This chapter is critical to your overall understanding of economics. Be sure to spend extra time deriving and drawing the various curves.
- Why do marginal costs first fall and then begin to rise? (Think about productivity and how it is impacted by fixed resources.)
- Why are marginal costs important to a firm when making decisions to increase or decrease production?
- How can you apply these cost concepts to your own life? How do they relate to opportunity costs?
Marginal costs will first fall due to the economies of scale as firm ramps up production and output. In the short term you realize returns set against your fixed costs which may be high at the beginning but usually flatter over time. Fixed costs are constant and steady regardless of quantity output. This leads to lower fixed cost per unit as the total is allocated over more units when production is higher. Variable Costs start to add up as the rate of productivity slows, Adding too many workers, which don’t add that much to the production output will cause the law of diminishing returns. Labor is usually expensive, and the size of the work space is fixed. When many people are involved it can require more middle managers to stay organized. Also a firm may require additional space, more machinery, more electricity, or water, or other input materials, and more storage in order to reach higher output levels. These new costs will reduce profit so businesses want to find the optimum production levels to raise profits.
Marginal cost is the change in total costs when 1 more unit is produced. It is important for business leaders to understand this concept so they can run an efficient business that lasts a long time. If they increase production to a level where profit is lost due to bottlenecks in productivity, then the firm will actually start losing money with more units being produced.
With our own personal lives we can think about marginal costs and opportunity costs with our time. Our time is a limited resource and we can’t create more of it. When it comes to our production we sell our labor hours in return for money. If we are spending hours of our day doing unproductive things like watching YouTube, Netflix, TikTok, etc, then that is time not spent bettering ourselves to make more money per labor hour. This can come from studying or learning, or gaining certifications that make us more marketable. The opportunity cost of watching a movie, TV, or Netflix is high and that is a missed opportunity to either put in some labor hours or study and learn to become higher paid for each labor hour we produce. You can think about Marginal Costs in a way like study hours. If you can study for 2 hours per day and achieve good results, but studying for 4 hours per day only gives you a small increase in your school scores, the marginal costs of studying too much in a day can show us the law of diminishing returns.
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