# Principles of Economics

Principles of Economics will allow you to learn a new set of tools to use in personal, professional, business, and political decision making.

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## Comparison of Principles of Economics Textbooks

Consider adding Top Hat’s Principles of Economics textbook to your upcoming course. We’ve put together a textbook comparison to make it easy for you in your upcoming evaluation.

### Top Hat

Stephen Buckles, Principles of Economics, Only One Edition needed

### Cengage

N. Gregory Mankiw, Principles of Economics, 8th Edition

### Pearson

Case, Fair, Oster, Principles of Economics, 12th Edition

### McGraw-Hill

McConnell, Brue, Flynn, Principles of Microeconomics, 7th Edition

### Pricing

Average price of textbook across most common format

#### $130 Hardcover print text only ####$175

Hardcover print text only

#### $140 Hardcover print text only ### Always up-to-date content, constantly revised by community of professors Content meets standard for Introduction to Anatomy & Physiology course, and is updated with the latest content ### In-Book Interactivity Includes embedded multi-media files and integrated software to enhance visual presentation of concepts directly in textbook Only available with supplementary resources at additional cost Only available with supplementary resources at additional cost Only available with supplementary resources at additional cost ### Customizable Ability to revise, adjust and adapt content to meet needs of course and instructor ### All-in-one Platform Access to additional questions, test banks, and slides available within one platform ## Pricing Average price of textbook across most common format ### Top Hat Stephen Buckles, Principles of Economics, Only One Edition needed #### Up to40-60%more affordable Lifetime access on any device ### Cengage N. Gregory Mankiw, Principles of Economics, 8th Edition ####$130

Hardcover print text only

### Pearson

Case, Fair, Oster, Principles of Economics, 12th Edition

#### $175 Hardcover print text only ### McGraw-Hill McConnell, Brue, Flynn, Principles of Microeconomics, 7th Edition ####$140

Hardcover print text only

## Always up-to-date content, constantly revised by community of professors

Constantly revised and updated by a community of professors with the latest content

### Top Hat

Stephen Buckles, Principles of Economics, Only One Edition needed

### Cengage

N. Gregory Mankiw, Principles of Economics, 8th Edition

### Pearson

Case, Fair, Oster, Principles of Economics, 12th Edition

### McGraw-Hill

McConnell, Brue, Flynn, Principles of Microeconomics, 7th Edition

## In-book Interactivity

Includes embedded multi-media files and integrated software to enhance visual presentation of concepts directly in textbook

### Top Hat

Stephen Buckles, Principles of Economics, Only One Edition needed

### Cengage

N. Gregory Mankiw, Principles of Economics, 8th Edition

### Pearson

Case, Fair, Oster, Principles of Economics, 12th Edition

### McGraw-Hill

McConnell, Brue, Flynn, Principles of Microeconomics, 7th Edition

## Customizable

Ability to revise, adjust and adapt content to meet needs of course and instructor

### Top Hat

Stephen Buckles, Principles of Economics, Only One Edition needed

### Cengage

N. Gregory Mankiw, Principles of Economics, 8th Edition

### Pearson

Case, Fair, Oster, Principles of Economics, 12th Edition

### McGraw-Hill

McConnell, Brue, Flynn, Principles of Microeconomics, 7th Edition

## All-in-one Platform

### Top Hat

Stephen Buckles, Principles of Economics, Only One Edition needed

### Cengage

N. Gregory Mankiw, Principles of Economics, 8th Edition

### Pearson

Case, Fair, Oster, Principles of Economics, 12th Edition

### McGraw-Hill

McConnell, Brue, Flynn, Principles of Microeconomics, 7th Edition

#### Stephen Buckles, Ph.DVanderbilt University

Stephen Buckles is a Senior Lecturer at Vanderbilt University, where he also received his Ph.D. in Economics. Buckles has been the recipient of numerous awards, including Madison Sarratt Prize for Excellence in Undergraduate Teaching (Vanderbilt, 2008), Kenneth G. Elzinga Distinguished Teaching Award (Southern Economic Association, 2006), and the Dean’s Award for Excellence in Teaching (Vanderbilt, 2007). His course pack, which this text is based on, has been used by thousands of students and engages the concepts of active learning.

#### PJ Glandon, PhDKenyon College

PJ Glandon joined Kenyon College as an Associate Professor of Economics after completing his Ph.D. at Vanderbilt University.

## Explore this textbook

Read the fully unlocked textbook below, and if you’re interested in learning more, get in touch to see how you can use this textbook in your course today.

# Chapter 8: Inputs, Production, and Costs in the Long Run​

Because you did so well as a budding planner, your summer internship assignment has been extended and you have been given more responsibilities. Your boss needs to know what she should do over the next several years. She now has a planning horizon that allows her to vary all inputs. Should she buy more machines and hire fewer workers at each possible level of output? Or perhaps use fewer machines and more workers? What happens to costs if she does substitute one for the other? What will happen to total and average costs if the firm expands production with more of both labor and capital?

## 8.1 Learning Objectives

After reading this chapter, answering the questions in the text, and doing the exercises, you will be able to:

• Explain how firms choose among combinations of resources.
• Use marginal analysis to explain why, when cost is at a minimum at each level of output, the marginal products of a dollar spent on all factors of production are equal.
• Derive a long-run average cost curve from a series of short-run cost curves.
• Explain the shape of the long-run average cost curve and the causes of shifts in the curve.
• Explain why firms are numerous and small in some industries but few and large in other industries.

Agriculture in China uses significant amounts of labor and relatively little capital compared to U.S. farming. Why? Does China not have access to advanced farm machinery?

Automobiles and jets are manufactured in large plants with thousands of workers and millions of dollars of capital equipment. Clothing and furniture are produced in plants with hundreds of workers and thousands of dollars of capital equipment. Why do these processes differ so greatly in size?

In the last chapter, we focused on how changes in variable inputs affect production and costs. All of that discussion was relevant to the short run. In the short run, we usually assume that labor is variable, but capital is fixed. Other inputs, such as land, may be fixed as well.

Now we will turn to the long run. We will ask similar questions regarding output, costs, and profits, but now with all inputs changing. In both the short and long run, firms attempt to produce given amounts of output at the lowest possible cost. In the short run, this means using as little of the variable input as technically possible for any given output level. In the long run, it means selecting a combination of inputs that results in the lowest possible average and total costs at a given level of output.

Once we have discovered how firms make the choice of inputs, we will explore the effects on costs of producing at a variety of different levels.

Our web page design firm from Chapter 7 has to make two determinations in the long run. The first is how many designers to hire and how many computers to use for each possible level of output. The second is how changes in output will affect costs.

## 8.2 Efficient Combinations of Labor and Capital

A software firm can substitute computers for workers. An automobile manufacturer can buy more robots and hire fewer assembly line workers. It is possible to grow and harvest corn using many workers in the field, but most farms today in the United States use tractors and combines instead.

To understand how each firm makes the decisions about how to produce goods and services, we will again assume that firms want to maximize their profits. There are several steps to maximize profits. Profit maximization can only occur with minimization of costs of inputs, given the level of output. How do we find the cost-minimizing input combination for a given level of output?

Suppose you are asked to advise the manager of a McDonald's franchise for the summer. Your job is to decide on the appropriate number of workers and hamburger-cooking machines that is best for the franchise. We are going to define the best as the combination that results in the lowest cost for each level of output.

The facts are as follows: each worker hired costs the franchise $100 for an eight-hour day. Each worker produces 1000 hamburgers. The last hamburger-cooking machine was rented at$50 per eight-hour day and also resulted in an expansion of 1000 hamburgers produced per day. We will assume that workers and machines can be perfectly substituted for one another.

Assuming (for the moment) that the marginal products of labor and capital do not change as the manager hires more or less labor or rents more or fewer machines, use this information to assist the manager in deciding how to lower costs, yet maintain the current level of total product.

Another dollar spent on machines will expand output by 20 hamburgers; 1000 hamburgers divided by $50 is equal to 20 hamburgers per dollar spent on capital. Thus, if the manager wants to maintain the current level of production, the manager should expand the capital spending by$1 (getting 20 more hamburgers) and will be able to reduce spending on labor by $2 (reducing production by two times the 10 hamburgers). Costs are lowered and quantity produced is maintained. Thus, we’ve increased our profits since the same amount of output was produced (keeping our revenues the same) but our costs of production are lower. Click here to return to Question 8.01. ### Answer to Question 8.02 This is an application of the law of diminishing marginal returns. If marginal product decreases when one input is increased, marginal product will increase as the input is reduced Click here to return to Question 8.02. ### Answer to Question 8.03 If the additional output that a company can get from hiring$1 more of one input is greater than the output that a company loses from reducing a substitute input by \$1, the firm should substitute the input with the higher marginal product per dollar spent. As a result of that substitution, the marginal product of the dollar spent on the increased input will decline and the marginal product of the dollar spent on the decreased input will increase. The substitution should continue until the two marginal products are equal. At that point, switching between the two inputs will no longer lower costs.

If demand for labor is the same in all countries, those with larger supplies of labor will have lower wages. If all countries initially use the same amounts of labor, the lower wages will mean that the marginal product per dollar spent on labor will be greater in those countries with lower wages than in other countries. The countries with the higher marginal product per dollar spent on labor will expand the amount of labor. That process will continue, decreasing the marginal product of labor, until the marginal product per dollar spent on labor is equal to the marginal product per dollar spent on capital.

The marginal product per dollar spent on machines is greater than the marginal product per dollar spent on labor. Thus, the firm should reduce the labor and expand the amount of capital. A reduction of one worker will allow the firm to rent two machines. Because the marginal product of a machine is twice that of a worker, output (for the same cost) will increase by four times the output lost by reducing workers.

In the short run, an increase in wages will increase variable costs (and thus average and marginal costs) and an increase in the cost of capital will increase fixed costs (and thus average costs). In the long run, increases in both will increase marginal and average costs.

If the cost of labor increases, the firm will use more capital and less labor as it can get more output per dollar spent from capital than labor. Average cost of production will increase, as the cost of the labor still used will be higher and the additional capital used will have a lower marginal product and thus higher cost per output unit.

If the marginal products per additional dollar spent on all inputs are not equal, a firm can reduce inputs that have lower marginal products per dollar spent, and take a portion of those dollars saved and spend them on other inputs that have higher marginal products per dollar spent. The firm will have reduced costs as a result.

Yes, it still holds. We can still hold an input constant in the long run, but we have the option to change them all. If we hold capital constant, we’ll still see diminishing marginal returns to labor. But remember that in the long run we can add more capital if we need to.

This is tricky, but the answer is yes. Diminishing marginal product means labor becomes less productive at the margin when capital is fixed. However, we could still add capital (in the long run) to get lower average costs with economies of scale, allowing both inputs to specialize more. Don’t get caught up thinking the firm can’t “operate at the same time” in both the short and long run – that’s not what the question is really asking. Think about the given output level and firm size. For any given level of capital, a firm could have diminishing marginal product of labor at some point. However, when capital can be changed, the firm could have economies of scale, constant returns to scale, or diseconomies of scale.

AC1 is the correct choice. The firm would choose the smallest firm size, as the average cost of producing 200 units of output would be less than if it built a larger capacity. This is seen graphically by noticing that at output Q = 200, AC1 is below AC2. That is, the small firm will have lower average costs than the medium firm at this output level. If the firm wanted instead to produce 300 web pages, it would choose to build the medium-sized firm. A lower average cost is achieved by building the medium plant size at this higher output level. In the long run, our firm will choose the amount of capital (office space and computers) and the amount of labor that minimize average cost. Thus, the long-run average cost curve is the lowest average cost at each level of output. If we are given short-run average cost curves, the long-run average cost curve is the part of each short-run average cost curve that minimizes average cost for that specific level of output.

At 125 units of output, the firm can choose a firm size with short-run average cost curve one, two, or three. The lowest average cost could be reached if the firm chooses size two. The smallest firm would generate a slightly higher average cost and the third largest would have the highest average cost. At 200 units of output, the firm can choose among the second, third, and fourth sizes. The second size firm appears to be the most expensive, the fourth, slightly less expensive, and the third, the least expensive. In planning for the long run, businesses will choose the size, office or factory that minimizes average cost for its chosen level of output. Thus, the long-run average cost curve, with many possible firm sizes and with each size firm able to produce at about the same minimum average cost, will look like the heavy line in Figure 8.9 (see below).

As the price of one factor increases, a firm will use less of the factor. So the first part of the statement is true. However, total costs will rise. This is because the cost per unit still used is higher. Why? When we use more of the other input, the marginal product of that other input will be lower but have the same cost per unit as before. Thus, costs will increase due to an increased use of that factor.

Some firms will hire Mexican labor and reduce U.S. labor. As the demand for Mexican labor increases, wages will increase. As the demand for U.S. labor decreases, wages will decrease.

Beer bottlers may face significant economies of scale and therefore be able to produce beer more inexpensively in large plants. If soft drink bottlers do not face the same economies of scale, it may not lower costs to have just a single bottler in an area and pay greater transportation costs.

This was answered earlier in the chapter. China is not inefficient. With less expensive labor, it makes sense to use more labor and less capital.

## Image Credits

[1] Image courtesy of Unsplash under CC0 1.0.

[2] Image courtesy of Keith Weller, U.S. Department of Agriculture in the Public Domain.

[3] Image courtesy of FunnyKHK under CC BY-SA 3.0.

[4] Image courtesy of Tony Wills under CC BY-SA 3.0.

[5] Image courtesy of Danmichaelo under CC BY-SA 3.0.

[6] Image courtesy of ICAPlants under CC BY-SA 3.0.

Short run: a period in which at least one factor of production is fixed
Long run: A time period long enough for a business to change all of its inputs
Marginal analysis: The process of comparing the change in benefits with the change in costs resulting from an action
Think about the cost and productivity of the inputs
Think about the law of diminishing marginal product. Can it work in reverse?
A firm will try to produce the output at the lowest cost. How can it keep output the same but reduce production costs?
A high supply means a low price, ceteris paribus.
Set up a comparison of productivity per dollar to help compare the inputs.
If an input gets more expensive, will a firm use more or less of that input?
If an input gets more expensive, will a firm use more or less of that input?
Think about why an inequality (rather than equality) CANNOT result in cost minimization!
Think about how diminishing marginal product can be applied with inputs.
Does one cause the other, or are they different concepts?
Where are costs lowest for the chosen level of output?
Find the curve with the lowest cost at the chosen level of output.
Economies of scale: Long-run average total cost decreases as the quantity of output increases
Diseconomies of scale: Long-run average total cost increases as the quantity of output increases
How are all the cost functions related?
If firms are now allowed to use cheaper inputs, what will happen?
Could there be differences in the amount of economies of scale each firm has?
Is China really inefficient?