as the amount of money you need to open a bakery. Price Determination in a Competitive Market.Market Equilibrium Consumer and Producer Surplus.Determinants of Price Elasticity of Demand.Cross Price Elasticity of Demand Formula.Effects of Taxes and Subsidies on Market Structures.Monopolistic Competition in the Short Run.Monopolistic Competition in the Long Run.Behavioural Economics and Public Policy.
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