This is an extensive guide specifically designed for students who are currently undertaking A-Level Economics. These notes directly correlate with the exam board specification. All diagrams included are originally provided by Cardiff and Vale College.
Microeconomics Revision Notes – Unit 3
Production = the process behind converting the factors of production (land, labour, capital,
enterprise) into a finished product.
Total product = the overall amount of a product produced in a given time period. The way
of calculating it is number of workers x amount each worker produces (also known as the
average product) e.g. 4 workers each produce 5 products, TP = 4 x 5 = 20.
Average product (productivity)= the amount that each worker produces. The way of
calculating it is total output / number of workers e.g. total output of 20 units by 4 workers,
AP = = 5.
Marginal product = the amount that an additional worker hired adds to total product. The
way of calculating it is calculating the rise in total product / number of workers that have
been added e.g. TP of 20 units rises to 30 when 2 workers are hired, MP = (30 – 20) / 2 = 5.
Production in the Short Run
A period of time over which at least one factor of production is fixed, and thus there is a
limit to the extent to which a company can grow.
Marginal returns = the amount an additional worker adds to total output in comparison
with the previous worker.
Increasing marginal returns (IMR):
As we begin to add more variable resources (labour) to a fixed resource (land/capital) then
marginal product will begin to rise – each workers adds more than the previous.
• This can be explained by sharing roles, motivation, specialisation, division of labour.
Decreasing marginal returns (DMR):
This typically occurs when a firm has hired too many workers; each one adds less than the
previous worker to total output.
• As the workforce continues to grow, we eventually expect to
witness decreasing (diminishing) marginal returns as the workforce
becomes less productive.
• This is because in the short-run, one factor of production is fixed, so there is a limit to
which output can increase when faced with restrictions on land and capital.
The Law of Diminishing Marginal Returns
As more variable factors are added to a fixed factor of production, eventually the marginal
returns from that factor will start to drop.
• Notice how marginal product for workers 1-4 increases each time – this is evidence
that marginal returns are increasing.
• The fifth worker has a marginal product of 50, as this is less than the fourth worker
(110) the marginal product is now falling and thus marginal returns are decreasing,
and this continues for the sixth and seventh workers.
• Worker 8 has a negative marginal product, shown by total product falling to
240 when worker 8 is hired, because there are now too many workers in a
fixed space, and they are making it difficult for others to perform tasks.
• The diagram below displays the marginal product (MP) and average
product (AP) curves. Output is on the y-axis and number of workers along the x-
axis.
• To begin with both are increasing as more workers are hired. The marginal product
is rising because workers are becoming more productive, whilst the average product
is rising because the marginal product is greater than it.
• Up until point A we experience increasing marginal returns for all numbers of
workers as the MP curve is rising upwards – AP rises quite rapidly (steep AP curve).
• Beyond point A we experience decreasing marginal returns for all numbers of
workers as the MP curve is falling downwards - AP rises quite slowly (gentle AP
curve)
• Between points A and B the AP curve is still rising despite MP falling. This is
because the MP curve is still above the AP curve throughout this period. It is only
when the MP curve falls below the AP curve that the AP curve actually falls.
• Point B represents the highest point on the AP curve and also the point at which the
MP curve crosses the AP curve.
, • The productivity of the workforce is represented by the average product,
meaning the workforce is at its most efficient when MP = AP (and typically
represents the point at which firms should stop hiring extra workers).
Marginal, Average and Total Product Curves:
This diagram includes the total product curve and identifies three key stages in the
production process:
• In stage 1 the marginal product curve is above the average product curve and thus
average product is rising. This is causing the total product curve to rise quite
rapidly (i.e. the curve is quite steep). Stage 1 ends when the MP curve and the AP
curve cross.
• In stage 2 TP is still rising but the rate of increase is now falling (i.e. the curve is
getting flatter and flatter). This is because the average product of workers is now
falling, but because the MP is still positive it means that TP will continue to rise
overall. Stage 2 ends when TP product reaches its peak, which is the point at which
the MP becomes zero.
• In stage 3 TP is now falling. This is because the marginal product curve has gone
below zero, meaning workers are adding a negative amount.
What output a firm chooses will depend upon its objective:
• Firms looking to produce as much as possible will continue to hire workers until
the MP becomes negative.
• Whereas firms looking to be as efficient as possible will employ workers up to
the point at which the AP starts to fall.
• No firm should want to enter stage 3 if acting rationally.
Production in the Long Run
A period of time over which all factors of production become variable (no resources are
fixed), thus there is not limit to the extent to which a firm can grow.
, Firms want to avoid productivity falling as it negatively impacts on profits. It is advisable
that the firm stop hiring workers for this firm once they have hired the fifth worker
and instead look to increase output by opening another outlet/store/factory etc. This
will prevent the issues of overcrowding that would occur if more workers were hired to
work in the one outlet/store/ factory etc.
However, firms tend to encounter new problems as they expand the scale of operations and
open new branches. Typical problems are likely to be:
• Difficult to guarantee quality in all branches – branches run by poor managers may
be inefficient.
• Difficult to implement changes – may take longer for some branches to adapt.
• Workers become disillusioned when working for huge companies – workers in large
chains are notoriously demotivated.
• Finding high quality workers in huge numbers can be tricky – typically hire the best
people first!
This means that eventually the law of diminishing returns will set in even in the long run,
albeit at a much higher output level than in the short run.
Short Run (SR) Costs
This refers to the costs incurred in the short run e.g., when at least one factor of production
is fixed.
Fixed costs = costs that do not vary with output. These would be the same amount if a firm
made 1 unit or 100,000. Examples would be rent, insurance and loan repayments. Adding
them all up gives us total fixed costs (TFC).
Variable costs = costs that do vary with output, and increase every time an additional unit
is made. These would be zero if output was zero. Examples would be raw
materials, electricity, and petrol. Adding them all up gives us total fixed costs (TVC).
Total costs = This is when fixed and variable costs are added together (TFC + TVC).
Marginal costs = the cost of making one additional unit of output.
• We can identify the marginal cost of a unit by identifying how much total cost has
increased by when one more is made e.g. if output rises from 10 to 11 units and total
cost goes from £30 to £33, the cost of making that additional unit is £3 (£33 - £30).
• When output goes up by more than one unit, the marginal cost will be the change in
total cost divided by the change in units of output e.g. a rise of 3 units which leads
to a rise in total cost of £60 means the marginal cost of each unit is £20 (£).
The MC Curve:
The marginal cost curve is drawn like a ‘tick’; it falls to begin with then rises (linked with
marginal returns – inverse relationship).
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