Behind the Supply Curve:

Inputs and Costs

Revised by Vitaly Terekhov

Krugman, Microeconomics:
Krugman,
Canadian
Economics,
Edition, 6e,
4e, © 2020
2021 Worth Publishers
 WHAT YOU WILL LEARN IN THIS CHAPTER

• What is the firm’s production function?

• Why is production often subject to diminishing returns to
inputs?
• The various types of costs and how to generate the marginal
and average cost curves?
• Why do the firm’s costs differ in the short run and in the long
run?
• What is increasing returns to scale, and what advantage does
it give?

Krugman, Microeconomics:
Krugman,
Canadian
Economics,
Edition, 6e,
4e, © 2020
2021 Worth Publishers
 THE PRODUCTION FUNCTION

• A firm is an organization that produces goods or services for

sale.
• Production is the process of turning inputs into outputs.
• A production function is the relationship between the
quantity of inputs a firm uses and the quantity of output it
produces.
• A fixed input is an input whose quantity is fixed for a period of
time and cannot be varied.
• A variable input is an input whose quantity the firm can vary
at any time.

Krugman, Microeconomics:
Krugman,
Canadian
Economics,
Edition, 6e,
4e, © 2020
2021 Worth Publishers
 INPUTS AND OUTPUT

• The long run is the period in which all inputs can be varied.
• The short run is the period in which at least one input is fixed.
• The total product curve shows how the quantity of output
depends on the quantity of the variable input for a given
quantity of the fixed input.

Krugman, Microeconomics:
Krugman,
Canadian
Economics,
Edition, 6e,
4e, © 2020
2021 Worth Publishers
 Widget Production in Classroom

• One volunteer produce … widgets

– Quality Matters – I will inspect the quality and only the
good quality widgets will count
• One volunteer to time the production for 90 seconds
• Two volunteers to produce widgets
– Discuss your operation
– Produce as many as you can in 90 seconds
– Count the production
• Add new volunteers one at a time
– Repeat the experiment
– Count the production

Krugman, Microeconomics:
Krugman,
Canadian
Economics,
Edition, 6e,
4e, © 2020
2021 Worth Publishers
 Widget Production in Classroom

• Output - Widgets
• Variable inputs
– Paper
– Staples
– Labour
• Fixed input
– Stapler
– Desk

Krugman, Microeconomics:
Krugman,
Canadian
Economics,
Edition, 6e,
4e, © 2020
2021 Worth Publishers
 PRODUCTION FUNCTION AND TOTAL PRODUCT
CURVE (1 of 2)
Figure 11-1

• The curve slopes upward because more wheat is produced as

more workers are employed. It becomes flatter because the
marginal product of labour declines as more workers are employed.
Krugman, Microeconomics:
Krugman,
Canadian
Economics,
Edition, 6e,
4e, © 2020
2021 Worth Publishers
 PRODUCTION FUNCTION AND TOTAL
PRODUCT CURVE (2 of 2)

• The marginal product of an input is the additional

quantity of output that is produced by using one more unit
of that input.
• Marginal product of labour (MPL) is the change in
output resulting from a one-unit increase in the amount of
labour input (Δq/ΔL).

Krugman, Microeconomics:
Krugman,
Canadian
Economics,
Edition, 6e,
4e, © 2020
2021 Worth Publishers
 Marginal Product of Labour
• MPL equals the slope of the total product curve.
• In Figure 11-1, MPL declines as more workers are hired. As
employment increases, the total product curve gets flatter.

Krugman, Microeconomics:
Krugman,
Canadian
Economics,
Edition, 6e,
4e, © 2020
2021 Worth Publishers
 DIMINISHING RETURNS TO AN INPUT
• Diminishing returns to an input: an increase in the quantity of
that input, holding other inputs and technology fixed, reduces that
input’s marginal product.
Figure 11-2

Here, the first worker

employed generates
an increase in
output of 19 bushels,
the second worker
generates an
increase of 17
bushels, and so on…

Krugman, Microeconomics:
Krugman,
Canadian
Economics,
Edition, 6e,
4e, © 2020
2021 Worth Publishers
LEARN BY DOING: PRACTICE QUESTION 1

• Marginal product is the slope of the:

a) marginal cost curve.
b) total product curve.
c) long-run average total cost curve.
d) total cost curve.

Krugman, Microeconomics:
Krugman,
Canadian
Economics,
Edition, 6e,
4e, © 2020
2021 Worth Publishers
 LEARN BY DOING: PRACTICE QUESTION 1
(Answer)

• Marginal product is the slope of the:

a) marginal cost curve.
b) total product curve. (correct answer)
c) long-run average total cost curve.
d) total cost curve.

Krugman, Microeconomics:
Krugman,
Canadian
Economics,
Edition, 6e,
4e, © 2020
2021 Worth Publishers
 PITFALLS: WHAT’S A UNIT?

• The MPL is defined as the increase in the quantity of output when

you increase the quantity of that input by one unit.
• What do we mean by a unit of labour? Is it an additional hour of
labour, an additional week, or a person-year?
• The answer is that it doesn’t matter, as long as you are consistent.

Krugman, Microeconomics:
Krugman,
Canadian
Economics,
Edition, 6e,
4e, © 2020
2021 Worth Publishers
TOTAL PRODUCT, MARGINAL PRODUCT, AND FIXED INPUT

Figure 11-3

• With more land (the fixed input), each worker can produce more. This
shifts the total product curve up.
• So the MPL of each worker is higher when the farm is larger; the MPL
curve shifts up, too from MPL10 to MPL20
Krugman, Microeconomics:
Krugman,
Canadian
Economics,
Edition, 6e,
4e, © 2020
2021 Worth Publishers
 AVERAGE PRODUCT

When the farm employs one worker, the average product is 19

bushels (same as total product). When the farm employs 2 workers,
each worker produces 18 bushels on average

Krugman, Microeconomics:
Krugman,
Canadian
Economics,
Edition, 6e,
4e, © 2020
2021 Worth Publishers
 AVERAGE PRODUCT versus MARGINAL PRODUCT

When marginal product is greater that average product, the average

product is increasing. When marginal product is less than average
product, the average product is decreasing

Krugman, Microeconomics:
Krugman,
Canadian
Economics,
Edition, 6e,
4e, © 2020
2021 Worth Publishers
 FROM THE PRODUCTION FUNCTION TO COST
CURVES

• A fixed cost is a cost that does not depend on the quantity

of output produced. It is the cost of the fixed input.

• A variable cost is a cost that depends on the quantity of

output produced. It is the cost of the variable input.

Krugman, Microeconomics:
Krugman,
Canadian
Economics,
Edition, 6e,
4e, © 2020
2021 Worth Publishers
 LEARN BY DOING: PRACTICE QUESTION 3

• You own a deli. Which of the following is most likely a fixed

input at your deli?
a) the dining room
b) the bread used to make sandwiches
c) the tomato base used to make soups
d) the employees

Krugman, Microeconomics:
Krugman,
Canadian
Economics,
Edition, 6e,
4e, © 2020
2021 Worth Publishers
 LEARN BY DOING: PRACTICE QUESTION 3
(Answer)

• You own a deli. Which of the following is most likely a fixed

input at your deli?
a) the dining room (correct answer)
b) the bread used to make sandwiches
c) the tomato base used to make soups
d) the employees

Krugman, Microeconomics:
Krugman,
Canadian
Economics,
Edition, 6e,
4e, © 2020
2021 Worth Publishers
 TOTAL COST CURVE
• The total cost of producing a given quantity of output is
the sum of the fixed cost and the variable cost of
producing that quantity of output.
TC = FC + VC
• The total cost curve shows how total cost depends on
the quantity of output.
• The total cost curve becomes steeper as more output is
produced, a result of diminishing returns.
• With diminishing returns, additional units of output require
more and more labour; therefore, the cost increases.

Krugman, Microeconomics:
Krugman,
Canadian
Economics,
Edition, 6e,
4e, © 2020
2021 Worth Publishers
TOTAL COST
CURVE

Figure 11-6:
The curve gets
steeper as output
increases due to
diminishing returns
to labour.

Krugman, Microeconomics:
Krugman,
Canadian
Economics,
Edition, 6e,
4e, © 2020
2021 Worth Publishers
 MARGINAL COST

As in the case of marginal product, marginal cost is equal

to rise (the increase in total cost) divided by run (the
increase in the quantity of output).

Krugman, Microeconomics:
Krugman,
Canadian
Economics,
Edition, 6e,
4e, © 2020
2021 Worth Publishers
MARGINAL COST EXAMPLE

Krugman, Microeconomics:
Krugman,
Canadian
Economics,
Edition, 6e,
4e, © 2020
2021 Worth Publishers
MARGINAL COST GRAPHS

Figure 11-8

Krugman, Microeconomics:
Krugman,
Canadian
Economics,
Edition, 6e,
4e, © 2020
2021 Worth Publishers
 WHY IS THE MARGINAL COST CURVE UPWARD
SLOPING?

• Because there are diminishing returns to inputs in this

example. As output increases, the marginal product of the
variable input declines.
• This implies that more and more of the variable input must
be used to produce each additional unit of output as the
amount of output already produced rises.
• And since each unit of the variable input must be paid for, the
cost per additional unit of output also rises.

Krugman, Microeconomics:
Krugman,
Canadian
Economics,
Edition, 6e,
4e, © 2020
2021 Worth Publishers
 AVERAGE COST
Average total cost (often referred to simply as average cost) = total
cost per unit of output produced.
ATC = TC/q = (Total Cost) / (Quantity of Output)
Average fixed cost = fixed cost per unit of output produced.
AFC = FC/q
Average variable cost = variable cost per unit of output produced.
AVC = VC/q

Krugman, Microeconomics:
Krugman,
Canadian
Economics,
Edition, 6e,
4e, © 2020
2021 Worth Publishers
 LEARN BY DOING: PRACTICE QUESTION 4

• You produce widgets. Currently you produce four widgets at a total

cost of $40.
Suppose you could produce one more widget (the fifth) at a
marginal cost of $5. If you do produce that fifth widget, what will
your average total cost be? Has your average total cost
increased or decreased?
a) Your average total cost has decreased to $11.
b) Your average total cost has decreased to $9.
c) Your average total cost has increased to $9.
d) Your average total cost has increased to $11.

Krugman, Microeconomics:
Krugman,
Canadian
Economics,
Edition, 6e,
4e, © 2020
2021 Worth Publishers
 LEARN BY DOING: PRACTICE QUESTION 4
(Answer)

• You produce widgets. Currently you produce four widgets at a total

cost of $40.
Suppose you could produce one more widget (the fifth) at a
marginal cost of $5. If you do produce that fifth widget, what will
your average total cost be? Has your average total cost
increased or decreased?
a) Your average total cost has decreased to $11.
b) Your average total cost has decreased to $9. (correct answer)
c) Your average total cost has increased to $9.
d) Your average total cost has increased to $11.

Krugman, Microeconomics:
Krugman,
Canadian
Economics,
Edition, 6e,
4e, © 2020
2021 Worth Publishers
Krugman, Microeconomics:
Krugman,
Canadian
Economics,
Edition, 6e,
4e, © 2020
2021 Worth Publishers
AVERAGE TOTAL COST CURVE FOR
SELENA’S GOURMET SALSAS
Figure 11-9

Krugman, Microeconomics:
Krugman,
Canadian
Economics,
Edition, 6e,
4e, © 2020
2021 Worth Publishers
 AVERAGE TOTAL COST CURVE

• Increasing output has two opposing effects on average

total cost:
– The spreading effect: the larger the output, the more output
over which fixed cost is spread, leading to lower average fixed
cost.
– The diminishing returns effect: the larger the output, the
more variable input required to produce additional units, which
leads to higher average variable cost.

Krugman, Microeconomics:
Krugman,
Canadian
Economics,
Edition, 6e,
4e, © 2020
2021 Worth Publishers
 PUTTING THE FOUR COST CURVES TOGETHER

• Note that:
1. Marginal cost slopes upward because of diminishing returns.
2. Average variable cost also slopes upward but is flatter than the
marginal cost curve.
3. Average fixed cost slopes downward because of the spreading
effect.
4. The marginal cost curve intersects the average total cost curve
from below, crossing it at its lowest point.

Krugman, Microeconomics:
Krugman,
Canadian
Economics,
Edition, 6e,
4e, © 2020
2021 Worth Publishers
 MARGINAL COST AND AVERAGE COST
CURVES FOR SELENA’S GOURMET SALSAS
Figure 11-10

Krugman, Microeconomics:
Krugman,
Canadian
Economics,
Edition, 6e,
4e, © 2020
2021 Worth Publishers
LEARN BY DOING: PRACTICE QUESTION 5

• At high levels of output the spreading effect is:

a) stronger than the diminishing returns effect.
b) weaker than the diminishing returns effect.

Krugman, Microeconomics:
Krugman,
Canadian
Economics,
Edition, 6e,
4e, © 2020
2021 Worth Publishers
 LEARN BY DOING: PRACTICE QUESTION 5
(Answer)

• At high levels of output the spreading effect is:

a) stronger than the diminishing returns effect.
b) weaker than the diminishing returns effect. (correct
answer)

Krugman, Microeconomics:
Krugman,
Canadian
Economics,
Edition, 6e,
4e, © 2020
2021 Worth Publishers
 MINIMUM AVERAGE TOTAL COST
• The minimum-cost output is the quantity of output at which
average total cost is lowest—the bottom of the U-shaped
average total cost curve.
• Three general principles are always true about a firm’s
marginal cost and average total cost curves:
1. At the minimum-cost output, average total cost is equal to
marginal cost.
2. At output less than the minimum-cost output, marginal
cost is less than average total cost and average total cost is
falling.
3. At output greater than the minimum-cost output, marginal
cost is greater than average total cost and average total cost
is rising.

Krugman, Microeconomics:
Krugman,
Canadian
Economics,
Edition, 6e,
4e, © 2020
2021 Worth Publishers
 THE RELATIONSHIP BETWEEN THE AVERAGE
TOTAL COST AND THE MARGINAL COST CURVES
When marginal cost equals average total cost, we must be at the bottom of the
U, because only at that point is average total cost neither falling nor rising
Figure 11-11

Krugman, Microeconomics:
Krugman,
Canadian
Economics,
Edition, 6e,
4e, © 2020
2021 Worth Publishers
 DOES THE MARGINAL COST CURVE
ALWAYS SLOPE UPWARD? (1 of 2)
• Marginal cost curves often slope downward as the output goes from
zero up to some low level, and they slope upward at higher levels of
production.
• The initial downward slope occurs when employing more workers
allows them to specialize in various tasks.
• This specialization leads to increasing returns to the hiring of
additional workers and results in the marginal cost curve sloping
downward.
• Once enough workers exhaust the benefits of specialization,
diminishing returns to labour set in, and the marginal cost curve
slopes upward.
• Typical marginal cost curves have the “swoosh” shape.

Krugman, Microeconomics:
Krugman,
Canadian
Economics,
Edition, 6e,
4e, © 2020
2021 Worth Publishers
DOES THE MARGINAL COST CURVE
ALWAYS SLOPE UPWARD? (2 of 2)
Figure 11-12

Krugman, Microeconomics:
Krugman,
Canadian
Economics,
Edition, 6e,
4e, © 2020
2021 Worth Publishers
 SHORT-RUN versus LONG-RUN COSTS

• All inputs are variable in the long run. This means that
in the long run, fixed cost (like factory size) may also vary.
• In the long run, in other words, a firm’s fixed cost
becomes a variable it can choose.

• The firm will choose its fixed cost in the long run
based on the level of output it expects to produce.

Krugman, Microeconomics:
Krugman,
Canadian
Economics,
Edition, 6e,
4e, © 2020
2021 Worth Publishers
 Figure 11-13

CHOOSING THE
LEVEL OF FIXED
COST

There is a trade-off between

higher fixed cost and lower
variable cost for any given
output level, and vice versa.

Krugman, Microeconomics:
Krugman,
Canadian
Economics,
Edition, 6e,
4e, © 2020
2021 Worth Publishers
THE LONG-RUN AVERAGE TOTAL COST CURVE

• The long-run average total cost curve shows the

relationship between output and average total cost when
fixed cost has been chosen to minimize average total
cost for each level of output.
– (We assume the firm has chosen the cheapest plant
size for each output level)

Krugman, Microeconomics:
Krugman,
Canadian
Economics,
Edition, 6e,
4e, © 2020
2021 Worth Publishers
 SHORT-RUN AND LONG-RUN AVERAGE
TOTAL COST CURVES
Short-run and long-run average
total cost curves differ because Figure 11-14
a firm can choose its fixed cost
in the long run.

If the firm chooses the fixed

cost that minimizes short-run
ATC at an output of six, and
produces six, it’s at point C.
If it produces only three, it will
move to point B.
If the firm expects to produce
three cases for a long time, it
will reduce its fixed cost and
move to point A.
If it produces nine (point Y) and
expects to continue this for a
long time, it will increase its
fixed cost and move to point X.
Krugman, Microeconomics:
Krugman,
Canadian
Economics,
Edition, 6e,
4e, © 2020
2021 Worth Publishers
 RETURNS TO SCALE

• There are increasing returns to scale (economies of

scale) when long-run average total cost declines as
output increases.
• There are decreasing returns to scale (diseconomies
of scale) when long-run average total cost increases as
output increases.
• There are constant returns to scale when long-run
average total cost is constant as output increases.

Krugman, Microeconomics:
Krugman,
Canadian
Economics,
Edition, 6e,
4e, © 2020
2021 Worth Publishers
Summing Up Costs

Krugman, Microeconomics:
Krugman,
Canadian
Economics,
Edition, 6e,
4e, © 2020
2021 Worth Publishers