Technology, Production, and Costs – Microeconomics Chapter 11 Study Notes

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Technology, Production, and Costs

11.1 Technology: An Economic Definition

Technology in economics refers to the processes a firm uses to turn inputs into outputs of goods and services. Technological change occurs when a firm improves or worsens its ability to produce a given level of output with a given quantity of inputs.

Inputs: Workers, machines, natural resources
Outputs: Goods and services
Technological change: Can be positive (improving productivity) or negative (reducing productivity)
Example: The introduction of AI chatbots like ChatGPT is a technological change that can substitute capital for labor, affecting productivity and employment.

Apply the Concept: Oil Roughnecks Encounter Robots and Drones

Fracking technology increased demand for oil field workers, but falling oil prices led firms to adopt labor-saving technologies (robots, drones), reducing the workforce by about 40,000.

11.2 The Short Run and the Long Run in Economics

Economists distinguish between the short run and the long run based on the flexibility of inputs.

Short run: At least one input is fixed (e.g., a factory lease)
Long run: All inputs can be varied; firms can adopt new technology and change plant size
Duration: The long run is "long enough" for all inputs to be changed

Fixed, Variable, and Total Costs

Variable costs: Change as output changes
Fixed costs: Remain constant as output changes
Total cost: Sum of fixed and variable costs

Apply the Concept: Fixed Costs in the Publishing Industry

Book publishers have fixed costs (e.g., intellectual property, machines) and variable costs (e.g., paper, labor). As output increases, variable costs rise, but fixed costs remain constant.

Implicit Costs Versus Explicit Costs

Explicit cost: Monetary outlay (e.g., wages, rent)
Implicit cost: Nonmonetary opportunity cost (e.g., foregone salary, interest)
Example: Owner's time spent on the firm is an implicit cost, even if not paid directly.

Table: Jill Johnson's Costs per Year

Jill's Explicit Costs	Amount
Pizza dough, tomato sauce, other ingredients	$20,000
Wages	$48,000
Interest payments on loan	$10,000
Electricity	$24,000
Lease payment	$24,000
Jill's Implicit Costs
Forgone salary	$30,000
Forgone interest	$3,000
Economic depreciation	$2,000
Total	$151,000

Production at Jill Johnson's Restaurant

For analysis, consider two inputs: pizza ovens (fixed cost) and workers (variable cost). Jill cannot change the number of ovens in the short run but can adjust the number of workers.

Table: Short-Run Production and Cost at Jill Johnson's Restaurant

Quantity of Workers	Quantity of Pizza Ovens	Quantity of Pizzas per Week
0	2	0
1	2	200
2	2	450
3	2	550
4	2	600
5	2	625
6	2	640

Each oven costs $400/week; each worker costs $650/week. Fixed costs: $800/week; variable costs increase by $650 per worker.

Table: Cost per Pizza (Average Total Cost)

Quantity of Workers	Total Cost per Week	Cost per Pizza (Average Total Cost)
1	$1,450	$7.25
2	$2,100	$4.67
3	$2,750	$5.00
4	$3,400	$5.67
5	$4,050	$6.48
6	$4,700	$7.34

Average total cost falls at low levels of production, then rises at higher levels, resulting in a U-shaped curve.

11.3 The Marginal Product of Labor and the Average Product of Labor

The marginal product of labor is the additional output produced by hiring one more worker. The average product of labor is the total output divided by the number of workers.

Division of labor: Specialization increases productivity
Law of diminishing returns: Adding more of a variable input to a fixed input eventually causes the marginal product to decline

Example Calculation: With 3 workers: pizzas per worker (average product) Marginal products for first three workers: 200, 250, 100 pizzas Average of marginal products:

11.4 The Relationship Between Short-Run Production and Short-Run Cost

Marginal cost is the change in total cost from producing one more unit. Average total cost is total cost divided by output.

Marginal cost curve typically intersects the average total cost curve at its minimum point.
Both curves are U-shaped due to the law of diminishing returns.

11.5 Graphing Cost Curves

Cost curves include average total cost (ATC), average variable cost (AVC), average fixed cost (AFC), and marginal cost (MC).

ATC and AVC are U-shaped.
MC curve cuts through the minimum points of ATC and AVC.
AFC declines as output increases, causing ATC and AVC to converge.

11.6 Costs in the Long Run

In the long run, all costs are variable. The long-run average cost curve shows the lowest cost at which a firm can produce a given quantity of output when no inputs are fixed.

Economies of scale: Long-run average costs fall as output increases
Minimum efficient scale: Output level where economies of scale are exhausted
Constant returns to scale: Long-run average cost remains unchanged as output increases
Diseconomies of scale: Long-run average costs rise as output increases

Appendix: Using Isoquants and Isocost Lines to Understand Production and Cost

Isoquants and isocost lines help firms choose the cost-minimizing combination of inputs for a given level of output.

Isoquant: Curve showing all combinations of inputs that produce the same output
Isocost line: Shows all combinations of inputs with the same total cost
Marginal rate of technical substitution (MRTS): Rate at which one input can be substituted for another, keeping output constant
Cost minimization: Occurs where the isoquant is tangent to the isocost line

Cost-Minimization Condition: Where is marginal product of labor, is wage rate, is marginal product of capital, is rental rate of capital.

Expansion path: Curve showing cost-minimizing input combinations for every output level