He has 5 acres of land o He can hire as many workers as he wants We will use

He has 5 acres of land o he can hire as many workers

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He has 5 acres of land o He can hire as many workers as he wants - We will use this example to illustrate the production function and marginal product, and to begin to look at the costs of production Examples 1: Farmer Jack’s Production Function Marginal Product - If Farmer Jack hires one more worker, his output rises by the marginal product of labour - The marginal product of any input is the increase in output arising from using an additional unit of that input, holding all other inputs constant - Notation: Δ (delta) = “change in…” - Examples: o ΔQ = change in output o ΔL = change in labour - Marginal product of labour MP L = ΔQ Δ L Example 1: Total and Marginal Product :MP L =Slope of Production function Why the MP L Is Important - Principle #3: Rational people think at the margin - When Farmer Jack hires an extra worker, o His costs rise by the wage he pays the worker o His output rises by the MP L and the value of that extra output (what he can sell it for) rises by p x MP L The latter is Farmer Jack’s benefit from hiring the extra worker o Comparing them helps Jack decide whether he would benefit from hiring the worker If the benefit exceeds the cost, hire; otherwise, do not hire - Thinking at the margin helps not only Farmer Jack, but all managers in the real world o They make business decisions every day by comparing marginal costs with marginal benefits L (No. of workers) Q (Bushels of Wheat) 0 0 1 1000 2 1800 3 2400 4 2800 5 3000
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Chapter 13: Cost of Production Why the MP L Falls - Farmer Jack’s output rises by a smaller and smaller amount for each additional worker. Why? - As Farmer Jack adds workers, the average worker has less land to work with and will be less productive - In general, MPL falls as L rises whether the fixed input is land or capital (equipment, machines, etc.) - Diminishing marginal product o The marginal product of an input declines as the quantity of the input increases (other things equal) Example 1: Farmer Jack’s Costs - Farmer Jack must pay $1,000 per month for the land on which he produces wheat, regardless of how much wheat he grows o This is a type of fixed cost - The market wage for a farm worker is $2,000 per month, but is paid only if the worker is used to produce wheat o This is a type of variable cost - So Farmer Jack’s costs are related to how much wheat he produces L (No. of Workers) Q (Bushels of wheat) Cost of land Cost of labour Total Cost 0 0 $1000 $0 $1000 1 1000 $1000 $2000 $3000 2 1800 $1000 $4000 $5000 3 2400 $1000 $6000 $7000 4 2800 $1000 $8000 $9000 5 3000 $1000 $10, 000 $11,000 Marginal Cost - Marginal lCost (MC): The increase in Total Cost from producing one more unit MC = ∆TC ∆Q Why MC Is Important - Farmer Jack is rational and wants to maximize his profit - To increase profit, should he produce more or less wheat? - To find the answer, Farmer Jack needs to “think at the margin” - If the cost of additional wheat (MC) is less than the revenue he would get from selling it, then Farmer Jack’s profits rise if he produces more o In the next chapter, we will learn more about how firms choose Q to maximize their profits Fixed & Variable Costs
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Chapter 13: Cost of Production - Fixed costs (FC) do not vary with the quantity of output produced o For Farmer Jack, FC = $1,000 for his land o Other examples: Cost of equipment, loan payments, rent - Variable costs (VC) vary with the quantity produced o For Farmer Jack, VC = the wages he pays workers o
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