ECONOMICS TOPIC 3 LESSON 5

ECONOMICS TOPIC 3 LESSON 5

LABOR AND OUTPUT

ESSENTIAL QUESTION

How do we affect the economy?

Labor and Output

Producers think about the cost of making one more unit of a good when deciding how to maximize profits. You’ll also see what happens when a factory’s operating costs are greater than its revenue.

How Many Workers to Hire

One basic question that any business owner has to answer is how many workers to hire. Owners have to consider how the number of workers they hire will affect their total production.

Marginal Product of Labor

The relationship between labor, measured by the number of workers in the factory and the number of beanbags produced, . This table details the marginal product of labor, or the change in output from hiring one more worker. This is called the marginal product because it measures the change in output at the margin, where the last worker has been hired or fired.

Open Ended

Marginal product of labor is the change in output that results when a unit of labor is added. Analyze Charts How does marginal product of labor change when a fourth worker is added?

Increasing Marginal Returns

The marginal product of labor increases for the first three workers because there are three tasks involved in making a beanbag. Workers cut cloth into the correct shape, stuff it with beans, and sew the bag closed. A single worker performing all these tasks can produce only four bags per hour. Adding a second worker allows each worker to specialize in one or two tasks. If each worker focuses on only one part of the process, she wastes less time switching between tasks and becomes more skillful at her assigned task. Because specialization increases output per worker, the second worker adds more to output than the first. The firm enjoys increasing marginal returns.

diminishing marginal returns

After the beanbag firm hires its first three workers, one for each task, the benefits of specialization end. At that point, adding more workers increases total output, but at a decreasing rate. This situation is known as diminishing marginal returns. A firm with diminishing marginal returns of labor will produce less and less output from each additional unit of labor.

Open Ended

This graph shows the rise and fall in marginal product of labor for the beanbag factory. Analyze Graphs What is the marginal product of labor when a fifth worker is added?

Negative Marginal Returns

Adding an eighth worker actually decreases output by one bag. This is called negative marginal return. At this stage, workers get in each other’s way and disrupt production, so overall output decreases. Of course, few companies ever hire so many workers that their marginal product of labor becomes negative.

Multiple Choice

Apply Concepts How would the decision by a beanbag factory to add more sewing machines affect marginal returns?

• It would reduce marginal returns.

• It would increase marginal returns.

• It would have no effect on marginal returns.

• It would hurt marginal returns at first but increase them later.

Production Costs

Paying workers and purchasing capital are both costs of producing goods. Economists divide a producer’s costs into two main categories: fixed costs and variable costs.

Fixed Costs

A fixed cost is a cost that does not change, no matter how much of a good is produced. Most fixed costs involve the property or production facility—the cost of building and equipping a factory, office, store, or restaurant. Examples of fixed costs include rent, machinery repairs, property taxes, and the salaries of workers who run the business even when production temporarily stops.

Variable Costs

Variable costs are costs that rise or fall depending on the quantity produced. They include the costs of raw materials and some labor. For example, to produce more beanbags, the firm must purchase more beans and hire more workers. If the company wants to produce less and cut costs, it can buy fewer beans or reduce weekly hours for some workers. The cost of labor is a variable cost because it changes with the number of workers, which changes with the quantity produced.

Open Ended

Producers must identify costs and revenues to calculate profit—total revenues minus total costs. Apply Concepts Why might this factory not seek the highest possible revenue?

Total Cost

Fixed and variable costs added together make up the total cost.

Marginal Cost

If we know the total cost at several levels of output, we can determine the marginal cost of production at each level. Marginal cost is the additional cost of producing one more unit.

Multiple Choice

Distinguish What costs might a factory that closes its doors and stops producing goods still face?

• fixed costs

• variable costs

• marginal revenues

• increasing marginal returns

Setting Output

Behind all of the hiring decisions is the firm’s basic goal: to maximize profits. Profit is defined as total revenue minus total cost. A firm’s total revenue is the money the firm gets by selling its product. Total revenue is equal to the price of each good multiplied by the number of goods sold.

Marginal Revenue and Marginal Cost

Marginal revenue is the additional income from selling one more unit of a good.

Marginal cost is the additional income required to make one more unit of a good.

Responding to Price Changes

What happens if the price of a beanbag rises from $24 to $37? Thinking at the margin, the firm would probably increase production to 12 beanbags per hour. At that quantity, marginal cost is equal to the new, higher price. 

Open Ended

Changes in price lead to a change in the ideal level of output. Analyze Graphs Based on this graph, what should output be if the price fell to $20?

The Shutdown Decision

Consider the problems faced by a factory that is losing money. The factory is producing at the most profitable level of output, where marginal revenue is equal to marginal cost. However, the market price is so low that the factory’s total revenue is still less than its total cost, and the firm is losing money. Should this factory continue to produce goods and lose money, or should its owners shut the factory down?

Open Ended

It makes sense to keep a factory operating if revenue exceeds operating costs. Analyze Charts What is the lowest market price this producer could accept given its costs?

Multiple Choice

Apply Concepts A firm that is losing money should nevertheless choose to continue operating if its

• operating costs are greater than its revenues.

• total costs are greater than its total revenues.

• total revenue is greater than its variable costs. s.

• marginal costs are greater than its total cost

Open Ended

How do we affect the economy?