11

After studying this chapter,

you will be able to:
OUTPUT AND COSTS

Behind the scenes of an Amazon fulfillment center,

many economic decisions have been made that affect
the cost of processing orders. Amazon has decided how
many people and robots to employ and how many
◆ Distinguish between the short run and the long run
and what size of fulfillment center to build. How does
◆ Explain and illustrate a firm’s short-run product Amazon make these decisions?
curves
This chapter answers this question and in
◆ Explain and derive a firm’s short-run cost curves Economics in the News at the end of the chapter, we’ll
◆ Explain and derive a firm’s long-run average cost look at a decision made by Amazon. But first, we’ll
curve study the costs of a simpler, smaller firm, Campus
Sweaters, a (fictional) producer of knitwear.

289
290 CHAPTER 11 Output and Costs

◆ Decision Time Frames production. We call the fixed factors of production the
firm’s plant: In the short run, a firm’s plant is fixed.
People who operate firms make many decisions, and For Campus Sweaters, the fixed plant is its factory
all of their decisions are aimed at achieving one over- building and its knitting machines. For an electric
riding goal: maximum attainable profit. But not all power utility, the fixed plant is its buildings, genera-
decisions are equally critical. Some decisions are big tors, computers, and control systems.
ones. Once made, they are costly (or impossible) to To increase output in the short run, a firm must
reverse. If such a decision turns out to be incorrect, it increase the quantity of a variable factor of production,
might lead to the failure of the firm. Other decisions which is usually labor. So to produce more output,
are small. They are easily changed. If one of these Campus Sweaters must hire more labor and operate its
decisions turns out to be incorrect, the firm can knitting machines for more hours a day. Similarly, an
change its actions and survive. electric power utility must hire more labor and operate
The biggest decision that an entrepreneur makes is its generators for more hours a day.
in what industry to establish a firm. For most entre- Short-run decisions are easily reversed. The firm
preneurs, their background knowledge and interests can increase or decrease its output in the short run by
drive this decision. But the decision also depends on increasing or decreasing the amount of labor it hires.
profit prospects—on the expectation that total rev-
enue will exceed total cost. The Long Run
Cindy has decided to set up Campus Sweaters. She
The long run is a time frame in which the quantities of
has also decided the most effective method of organiz-
all factors of production can be varied. That is, the long
ing the firm. But she has not decided the quantity to
run is a period in which the firm can change its plant.
produce, the factors of production to hire, or the price
To increase output in the long run, a firm can
to charge for sweaters.
change its plant as well as the quantity of labor it hires.
Decisions about the quantity to produce and the
Campus Sweaters can decide whether to install more
price to charge depend on the type of market in
knitting machines, use a new type of machine, reorgan-
which the firm operates. Perfect competition,
ize its management, or hire more labor. Long-run deci-
monopolistic competition, oligopoly, and monopoly
sions are not easily reversed. Once a plant decision is
all confront the firm with different problems.
made, the firm usually must live with it for some
Decisions about how to produce a given output do
time. To emphasize this fact, we call the past expendi-
not depend on the type of market in which the firm
ture on a plant that has no resale value a sunk cost. A
operates. All types of firms in all types of markets
sunk cost is irrelevant to the firm’s current decisions.
make similar decisions about how to produce.
The only costs that influence its current decisions are
The actions that a firm can take to influence the
the short-run cost of changing its labor inputs and the
relationship between output and cost depend on how
long-run cost of changing its plant.
soon the firm wants to act. A firm that plans to
change its output rate tomorrow has fewer options
than one that plans to change its output rate six
months or six years in the future.
To study the relationship between a firm’s output REVIEW QUIZ
decision and its costs, we distinguish between two
decision time frames: 1 Distinguish between the short run and the long
run.
■ The short run 2 Why is a sunk cost irrelevant to a firm’s current
■ The long run decisions?

The Short Run

The short run is a time frame in which the quantity of We’re going to study costs in the short run and
at least one factor of production is fixed. For most the long run. We begin with the short run and
firms, capital, land, and entrepreneurship are fixed fac- describe a firm’s technology constraint.
tors of production and labor is the variable factor of
 Short-Run Technology Constraint 291

◆ Short-Run Technology TABLE 11.1 Total Product, Marginal Product,

Constraint and Average Product
To increase output in the short run, a firm must Marginal
increase the quantity of labor employed. We describe Total product Average
the relationship between output and the quantity of Labor product (sweaters per product
labor employed by using three related concepts: (workers (sweaters additional (sweaters
per day) per day) worker) per worker)
1. Total product
A 0 0
2. Marginal product ........4
3. Average product B 1 4 4.00
........6
These product concepts can be illustrated either by C 2 10 5.00
product schedules or by product curves. Let’s look ........3
D 3 13 4.33
first at the product schedules. ........2
E 4 15 3.75
Product Schedules ........1
F 5 16 3.20
Table 11.1 shows some data that describe Campus
Sweaters’ total product, marginal product, and aver- Total product is the total amount produced. Marginal product
age product. The numbers tell us how the quantity of is the change in total product that results from a one-unit in-
sweaters produced increases as Campus Sweaters crease in labor. For example, when labor increases from 2 to 3
employs more workers. The numbers also tell us workers a day (row C to row D), total product increases from 10
about the productivity of the labor that Campus to 13 sweaters per day. The marginal product of going from 2 to
Sweaters employs. 3 workers is 3 sweaters.
Focus first on the columns headed “Labor” and
Average product is total product divided by the quantity of
“Total product.” Total product is the maximum output
labor employed. For example, the average product of 3 work-
that a given quantity of labor can produce. You can see
ers is 4.33 sweaters per worker (13 sweaters a day divided by
from the numbers in these columns that as Campus
3 workers).
Sweaters employs more labor, total product increases.
For example, when 1 worker is employed, total prod-
uct is 4 sweaters a day, and when 2 workers are
employed, total product is 10 sweaters a day. Each
increase in employment increases total product.
The marginal product of labor is the increase in then begins to decrease. For example, marginal prod-
total product that results from a one-unit increase in uct increases from 4 sweaters a day for the first worker
the quantity of labor employed, with all other inputs to 6 sweaters a day for the second worker and then
remaining the same. For example, in Table 11.1, decreases to 3 sweaters a day for the third worker.
when Campus Sweaters increases employment from 2 Average product also increases at first and then
to 3 workers and does not change its capital, the mar- decreases. You can see the relationships between the
ginal product of the third worker is 3 sweaters—total quantity of labor hired and the three product con-
product increases from 10 to 13 sweaters. cepts more clearly by looking at the product curves.
Average product tells how productive workers are
on average. The average product of labor is equal to
total product divided by the quantity of labor Product Curves
employed. For example, in Table 11.1, the average The product curves are graphs of the relationships
product of 3 workers is 4.33 sweaters per worker— between employment and the three product concepts
13 sweaters a day divided by 3 workers. you’ve just studied. They show how total product, mar-
If you look closely at the numbers in Table 11.1, ginal product, and average product change as employ-
you can see some patterns. As Campus Sweaters hires ment changes. They also show the relationships among
more labor, marginal product increases initially, and the three concepts. Let’s look at the product curves.
292 CHAPTER 11 Output and Costs

Total Product Curve Marginal Product Curve

Figure 11.1 shows Campus Sweaters’ total product Figure 11.2 shows Campus Sweaters’ marginal prod-
curve, TP, which is a graph of the total product uct of labor. Part (a) reproduces the total product
schedule. Points A through F correspond to rows A curve from Fig. 11.1 and part (b) shows the marginal
through F in Table 11.1. To graph the entire total product curve, MP.
product curve, we vary labor by hours rather than In part (a), the orange bars illustrate the marginal
whole days. product of labor. The height of a bar measures mar-
Notice the shape of the total product curve. As ginal product. Marginal product is also measured by
employment increases from zero to 2 workers a day, the slope of the total product curve. Recall that the
the curve becomes steeper. Then, as employment slope of a curve is the change in the value of the vari-
increases to 3, 4, and 5 workers a day, the curve able measured on the y-axis—output—divided by the
becomes less steep. change in the variable measured on the x-axis—
The total product curve is similar to the production labor—as we move along the curve. A one-unit
possibilities frontier (explained in Chapter 2). It sepa- increase in labor, from 2 to 3 workers, increases out-
rates the attainable output levels from those that are put from 10 to 13 sweaters, so the slope from point
unattainable. All the points that lie above the curve C to point D is 3 sweaters per additional worker, the
are unattainable. Points that lie below the curve, in same as the marginal product we’ve just calculated.
the orange area, are attainable, but they are ineffi- Again varying the amount of labor in the smallest
cient—they use more labor than is necessary to pro- units possible, we can draw the marginal product
duce a given output. Only the points on the total curve shown in Fig. 11.2(b). The height of this curve
product curve are technologically efficient. measures the slope of the total product curve at a
point. Part (a) shows that an increase in employment
from 2 to 3 workers increases output from 10 to 13
sweaters (an increase of 3). The increase in output of
FIGURE 11.1 Total Product Curve 3 sweaters appears on the y-axis of part (b) as the
marginal product of going from 2 to 3 workers. We
plot that marginal product at the midpoint between
TP
Output (sweaters per day)

2 and 3 workers. Notice that the marginal product

15 F
E shown in Fig. 11.2(b) reaches a peak at 1.5 workers,
D and at that point, marginal product is 6 sweaters per
Unattainable
additional worker. The peak occurs at 1.5 workers
because the total product curve is steepest when
10
C employment increases from 1 worker to 2 workers.
The total product and marginal product curves
Attainable differ across firms and types of goods. GM’s product
curves are different from those of PennPower, whose
5 curves in turn are different from those of Campus
B Sweaters. But the shapes of the product curves are
similar because almost every production process has
A two features:
0 1 2 3 4 5
Labor (workers per day)
■ Increasing marginal returns initially
The total product curve, TP, is based on the data in Table 11.1. ■ Diminishing marginal returns eventually
The total product curve shows how the quantity of sweat-
ers produced changes as the quantity of labor employed
changes. For example, 2 workers can produce 10 sweaters a
Increasing Marginal Returns Increasing marginal
day (point C). Points A through F on the curve correspond to
returns occur when the marginal product of an addi-
the rows of Table 11.1. The total product curve separates at-
tional worker exceeds the marginal product of the
tainable outputs from unattainable outputs. Points below the
previous worker. Increasing marginal returns arise
TP curve are attainable but inefficient.
from increased specialization and division of labor in
the production process.
 Short-Run Technology Constraint 293

For example, if Campus Sweaters employs one

FIGURE 11.2 Total Product and Marginal Product worker, that person must learn all the aspects of
sweater production: running the knitting machines,
TP
Output (sweaters per day)

fixing breakdowns, packaging and mailing sweaters,

15
buying and checking the type and color of the wool.
D All these tasks must be performed by that one person.
13
If Campus Sweaters hires a second person, the two
workers can specialize in different parts of the pro-
10
C duction process and can produce more than twice as
much as one worker. The marginal product of the
second worker is greater than the marginal product of
the first worker. Marginal returns are increasing.
5
4

Diminishing Marginal Returns Most production

processes experience increasing marginal returns ini-
0 1 2 3 4 5 tially, but all production processes eventually reach a
Labor (workers per day) point of diminishing marginal returns. Diminishing
(a) Total product
marginal returns occur when the marginal product of
an additional worker is less than the marginal prod-
uct of the previous worker.
Diminishing marginal returns arise from the fact
(sweaters per additional worker)
Marginal product

6
that more and more workers are using the same cap-
ital and working in the same space. As more workers
are added, there is less and less for the additional
workers to do that is productive. For example, if
4
Campus Sweaters hires a third worker, output
increases but not by as much as it did when it hired
the second worker. In this case, after two workers are
3
hired, all the gains from specialization and the divi-
sion of labor have been exhausted. By hiring a third
2
worker, the factory produces more sweaters, but
the equipment is being operated closer to its limits.
There are even times when the third worker has
MP nothing to do because the machines are running
0 1 2 3 4 5 without the need for further attention. Hiring more
Labor (workers per day)
and more workers continues to increase output but
(b) Marginal product by successively smaller amounts. Marginal returns are
diminishing. This phenomenon is such a pervasive
Marginal product is illustrated by the orange bars. For exam- one that it is called a “law”—the law of diminishing
ple, when labor increases from 2 to 3 workers a day, mar- returns. The law of diminishing returns states that
ginal product is the orange bar whose height is 3 sweaters.
(Marginal product is shown midway between the quantities As a firm uses more of a variable factor of produc-
of labor to emphasize that marginal product results from tion with a given quantity of the fixed factor of
changing the quantity of labor.) The steeper the slope of the production, the marginal product of the variable
total product curve (TP) in part (a), the larger is marginal factor eventually diminishes.
product (MP) in part (b). Marginal product increases to a
maximum (in this example when 1.5 workers a day are You are going to return to the law of diminishing
employed) and then declines—diminishing marginal product. returns when we study a firm’s costs, but before we
do that, let’s look at the average product of labor and
the average product curve.
294 CHAPTER 11 Output and Costs

Average Product Curve

Figure 11.3 illustrates Campus Sweaters’ average ECONOMICS IN ACTION
product of labor and shows the relationship between How to Pull Up Your Average
average product and marginal product. Points B
through F on the average product curve AP corre- Do you want to pull up your average grade? Then
spond to those same rows in Table 11.1. Average make sure that your grade this semester is better than
product increases from 1 to 2 workers (its maximum your current average! This semester is your marginal
value at point C ) but then decreases as yet more semester. If your marginal grade exceeds your average
workers are employed. Notice also that average prod- grade (like the second semester in the figure), your
uct is largest when average product and marginal average will rise. If your marginal grade equals your
product are equal. That is, the marginal product average grade (like the third semester in the figure),
curve cuts the average product curve at the point of your average won’t change. If your marginal grade is
maximum average product. For the number of work- below your average grade (like the fourth semester in
ers at which marginal product exceeds average prod- the figure), your average will fall.
uct, average product is increasing. For the number of The relationship between your marginal and aver-
workers at which marginal product is less than aver- age grades is exactly the same as that between mar-
age product, average product is decreasing. ginal product and average product.
The relationship between the average product and
4
marginal product is a general feature of the relation- Average
ship between the average and marginal values of any grade
variable—even your grades.
3

Marginal
2 grade
FIGURE 11. 3 Average Product
(sweaters per day per worker)
Average product and marginal product

6 Maximum 1
average
C product
GPA

D 0
First Second Third Fourth
4 B E Semester
F
AP Marginal and Average Grade Curves

REVIEW QUIZ
MP
1 Explain how the marginal product and average
0 1 2 3 4 5
Labor (workers per day)
product of labor change as the labor employed
increases (a) initially and (b) eventually.
2 What is the law of diminishing returns? Why
The figure shows the average product of labor and the con- does marginal product eventually diminish?
nection between average product and marginal product. 3 Explain the relationship between marginal
With 1 worker, marginal product exceeds average product, product and average product.
so average product is increasing. With 2 workers, marginal
product equals average product, so average product is at its
maximum. With more than 2 workers, marginal product is Campus Sweaters’ product curves influence its
less than average product, so average product is decreasing. costs, as you are now going to see.
 Short-Run Cost 295

◆ Short-Run Cost FIGURE 11.4 Total Cost Curves

To produce more output in the short run, a firm must

Cost (dollars per day)

150 TC
employ more labor, which means that it must increase
its costs. We describe the relationship between output
TC = TFC + TVC
and cost by using three cost concepts: TVC

■ Total cost 100

■ Marginal cost
75
■ Average cost
50

Total Cost
25 TFC
A firm’s total cost (TC ) is the cost of all the factors
of production it uses. We separate total cost into total
fixed cost and total variable cost. 0 5 10 13 15
Output (sweaters per day)
Total fixed cost (TFC ) is the cost of the firm’s
fixed factors. For Campus Sweaters, total fixed cost
includes the cost of renting knitting machines and Total Total
normal profit, which is the opportunity cost of fixed variable Total
Cindy’s entrepreneurship (see Chapter 10, p. 267). cost cost cost
The quantities of fixed factors don’t change as out- Labor Output (TFC) (TVC) (TC)
(workers (sweaters
put changes, so total fixed cost is the same at all per day) per day) (dollars per day)
outputs.
Total variable cost (TVC ) is the cost of the firm’s A 0 0 25 0 25
variable factors. For Campus Sweaters, labor is the B 1 4 25 25 50
variable factor, so this component of cost is its wage
C 2 10 25 50 75
bill. Total variable cost changes as output changes.
Total cost is the sum of total fixed cost and total D 3 13 25 75 100
variable cost. That is, E 4 15 25 100 125

TC = TFC + TVC . F 5 16 25 125 150

The table in Fig. 11.4 shows total costs. Campus

Sweaters rents one knitting machine for $25 a day, so Campus Sweaters rents a knitting machine for $25 a day,
its TFC is $25. To produce sweaters, the firm hires so this cost is the firm’s total fixed cost. The firm hires work-
labor, which costs $25 a day. TVC is the number of ers at a wage rate of $25 a day, and this cost is its total
workers multiplied by $25. For example, to produce variable cost. For example, in row D, Campus Sweaters
13 sweaters a day, in row D, the firm hires 3 workers employs 3 workers and its total variable cost is 3 × $25,
and TVC is $75. TC is the sum of TFC and TVC, so which equals $75. Total cost is the sum of total fixed cost
to produce 13 sweaters a day, TC is $100. Check the and total variable cost. For example, when Campus
calculations in the other rows of the table. Sweaters employs 3 workers, total cost is $100—total fixed
Figure 11.4 shows Campus Sweaters’ total cost cost of $25 plus total variable cost of $75.
curves, which graph total cost against output. The The graph shows Campus Sweaters’ total cost curves.
green TFC curve is horizontal because total fixed Total fixed cost is constant—the TFC curve is a horizontal
cost ($25 a day) does not change when output line. Total variable cost increases as output increases, so
changes. The purple TVC curve and the blue TC the TVC curve and the TC curve slope upward as output
curve both slope upward because to increase output, increases. The vertical distance between the TC curve and
more labor must be employed, which increases total the TVC curve equals total fixed cost, as illustrated by the
variable cost. Total fixed cost equals the vertical dis- two arrows.
tance between the TVC and TC curves.
Let’s now look at a firm’s marginal cost.
296 CHAPTER 11 Output and Costs

Marginal Cost TC = TFC + TVC .

Figure 11.4 shows that total variable cost and total
cost increase at a decreasing rate at small outputs Divide each total cost term by the quantity produced,
but eventually, as output increases, total variable Q, to get
cost and total cost increase at an increasing rate. To TC TFC TVC
understand this pattern in the change in total cost = + ,
as output increases, we need to use the concept of Q Q Q
marginal cost. or
A firm’s marginal cost is the increase in total cost ATC = AFC + AVC .
that results from a one-unit increase in output. We
calculate marginal cost as the increase in total cost The table in Fig. 11.5 shows the calculation of
divided by the increase in output. The table in Fig. average total cost. For example, in row C, output is
11.5 shows this calculation. When, for example, out- 10 sweaters. Average fixed cost is ($25 ÷ 10), which
put increases from 10 sweaters to 13 sweaters, total equals $2.50; average variable cost is ($50 ÷ 10),
cost increases from $75 to $100. The change in out- which equals $5.00; and average total cost is
put is 3 sweaters, and the change in total cost is ($75 ÷ 10), which equals $7.50. Note that average
$25. The marginal cost of one of those 3 sweaters total cost is equal to average fixed cost ($2.50) plus
is ($25 ÷ 3), which equals $8.33. average variable cost ($5.00).
Figure 11.5 graphs the marginal cost data in the Figure 11.5 shows the average cost curves. The
table as the red marginal cost curve, MC. This curve green average fixed cost curve (AFC ) slopes down-
is U-shaped because when Campus Sweaters hires a ward. As output increases, the same constant total
second worker, marginal cost decreases, but when it fixed cost is spread over a larger output. The blue
hires a third, a fourth, and a fifth worker, marginal average total cost curve (ATC ) and the purple aver-
cost successively increases. age variable cost curve (AVC ) are U-shaped. The
At small outputs, marginal cost decreases as output vertical distance between the average total cost and
increases because of greater specialization and the average variable cost curves is equal to average fixed
division of labor. But as output increases further, cost—as indicated by the two arrows. That distance
marginal cost eventually increases because of the law shrinks as output increases because average fixed cost
of diminishing returns. The law of diminishing returns declines with increasing output.
means that the output produced by each additional
worker is successively smaller. To produce an addi-
tional unit of output, ever more workers are required, Marginal Cost and Average Cost
and the cost of producing the additional unit of out-
put—marginal cost—must eventually increase. The marginal cost curve (MC ) intersects the average
Marginal cost tells us how total cost changes as variable cost curve and the average total cost curve at
output increases. The final cost concept tells us what their minimum points. When marginal cost is less
it costs, on average, to produce a unit of output. Let’s than average cost, average cost is decreasing, and
now look at Campus Sweaters’ average costs. when marginal cost exceeds average cost, average cost
is increasing. This relationship holds for both the
ATC curve and the AVC curve. It is another example
Average Cost of the relationship you saw in Fig. 11.3 for average
There are three average costs of production: product and marginal product and in your average
and marginal grades.
1. Average fixed cost
2. Average variable cost
Why the Average Total Cost Curve
3. Average total cost
Is U-Shaped
Average fixed cost (AFC ) is total fixed cost per unit Average total cost is the sum of average fixed cost and
of output. Average variable cost (AVC ) is total variable average variable cost, so the shape of the ATC curve
cost per unit of output. Average total cost (ATC ) is to- combines the shapes of the AFC and AVC curves.
tal cost per unit of output. The average cost concepts The U shape of the ATC curve arises from the influ-
are calculated from the total cost concepts as follows: ence of two opposing forces:
 Short-Run Cost 297

FIGURE 11.5 Marginal Cost and Average Costs

Cost (dollars per sweater)

15 MC Marginal cost is calculated as the change in total cost divided

by the change in output. When output increases from 4 to 10
ATC = AFC + AVC sweaters, an increase of 6 sweaters, total cost increases by
$25. Marginal cost is $25 ÷ 6, which is $4.17.
10 ATC Each average cost concept is calculated by dividing the
related total cost by output. When 10 sweaters are produced,
AVC
AFC is $2.50 ($25 ÷ 10), AVC is $5 ($50 ÷ 10) , and ATC is
$7.50 ($75 ÷ 10) .
5 The graph shows that the MC curve is U-shaped and
intersects the AVC curve and the ATC curve at their minimum
points. The average fixed cost curve (AFC) is downward slop-
AFC ing. The ATC curve and AVC curve are U-shaped. The vertical
distance between the ATC curve and the AVC curve is equal to
0 5 10 15
Output (sweaters per day)
average fixed cost, as illustrated by the two arrows.

Total Total Marginal Average Average Average

fixed variable Total cost fixed variable total
cost cost cost (MC) cost cost cost
Labor Output
(TFC) (TVC) (TC) (AFC) (AVC) (AVC)
(workers (sweaters (dollars per
per day) per day) (dollars per day) additional sweater) (dollars per sweater)

A 0 0 25 0 25 — — —
. . . . . . . . . . . . . 6.25
B 1 4 25 25 50 6.25 6.25 12.50
. . . . . . . . . . . . . 4.17
C 2 10 25 50 75 2.50 5.00 7.50
. . . . . . . . . . . . . 8.33
D 3 13 25 75 100 1.92 5.77 7.69
. . . . . . . . . . . . .12.50
E 4 15 25 100 125 1.67 6.67 8.33
. . . . . . . . . . . . . 25.00
F 5 16 25 125 150 1.56 7.81 9.38

1. Spreading total fixed cost over a larger output The shape of the ATC curve combines these two
2. Eventually diminishing returns effects. Initially, as output increases, both average fixed
cost and average variable cost decrease, so average total
When output increases, the firm spreads its total cost decreases. The ATC curve slopes downward.
fixed cost over a larger output and so its average But as output increases further and diminishing
fixed cost decreases—its AFC curve slopes returns set in, average variable cost starts to increase.
downward. With average fixed cost decreasing more quickly than
Diminishing returns means that as output in- average variable cost is increasing, the ATC curve
creases, ever-larger amounts of labor are needed to continues to slope downward. Eventually, average
produce an additional unit of output. So as output variable cost starts to increase more quickly than
increases, average variable cost decreases initially but average fixed cost decreases, so average total cost
eventually increases, and the AVC curve slopes starts to increase. The ATC curve slopes upward.
upward. The AVC curve is U-shaped.
298 CHAPTER 11 Output and Costs

Cost Curves and Product Curves

The technology that a firm uses determines its costs.
ECONOMICS IN THE NEWS
A firm’s cost curves come directly from its product
curves. You’ve used this link in the tables in which Checkout Cost Curves
we have calculated total cost from the total product Target Is Getting a Major Facelift
schedule and information about the prices of the fac- Target is remodeling stores across the country. Shoppers
tors of production. We’re now going to get a clearer can expect more room between checkout lanes and con-
view of the link between the product curves and the tactless self-checkouts, and updated restrooms.
cost curves. We’ll look first at the link between total Source: kroc.com, April 21, 2021
cost and total product and then at the links between
the average and marginal product and cost curves. DATA AND ASSUMPTIONS
A store paid $20,000 to install 5 worker-operated check-
Total Product and Total Variable Cost Figure 11.6 out lanes. With a life of 9 years and operating for 10
shows the links between the firm’s total product hours a day, these machines have an implicit rental rate of
curve, TP, and its total variable cost curve, TVC. $1.00 an hour. Checkout clerks can be hired for $10 an
The graph is a bit unusual in two ways. First, it mea- hour. The total product schedule (checkouts per hour)
sures two variables on the x-axis—labor and variable for this store is
cost. Second, it graphs the TVC curve but with
variable cost on the x-axis and output on the y-axis. Checkout clerks 1 2 3 4 5
The graph can show labor and cost on the x-axis Checkouts per hour 12 22 30 36 40
because variable cost is proportional to labor. One
worker costs $25 a day. Graphing output against Another store has converted to all self-checkout. It paid
labor gives the TP curve and graphing variable cost $100,000 to install a 5-lane self-operated system. With a
against output gives the TVC curve. 5-year life and operating for 10 hours a day, the system
has an implicit rental rate of $7.00 an hour. It hires check-
out assistants to help customers at $10 an hour—the
same wage as paid to checkout clerks. The total product
FIGURE 11. 6 Total Product and
schedule for this store is
Total Variable Cost
Checkout assistants 1 1 1 2
Output (sweaters per day)

18 Checkouts per hour 12 22 30 36

TP or TVC
16
That is, one checkout assistant can help shoppers
14 check out up to a rate of 30 an hour and a second
12 assistant can boost output to 36 an hour. (Shoppers
10 using self-checkout aren’t as quick as clerks, so the
8 Output plotted against labor fastest rate at which this store can check out cus-
is the TP curve. Output plotted tomers is 36 an hour.)
6 against the cost of labor is
4 the TVC curve.
THE PROBLEM
2 ■ Which checkout system has the lower average total
0 1 2 3 4 5 cost (ATC )? Which system has the lower marginal
Labor (workers per day) cost (MC )? Sketch the ATC and MC curves for the
0 25 50 75 100 125
two systems.
Variable cost (dollars per day)

The figure shows the total product curve, TP, as a graph THE SOLUTION
of output (sweaters per day) plotted against labor (workers ■ Start with the worker-operated checkout system.
per day). It also shows the total variable cost curve, TVC, as Fixed cost is $1.00 per hour and variable cost is
a graph of total variable cost (dollars per day) against output. $10.00 per clerk. So the total cost schedule is
The only difference between the TVC curve here and that in
Checkout clerks 1 2 3 4 5
Fig. 11.4 is that we’ve switched the x- and y-axes.
Checkouts per hour 12 22 30 36 40
Total cost (TC) per hour 11 21 31 41 51
 Short-Run Cost 299

■ Calculate MC as the change in TC divided by the

change in output (change in number of checkouts) ■ Now do similar calculations for the self-checkout system.
and calculate ATC as TC divided by output to get Fixed cost is $7.00 per hour and variable cost is $10.00
per clerk hour. So the total cost schedule is
Checkouts per hour 12 22 30 36 40
Marginal cost (MC) 0.83 1.00 1.25 1.67 2.50 Checkout assistants 1 1 1 2
Average total cost (ATC) 0.92 0.95 1.03 1.14 1.28 Checkouts per hour 12 22 30 36
Total cost (TC) per hour 17 17 17 27
■ Figure 1 graphs the MC and ATC values at each
output rate. ■ Calculate MC and ATC in the same way as before
to get
Cost (dollars per checkout)

3.00
MC Checkouts per hour 12 22 30 36
2.50 Marginal cost (MC) 0.83 0 0 1.67
Average total cost (ATC) 1.42 0.77 0.57 0.75
2.00
■ Figure 2 graphs the MC and ATC values at each
1.50 ATC
output rate.
1.00 ■ Figure 3 compares the ATC of the two systems.
You can see that the self-checkout system has
0.50
higher ATC at low output rates and lower ATC at
high output rates. The reason is that self-checkout
0 10 20 30 40 50
Output (checkouts per hour)
has a higher fixed cost and lower variable cost than
the worker-operated system.
Figure 1 Operator Checkout
Cost (dollars per checkout)

Cost (dollars per checkout)

2.00 MC 2.00

1.50 ATC ATCOperator

1.50

1.00 ATCSelf
1.00

0.50
0.50

0 10 20 30 40 50
0 10 20 30 40 50
Output (checkouts per hour)
Output (checkouts per hour)
Figure 2 Self-Checkout
Figure 3 ATC Compared
300 CHAPTER 11 Output and Costs

Average and Marginal Product and Cost Figure

11.7 shows the links between the firm’s average and FIGURE 11.7 Average and Marginal Product
marginal product curves and its average and marginal Curves and Cost Curves
cost curves. The upper graph shows the average prod-
uct curve, AP, and the marginal product curve, MP—

Average product and marginal product

like those in Fig. 11.3. The lower graph shows the
6
average variable cost curve, AVC, and the marginal
cost curve, MC—like those in Fig. 11.5.
As labor increases up to 1.5 workers a day (upper AP
graph), output increases to 6.5 sweaters a day (lower
graph). Marginal product and average product rise 4 MP
and marginal cost and average variable cost fall. At
the point of maximum marginal product, marginal
cost is at a minimum.
As labor increases from 1.5 workers to 2 workers a 2
Rising MP and Falling MP and Falling MP and
day (upper graph), output increases from 6.5 sweaters falling MC: rising MC: rising MC:
to 10 sweaters a day (lower graph). Marginal product rising AP and rising AP and falling AP and
falls and marginal cost rises, but average product con- falling AVC falling AVC rising AVC
tinues to rise and average variable cost continues to
0 1.5 2.0
fall. At the point of maximum average product, aver- Labor
age variable cost is at a minimum. As labor increases
Cost (dollars per unit)

further, output increases. Average product diminishes

and average variable cost increases. Maximum MP and
12 Minimum MC

Shifts in the Cost Curves Maximum AP and

9
The position of a firm’s short-run cost curves depends Minimum AVC
on two factors: MC

■ Technology 6 AVC

■ Prices of factors of production

3
Technology A technological change that increases
productivity increases the marginal product and aver-
age product of labor. With a better technology, the
0 6.5 10
same factors of production can produce more output, Output
so the technological advance lowers the costs of pro-
duction and shifts the cost curves downward. A firm’s MP curve is linked to its MC curve. If, as the firm
For example, advances in robot production tech- increases its labor from 0 to 1.5 workers a day, the firm’s
niques have increased productivity in the automobile marginal product rises, its marginal cost falls. If marginal
industry. As a result, the product curves of Chrysler, product is at a maximum, marginal cost is at a minimum. If,
Ford, and GM have shifted upward and their cost as the firm hires more labor, its marginal product dimin-
curves have shifted downward. But the relationships ishes, its marginal cost rises.
between their product curves and cost curves have A firm’s AP curve is linked to its AVC curve. If, as the
not changed. The curves are still linked in the way firm increases its labor to 2 workers a day, its average
shown in Figs. 11.6 and 11.7. product rises, its average variable cost falls. If average
Often, as in the case of robots producing cars, a product is at a maximum, average variable cost is at a mini-
technological advance results in a firm using more mum. If, as the firm hires more labor, its average product
diminishes, its average variable cost rises.
 Short-Run Cost 301

TABLE 11. 2 A Compact Glossary of Costs

Term Symbol Definition Equation

Fixed cost Cost that is independent of the output level;

cost of a fixed factor of production

Variable cost Cost that varies with the output level; cost of
a variable factor of production

Total fixed cost TFC Cost of the fixed factors of production

Total variable cost TVC Cost of the variable factors of production

Total cost TC Cost of all factors of production TC = TFC + TVC

Output (total product) TP Total quantity produced (output Q)

Marginal cost MC Change in total cost resulting from a one- MC = ΔTC ÷ ΔQ

unit increase in total product

Average fixed cost AFC Total fixed cost per unit of output AFC = TFC ÷ Q

Average variable cost AVC Total variable cost per unit of output AVC = TVC ÷ Q

Average total cost ATC Total cost per unit of output ATC = AFC + AVC

capital, which is a fixed factor, and less labor, which is upward and shifts the MC curve upward but leaves
a variable factor. Another example is the use of ATMs the AFC and TFC curves unchanged. For example, if
by banks to dispense cash. ATMs, which are fixed capi- truck drivers’ wages or the price of gasoline increases,
tal, have replaced tellers, which are variable labor. Such the variable cost and marginal cost of transportation
a technological change decreases total cost but increases services increase.
fixed costs and decreases variable cost. This change in
You’ve now completed your study of short-run
the mix of fixed cost and variable cost means that at
costs. All the concepts that you’ve met are summa-
small outputs, average total cost might increase, while
rized in a compact glossary in Table 11.2.
at large outputs, average total cost decreases.
Prices of Factors of Production An increase in the
REVIEW QUIZ
price of a factor of production increases the firm’s
costs and shifts its cost curves. How the curves shift 1 What relationships do a firm’s short-run cost
depends on which factor price changes. curves show?
An increase in rent or some other component of 2 How does marginal cost change as output
fixed cost shifts the TFC and AFC curves upward and increases (a) initially and (b) eventually?
shifts the TC curve upward but leaves the AVC and
3 What does the law of diminishing returns
TVC curves and the MC curve unchanged. For
imply for the shape of the marginal cost curve?
example, if the interest expense paid by a trucking
company increases, the fixed cost of transportation 4 What is the shape of the AFC curve and why
services increases. does it have this shape?
An increase in wages, gasoline, or another compo- 5 What are the shapes of the AVC curve and the
nent of variable cost shifts the TVC and AVC curves ATC curve and why do they have these shapes?
302 CHAPTER 11 Output and Costs

◆ Long-Run Cost TABLE 11.3 The Production Function

We are now going to study the firm’s long-run costs. Output
In the long run, a firm can vary both the quantity of (sweaters per day)
Labor
labor and the quantity of capital, so in the long run, (workers per day) Plant 1 Plant 2 Plant 3 Plant 4
all the firm’s costs are variable.
The behavior of long-run cost depends on the 1 4 10 13 15
firm’s production function, which is the relationship 2 10 15 18 20
between the maximum output attainable and the
quantities of both labor and capital. 3 13 18 22 24

4 15 20 24 26
The Production Function 5 16 21 25 27
Table 11.3 shows Campus Sweaters’ production
function. The table lists total product schedules for Knitting machines 1 2 3 4
(number)
four different quantities of capital. The quantity of
capital identifies the plant size. The numbers for
plant 1 are for a factory with 1 knitting machine— The table shows the total product data for four quantities
the case we’ve just studied. The other three plants of capital (plant sizes). As the plant size increases, the
have 2, 3, and 4 machines. If Campus Sweaters uses output produced by any given quantity of labor increases.
plant 2 with 2 knitting machines, the various For a given plant size, the marginal product of labor dimin-
amounts of labor can produce the outputs shown in ishes as more labor is employed. For a given quantity of
the second column of the table. The other two columns labor, the marginal product of capital diminishes as the
show the outputs of yet larger quantities of capital. quantity of capital used increases.
Each column of the table could be graphed as a total
product curve for each plant.
Diminishing Returns Diminishing returns occur with and increases the number of machines from 2 to 3,
each of the four plant sizes as the quantity of labor output increases from 18 to 22 sweaters a day. The
increases. You can check that fact by calculating the marginal product of the third machine is 4 sweaters
marginal product of labor in each of the plants with a day, down from 5 sweaters a day for the second
2, 3, and 4 machines. With each plant size, as the machine.
firm increases the quantity of labor employed, the Let’s now see what the production function
marginal product of labor (eventually) diminishes. implies for long-run costs.
Diminishing Marginal Product of Capital
Diminishing returns also occur with each quantity Short-Run Cost and Long-Run Cost
of labor as the quantity of capital increases. You can As before, Campus Sweaters can hire workers for $25
check that fact by calculating the marginal product a day and rent knitting machines for $25 a day.
of capital at a given quantity of labor. The marginal Using these factor prices and the data in Table 11.3,
product of capital is the change in total product we can calculate the average total cost and graph the
divided by the change in capital when the quantity ATC curves for factories with 1, 2, 3, and 4 knitting
of labor is constant—equivalently, the change in machines. We’ve already studied the costs of a factory
output resulting from a one-unit increase in the with 1 machine in Figs. 11.4 and 11.5. In Fig. 11.8,
quantity of capital. For example, if Campus the average total cost curve for that case is ATC1.
Sweaters has 3 workers and increases its capital Figure 11.8 also shows the average total cost curve for
from 1 machine to 2 machines, output increases a factory with 2 machines, ATC2, with 3 machines,
from 13 to 18 sweaters a day. The marginal product ATC3, and with 4 machines, ATC4.
of the second machine is 5 sweaters a day. If You can see, in Fig. 11.8, that the plant size has a
Campus Sweaters continues to employ 3 workers big effect on the firm’s average total cost.
 Long-Run Cost 303

FIGURE 11.8 Short-Run Costs of Four Different Plants

The figure shows short-run
Average cost (dollars per sweater)

average total cost curves for

12.00 four different quantities of
capital at Campus Sweaters.
The firm can produce 13
sweaters a day with 1 knit-
10.00 ATC 1 ATC 2 ATC 3 ATC 4 ting machine on ATC1 or with
9.50 3 knitting machines on ATC3
for an average cost of $7.69
a sweater. The firm can pro-
8.00 duce 13 sweaters a day by
7.69
using 2 machines on ATC2 for
6.80 $6.80 a sweater or by using
4 machines on ATC4 for
6.00 $9.50 a sweater.
If the firm produces 13
sweaters a day, the least-cost
0 5 10 13 15 20 25 30 method of production, the
Output (sweaters per day) long-run method, is with 2
machines on ATC2.

In Fig. 11.8, two things stand out: average total cost of 13 sweaters a day is $7.69 a
sweater. With 2 machines, on ATC2, average total
1. Each short-run ATC curve is U-shaped.
cost is $6.80 a sweater. With 3 machines, on ATC3,
2. For each short-run ATC curve, the larger the average total cost is $7.69 a sweater, the same as with
plant, the greater is the output at which average 1 machine. Finally, with 4 machines, on ATC4, aver-
total cost is at a minimum. age total cost is $9.50 a sweater.
Each short-run ATC curve is U-shaped because, as The economically efficient plant for producing a
the quantity of labor increases, its marginal product given output is the one that has the lowest average
initially increases and then diminishes. This pattern total cost. For Campus Sweaters, the economically
in the marginal product of labor, which we examined efficient plant to use to produce 13 sweaters a day is
in some detail for the plant with 1 knitting machine the one with 2 machines.
on pp. 292–293, occurs at all plant sizes. In the long run, Cindy chooses the plant that mini-
The minimum average total cost for a larger plant mizes average total cost. When a firm is producing a
occurs at a greater output than it does for a smaller given output at the least possible cost, it is operating
plant because the larger plant has a higher total fixed on its long-run average cost curve.
cost and therefore, for any given output, a higher The long-run average cost curve is the relationship
average fixed cost. between the lowest attainable average total cost and
Which short-run ATC curve a firm operates on output when the firm can change both the plant it
depends on the plant it has. In the long run, the firm uses and the quantity of labor it employs.
can choose its plant and the plant it chooses is the The long-run average cost curve is a planning
one that enables it to produce its planned output at curve. It tells the firm the plant and the quantity of
the lowest average total cost. labor to use to produce each output to minimize
To see why, suppose that Campus Sweaters plans average cost. Once the firm chooses a plant, the firm
to produce 13 sweaters a day. In Fig. 11.8, with 1 operates on the short-run cost curves that apply to
machine, the average total cost curve is ATC1 and the that plant.
304 CHAPTER 11 Output and Costs

The Long-Run Average Cost Curve GM produces 100 cars a week, each worker must per-
Figure 11.9 shows how a long-run average cost curve form many different tasks and the capital must be gen-
is derived. The long-run average cost curve LRAC eral-purpose machines and tools. But if GM produces
consists of pieces of the four short-run ATC curves. 10,000 cars a week, each worker specializes in a small
For outputs up to 10 sweaters a day, average total cost number of tasks, uses task-specific tools, and becomes
is the lowest on ATC1. For outputs between 10 and highly proficient.
18 sweaters a day, average total cost is the lowest on Diseconomies of scale are features of a firm’s tech-
ATC2. For outputs between 18 and 24 sweaters a day, nology that make average total cost rise as output
average total cost is the lowest on ATC3. And for out- increases. When diseconomies of scale are present,
puts in excess of 24 sweaters a day, average total cost the LRAC curve slopes upward. In Fig. 11.9,
is the lowest on ATC4. The piece of each ATC curve Campus Sweaters experiences diseconomies of scale
with the lowest average total cost is highlighted in at outputs greater than 15 sweaters a day.
dark blue in Fig. 11.9. This dark blue scallop-shaped The challenge of managing a large enterprise is the
curve made up of the pieces of the four ATC curves is main source of diseconomies of scale.
the LRAC curve. Constant returns to scale are features of a firm’s tech-
nology that keep average total cost constant as output
increases. When constant returns to scale are present,
Economies and Diseconomies of Scale the LRAC curve is horizontal.
Economies of scale are features of a firm’s technology
Economies of Scale at Campus Sweaters The
that make average total cost fall as output increases.
When economies of scale are present, the LRAC curve economies of scale and diseconomies of scale at
slopes downward. In Fig. 11.9, Campus Sweaters has Campus Sweaters arise from the firm’s production
economies of scale for outputs up to 15 sweaters a day. function in Table 11.3. With 1 machine and 1
Greater specialization of both labor and capital is worker, the firm produces 4 sweaters a day. With
the main source of economies of scale. For example, if 2 machines and 2 workers, total cost doubles but

FIGURE 11.9 Long-Run Average Cost Curve

The long-run average cost
Average cost (dollars per sweater)

Economies of scale Diseconomies of scale curve traces the lowest attain-

Least-cost plant is 1 Least-cost plant is 2 Least-cost plant is 3 Least-cost plant is 4 able ATC when both labor
12.00 and capital change. The
green arrows highlight the
output range over which each
plant achieves the lowest
10.00 ATC 1 ATC 2 ATC 3 ATC 4 ATC. Within each range, to
change the quantity pro-
duced, the firm changes the
quantity of labor it employs.
8.00 Along the LRAC curve,
LRAC curve economies of scale occur if
average cost falls as output
increases; diseconomies of
6.00 scale occur if average cost
rises as output increases.
Minimum efficient scale is the
0 5 10 15 18 20 24 25 30 output at which average cost
Output (sweaters per day) is lowest, 15 sweaters a day.
 Long-Run Cost 305

ECONOMICS IN ACTION
Produce More to Cut Cost
Why do GM, Ford, and the other automakers have
expensive equipment lying around that isn’t fully
used? You can answer this question with what you’ve
learned in this chapter.
The basic answer is that auto production enjoys
economies of scale. A larger output rate brings a

Average cost (thousands of dollars per vehicle)

40
lower long-run average cost—the firm’s LRAC curve
slopes downward.
An auto producer’s average total cost curves look
30
like those in the figure. To produce 20 vehicles an
hour, the firm installs the plant with the short-run ATC 1
average total cost curve ATC1. The average cost of ATC 2

producing a vehicle is $20,000. 20

Producing 20 vehicles an hour doesn’t use the
15
plant at its lowest possible average total cost. If the
firm could sell enough cars for it to produce 40 vehi- 10
cles an hour, the firm could use its current plant and
produce at an average cost of $15,000 a vehicle. LRAC
But if the firm planned to produce 40 vehicles an
hour, it would not stick with its current plant. The 0 20 40 60 80
firm would install a bigger plant with the short-run Output (vehicles per hour)
average total cost curve ATC2, and produce 40 vehi-
Automobile Plant Average Cost Curves
cles an hour for $10,000 a car.

output more than doubles to 15 sweaters a day, so aver-

age cost decreases and Campus Sweaters experiences REVIEW QUIZ
economies of scale. With 4 machines and 4 workers, 1 What does a firm’s production function show
total cost doubles again but output less than doubles and how is it related to a total product curve?
to 26 sweaters a day, so average cost increases and the
2 Does the law of diminishing returns apply to
firm experiences diseconomies of scale.
capital as well as labor? Explain why or why not.
3 What does a firm’s LRAC curve show? How is
Minimum Efficient Scale A firm’s minimum efficient it related to the firm’s short-run ATC curves?
scale is the smallest output at which long-run average
4 What are economies of scale and diseconomies
cost reaches its lowest level. At Campus Sweaters, the
of scale? How do they arise? What do they imply
minimum efficient scale is 15 sweaters a day.
for the shape of the LRAC curve?
The minimum efficient scale plays a role in deter-
5 What is a firm’s minimum efficient scale?
mining market structure. In a market in which the
minimum efficient scale is small relative to market
demand, the market has room for many firms, and
the market is competitive. In a market in which the
minimum efficient scale is large relative to market ◆ Economics in the News on pp. 306–307 applies what
demand, only a small number of firms, and possibly you’ve learned about a firm’s cost curves. It looks at
only one firm, can make a profit and the market is Amazon’s costs and explains how opening a new ful-
either an oligopoly or monopoly. We will return to fillment center enables Amazon to increase production
this idea in the next three chapters. at the lowest average total cost.
 ECONOMICS IN THE NEWS

A Long-Run Decision
for Amazon
Around the world, Amazon has approaching 200 fulfilment centers and more than 150 million
square feet of space where employees and robots process thousands of orders a day. Since
2017, Amazon has opened 20 facilities in Arizona. How does Amazon know when to open a
new filfullment center and when to expand an existing one?

Read these headlines and news clips and then explain how Amazon makes its decision.

Take a Tour of Arizona’s Largest Amazon

Fulfillment Center
Amazon has more than 7,000 full-time employees in Arizona and five fulfillment centers in
the state: one in Tucson, one in Goodyear, and three in ...
www.bizjournals.com, October 3, 2019

Amazon Becomes Goodyear’s Largest Employer

With New ...
Next year, Amazon will open a fifth Goodyear facility to support its customer fulfillment
network, creating another 1,000 full-time jobs.
www.goodyearaz.gov, August 19, 2020

Amazon to Add Facilities and Hire 3,000 in Metro

Phoenix This Year
A third of Amazon’s 3,000 hires will be at a high-tech
fulfillment center in Goodyear that will be the company’s
ESSENCE OF THE STORY
■ Amazon operates 50 technology-intensive
only robotics facility.
fulfillment centers around the country, which
www.goodyearaz.gov, August 19, 2020 employ robotic units.
■ A new center in Goodyear, Arizona, identical to
Robots at Amazon Fulfillment one in Tucson but smaller than some Amazon
facilities, is highly mechanized with robotic
Center in Goodyear Boost Speed units.
■ At the Goodyear center, 1,000 workers process
The advanced Goodyear and Tucson centers are among 300,000 orders in a typical day
50 technology-intensive Amazon fulfillment facilities ...
■ Amazon will become the largest employer in
Goodyear processes 300,000 orders per day. Arizona.
www.azcentral.com, May 5, 2021

306
ECONOMIC ANALYSIS
■ In 2020, Amazon’s 1,298,000 employees processed ■ This center can fill 300,000 orders per day at an average total
around 1 billion orders from its 295 fulfillment centers. cost of $1 an order. (This cost doesn’t include the cost of the
items shipped.)
■ Two of Amazon’s fulfillment centers are in Arizona in
Goodyear and Tucson. ■ If Amazon increased the output of this center to above
300,000 orders per year, its marginal cost would increase
■ The number of orders processed by Amazon increases
sharply, which would increase average total cost.
every year, and the firm must decide how to meet the
growing demand for its service. ■ Amazon can avoid the higher average total cost by build-
ing its new Goodyear center.
■ Amazon can increase the number of orders it fills either by
increasing the output of its existing centers or by building ■ Figure 2 shows Amazon’s average total cost with a new
more centers. center.
■ Amazon has decided that the least-cost way of increasing ■ Amazon will pay the same wages and employee benefits
output in Arizona is to open a new technology-intensive and use the same technologies in Goodyear as in Tucson,
center in Goodyear. so the new Goodyear center has the same average total
cost curve as the Tucson center.
■ Amazon could have processed a greater number of orders
by hiring more workers and installing more robots in ■ The Tucson center’s average total cost curve is ATC0, so
Tucson. when the new center is opened, Amazon can fill 600,000
■ But the Tucson center would have become congested and orders at a cost of $1 an order on ATC1.
the cost of filling an order would have increased. ■ By building a new center, Amazon is expanding along its
■ By building the Goodyear center, Amazon can increase its long-run average cost curve (LRAC).
output at a production cost that is the same as in its other ■ At small outputs, the average total cost of filling an order
centers. is lower at one center than at two. And at large outputs,
■ We don’t know Amazon’s costs, but we can gain insight into the average total cost is lower at two centers than at one
the firm’s decisions with an example using assumed costs. large center.
■ In Fig. 2, Amazon experiences constant returns to scale
■ Figure 1 graphs the (assumed) marginal cost (MC) and aver-
age total cost (ATC) curves for Amazon’s Tucson fulfillment (an assumption, but not unlikely).
center.
Cost (dollars per order)

Cost (dollars per order)

MC
3 3 By increasing plant size,
Amazon can process more
MC rises sharply orders at lower cost on ATC1
and pulls up ATC
as output increases ATC ATC 0 ATC 1
above 300,000
2 orders per day 2

1 1 LRAC

0 100 200 300 400 500 600 0 300 600 900

Output (thousands of orders per day) Output (thousands of orders per day)

Figure 1 Amazon's Short-Run Cost Curves Figure 2 Amazon's Long-Run Cost Curve

307
308 CHAPTER 11 Output and Costs

WORKED PROBLEM

The table provides data about a firm’s short-run 1b. TFC equals TC at zero output, so you can fill in the
costs. It shows the firm’s total cost, TC, and mar- TFC column as $12 at each quantity of output.
ginal cost, MC, at five levels of output, including 1c. Because TC = TFC + TVC , you can fill in the TVC
zero output. column as TVC = TC − TFC . For example, at 1 unit
Output MC TC TFC TVC ATC AFC AVC of output, TVC = $22 − $12 = $10.
1d. Average cost equals TC ÷ output , so to fill in the
0 $12 ? ?
ATC, AFC, and AVC columns, divide the numbers
$10 for TC, TFC, and TVC by the output level. For ex-
1 ? ? ? ? ? ? ample, ATC at 3 units of output is $30 ÷ 3 = $10.
$2
2 ? ? ? ? ? ? Output MC TC TFC TVC ATC AFC AVC
$6 0 $12 $12 0
3 ? ? ? ? ? ? $10
$22 1 $22 $12 $10 $22 $12 $10
4 ? ? ? ? ? ? $2
Questions 2 $24 $12 $12 $12 $6 $6
1. Fill in the cells marked “?” to record the firm’s costs: $6
TC, TFC, TVC, ATC, AFC, and AVC at each 3 $30 $12 $18 $10 $4 $6
output. $22
2. Draw a graph of the total cost curves, and a graph 4 $52 $12 $40 $13 $3 $10
of the average and marginal cost curves.
Key Point: Given a firm’s total cost at zero output
Solutions and its marginal cost at each output, by using the re-
1a. Begin by using the fact that marginal cost, MC, is lationships among the cost concepts, we can calculate
the change in total cost, TC, when output increases the total costs and the average costs at each output.
by 1 unit. This fact means that TC at 1 unit equals 2. The key figure (a) graphs the total cost curves and
TC at zero units plus MC of the first unit. TC is $12 the key figure (b) graphs the marginal and average
at zero and MC of the first unit is $10, so TC at 1 cost curves.
unit equals $22. The rest of the TC column is calcu-
Key Point: The marginal cost curve intersects the two
lated in the same way. For example, TC at 4 units is
average cost curves at their minimum points.
$52, which equals $30 + $22 .

Key Figure
Cost (dollars per unit)

Cost (dollars per unit)

60 40

TC MC
35
50
30
TVC
40
25

30 20

15
20 ATC
10 AVC
TFC
10
5
AFC

0 1 2 3 4 0 1 2 3 4
Output (units per day) Output (units per day)

(a) Total Cost Curves (b) Average and Marginal Cost Curves
 Summary 309

SUMMARY

Key Points Short-Run Cost (pp. 295–301)

■ As output increases, total fixed cost is constant,
Decision Time Frames (p. 290) and total variable cost and total cost increase.
■ In the short run, the quantity of at least one factor ■ As output increases, average fixed cost decreases
of production is fixed and the quantities of the and average variable cost, average total cost, and
other factors of production can be varied. marginal cost decrease at low outputs and increase
■ In the long run, the quantities of all factors of at high outputs. These cost curves are U-shaped.
production can be varied..
Long-Run Cost (pp. 302–305)
Short-Run Technology Constraint (pp. 291–294) ■ A firm has a set of short-run cost curves for each
■ A total product curve shows the quantity a firm different plant. For each output, the firm has one
can produce with a given quantity of capital and least-cost plant. The larger the output, the larger is
different quantities of labor. the plant that will minimize average total cost.
■ Initially, the marginal product of labor increases ■ The long-run average cost curve traces out the
as the quantity of labor increases, because of lowest attainable average total cost at each output
increased specialization and the division of labor. when both capital and labor inputs can be varied.
■ Eventually, marginal product diminishes because an ■ With economies of scale, the long-run average cost
increasing quantity of labor must share a fixed quan- curve slopes downward. With diseconomies
tity of capital—the law of diminishing returns. of scale, the long-run average cost curve slopes
■ Initially, average product increases as the quantity upward.
of labor increases, but eventually average product
diminishes.

Key Terms
Average fixed cost , 296 Economies of scale, 304 Short run, 290
Average product , 291 Law of diminishing returns, 293 Sunk cost , 290
Average total cost , 296 Long run, 290 Total cost , 295
Average variable cost , 296 Long-run average cost curve, 303 Total fixed cost , 295
Constant returns to scale, 304 Marginal cost , 296 Total product , 291
Diminishing marginal returns, 293 Marginal product , 291 Total variable cost , 295
Diseconomies of scale, 304 Minimum efficient scale, 305
310 CHAPTER 11 Output and Costs

PROBLEMS AND APPLICATIONS

Decision Time Frames 6. Explain how it is possible for a firm to experience

1. Which of the following news clips involves a simultaneously an increasing average product and
short-run decision and which involves a long-run a diminishing marginal product.
decision? Explain. Short-Run Cost
■ In 2013, Nokia announced that it would cut Use the following data to work Problems 7 to 11.
300 jobs, mostly in Finland, and transfer Sue’s Surfboards, in Problem 2, hires workers at $500
hundreds of employees to the firm’s Indian a week and its total fixed cost is $1,000 a week.
branches to take them off its payroll. 7. Calculate total cost, total variable cost, and total
■ In October 2013, Peugeot shut down its fac- fixed cost of each output in the table. Plot these
tory in Aulnay-sous-Bois and announced that points and sketch the short-run total cost curves.
it would lay off more than 11,000 employees 8. Calculate average total cost, average fixed cost,
in the following years. average variable cost, and marginal cost of each
■ In 2016, the Renault-Nissan-Mitsubishi Alliance output in the table. Plot these points and sketch
was considering shutting down Nissan’s plant in the short-run average and marginal cost curves.
Sunderland, England, following Brexit. 9. Illustrate the connection between Sue’s AP, MP,
■ The French insurance firm Axa had taken AVC, and MC curves in graphs like Fig. 11.7.
steps to limit e-mailing and messaging em- 10. Sue’s Surfboards rents a factory. If the rent rises
ployees outside of working hours even before by $200 a week and other things remain the
the “right to disconnect” law came into effect same, how do Sue’s Surfboards’ short-run average
on January 1, 2017. cost curves and marginal cost curve change?
11. Workers at Sue’s Surfboards negotiate a wage increase
Short-Run Technology Constraint of $100 a week per worker. If other things remain the
Use the following table to work Problems 2 to 6. same, explain how Sue’s Surfboards’ short-run aver-
The table sets out Sue’s Surfboards’ total product age cost curves and marginal cost curve change.
schedule. Long-Run Cost
Labor Output
(workers per week) (surfboards per week)
Use the following data to work Problems 12 to 14.
Jackie’s Canoe Rides rents canoes at $100 per day and
1 30 pays $50 per day for each canoe operator it hires. The
2 70 table shows the firm’s production function.
3 120 Output
4 160 (rides per day)
Labor
5 190 (workers per day) Plant 1 Plant 2 Plant 3 Plant 4
6 210
10 20 40 55 65
7 220
20 40 60 75 85
2. Draw the total product curve. 30 65 75 90 100
3. Calculate the average product of labor and draw 40 75 85 100 110
the average product curve. Canoes 10 20 30 40
4. Calculate the marginal product of labor and
draw the marginal product curve. 12. Graph the average total cost curves for Plant 1
and Plant 2. Explain why they differ.
5. a. Over what output range does Sue’s Surfboards
enjoy the benefits of increased specialization 13. Graph the average total cost curves for Plant 3
and division of labor? and Plant 4. Explain why they differ.
b. Over what output range does Sue’s Surfboards 14. a. On Jackie’s LRAC curve, what is the average
experience diminishing marginal product of labor? cost of producing 40, 75, and 85 rides a week?
c. Over what output range does Sue’s Surfboards b. What is Jackie’s minimum efficient scale?
experience an increasing average product of la- c. Does Jackie’s experience economies of scale
bor but a diminishing marginal product of labor? or diseconomies of scale?
 Additional Problems and Applications 311

ADDITIONAL PROBLEMS AND APPLICATIONS

Decision Time Frames TP AFC AVC ATC MC

15. Nestlé Purina PetCare Plans to Open New 10 120 100 220
Factory in North Carolina 80
Nestlé Purina PetCare announced a $450 mil- 20 A B 150
lion investment to open a new factory in North 90
Carolina. Purina plans to employ more than 300 30 40 90 130
people at its new factory location. 130
Source: prnewswire.com, September 30, 2020 40 30 C D
E
a. Which of Nestlé Purina’s decisions described 50 24 108 132
in the news clip is a short-run decision and
which is a long-run decision? Bill asks you to come to his rescue and provide
b. Why is Nestlé Purina’s long-run decision the missing data in the five spaces identified as
riskier than its short-run decision? A, B, C, D, and E.
16. A Bad Fit: Why You Should Care About
Use the following table to work Problems 20 and 21.
Sunk Costs
ProPainters hires students at $250 a week to paint
We all relate to wearing an ill-fitting pair of shoes
houses. It leases equipment at $500 a week. The
to get our money’s worth. When we come to our
table sets out its total product schedule.
senses, we ditch the toe crunchers and buy shoes
that don’t destroy our feet. Labor Output
Source: bizjournals.com, May 27, 2021 (students) (houses painted per week)

a. What type of cost is expenditure on shoes? 1 2

b. Why is the price paid for the shoes irrelevant to 2 5
your decision about whether to keep on wear- 3 9
ing a pair that cause pain? 4 12
5 14
Short-Run Technology Constraint 6 15
17. Terri runs a rose farm. One worker produces
20. If ProPainters paints 12 houses a week, calculate its
1,000 roses a week; hiring a second worker dou-
total cost, average total cost, and marginal cost. At
bles her total product; hiring a third worker dou-
what output is average total cost a minimum?
bles her output again; hiring a fourth worker in-
creases her total product but by only 1,000 roses. 21. Explain why the gap between ProPainters’ total
Construct Terri’s marginal product and average cost and total variable cost is the same no matter
product schedules. Over what range of workers how many houses are painted.
do marginal returns increase? 22. Skyrocketing Meat Costs May Prompt
Restaurant Price Increases
Short-Run Cost With soaring meat costs, Americans might soon
18. Read the information about Nestlé Purina’s busi- have to dish out more money than usual at res-
ness decisions in the news clip in Problem 15. Ex- taurants. Executive Chef Luca Corrazina says
plain how Nestlé Purina’s short-run decision will his restaurant is already charging its customers
change its average variable cost and its short-run “a little bit extra.”
average total cost curve. Source: nbcchicago.com, May 24, 2021
19. Bill’s Bakery has a fire and Bill loses some of his a. Does the rising price of meat change a res-
cost data. The bits of paper that he recovers after taurant’s fixed cost, variable cost, or marginal
the fire provide the data in the following table. cost?
The total product numbers are loaves and the
cost numbers are dollars. b. Explain how the rising price of meat influ-
ences a restaurant’s short-run cost curves.
312 CHAPTER 11 Output and Costs

Long-Run Cost Economics in the News

Use the table in Problem 20 and the following 28. After you have studied Economics in the News on
information to work Problems 23 and 24. pp. 306–307, answer the following questions.
a. Explain the distinction between the short
If ProPainters doubles the number of students it hires run and the long run, and identify when
and doubles the amount of equipment it leases, it Amazon would want to make each type of
experiences diseconomies of scale. decision.
23. Explain how the ATC curve with one unit of b. Explain constant returns to scale. Why does
equipment differs from that when ProPainters Amazon reap constant returns to scale in the
uses double the amount of equipment. example with the assumed costs on p. 307?
24. Explain what might be the source of the dis-
c. Amend the graph in Fig. 2 on p. 307 to illus-
economies of scale that ProPainters experiences.
trate Amazon’s ATC1 and LRAC curves if it
Use the following data to work Problems 25 to 27. experiences economies of scale.
The table shows the production function of Bonnie’s 29. Marriott is Testing Contactless Check-in
Balloon Rides. Bonnie’s pays $500 a day for each bal- Via Kiosks
loon it rents and $25 a day for each balloon operator Marriott is testing its new contactless arrival
it hires. kiosks, eliminating the need for face-to-face
check-ins. The kiosks help speed up the check-in
Output process.
(rides per day)
Labor Source: yahoo.com, April 11, 2021
(workers per day) Plant 1 Plant 2 Plant 3 Plant 4
a. What is the total fixed cost of operating one
10 6 10 13 15 contactless check-in kiosk?
20 10 15 18 20 b. Explain how the fixed costs, variable costs,
30 13 18 22 24 and total costs differ if you check in at a hotel
40 15 20 24 26 using a contactless kiosk or check in with an
50 16 21 25 27 employee at the front desk.
Balloons (number) 1 2 3 4 c. Sketch the marginal cost and average cost
curves implied by your answer to part (b).
25. Graph the average total cost curves for Plant 1
and Plant 2. Explain why these two ATC curves Use the following news clip to work Problems 30, 31,
differ. and 32.
26. Graph the average total cost curves for Plant 3 Macy’s Plans to Open Smaller Stores
and Plant 4. Explain why these two ATC curves Macy’s CEO Jeff Gennette believes that Macy’s has
differ. high potential outside of malls and in smaller for-
27. a. On Bonnie’s LRAC curve, what is the average mats. The department store chain is planning to test
cost of producing several smaller Macy’s stores outside of malls.
Source: today.com, September 2, 2020
(i) 15 rides a day?
(ii) 18 rides a day? 30. Thinking of a Macy’s store as a production plant,
explain why Macy’s is opening smaller stores. Is
b. Explain how Bonnie’s uses its long-run average
Macy’s decision a long-run decision or a short-
cost curve to decide how many balloons to
run decision?
rent.
31. Is Macy’s expecting to benefit from economies
of scale or does the firm think there are disec-
onomies of scale? Explain your answer.
32. Draw a graph to illustrate Macy’s average total
cost curves for a small format store and the
regular Macy’s store.