Economics: Relating Costs to Productivity

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We're now entering a series of lectures that a lot of students consider very difficult. So we're going to take our time and try to do this extra clearly. We're going to be talking about the costs of production. Now, you'll recall, we've just done a series of lectures on productivity, the firm's technology. Now were going to talk about how you take the firm's technology, what they know how to do, and combine it with the cost of hiring inputs, like labor and capital, and come up with the cost of producing output, in our case, the cost of producing television sets. This information is going to be very helpful to us when we move to the next phase--finding the profit maximizing output choice for a firm.
So here we are--technology, costs and profit. We're in the middle of this stream of questions that's going to lead us to the answer, what is the best choice for a firm to make if it wants to maximize its profits. Students find this material difficult because it involves a lot of different tools used at once. We're going to be looking at charts and some simple mathematics, then we're going to be looking at curves that represent the information in those charts. So I'm going to try to do this very carefully. I'll show you some charts, then show you the curves that go along with it, and at each stage I'll try to remind you of the intuition behind all of it.
Let me start with what I think is a very simple explanation of the relationship between costs and productivity. The first relationship we want to begin with as we start our discussion of the costs of production is the relationship between cost and productivity. In particular, cost and productivity are inversely related. That is, when productivity is increasing, the cost of production is falling. And when the productivity of your workers is falling, the cost of production is increasing. Let me see if I can make that very, very clear.
Let's suppose we had a television factory, and in this television factory we have a certain number of fixed inputs, like the size of the factory, the number of conveyor belts, the number of tools. And we also have variable input, that is, the number of workers that we hire to assemble television sets. Let's suppose we start with an assumption about productivity. Let's suppose we assume right now that one worker given her know-how and the tools available to her, can assemble one-quarter of a television in a day. If one worker can assemble one-quarter of a television in a day, then how many workers will it take to make a whole television? The answer is, it will take four workers. Four workers, each assembling one-quarter of a television, will produce a whole television.
Now notice the point that I'm making. If one worker has an average product, or an average output of one-quarter of a television, one over four, then the reciprocal of that, four workers, is what it takes to produce a single television set. Notice productivity and costs are reciprocal. If one worker can produce one-fourth of a television, then it takes four workers to product one television, and you've got to pay those workers a wage, and that's what determines the cost of getting that television put together. One-quarter is the reciprocal of four. If one-fourth is the productivity of your worker, then four is the number of workers it takes, which becomes your cost of producing the television. This idea, this simple explanation, is the basis of the relationship between cost and productivity. The more productive your workers are, the fewer workers you'll need to produce your output.
Now, what I'm going to do, is I'm going to step-by-step, do a description of the different notions of cost of production. We will look at the costs associated with hiring labor. We'll look at the costs associated with having a factory and tools ready for those workers to use. And finally, we'll look at the cost of producing another television set. What is the cost on average of producing a single TV, and what is the cost to produce one extra television set? The notion of average cost and marginal cost.
Along the way, after I give you an example of each of these concepts, I'll be taking a break and then drawing the curve that goes with each concept, so that when you look at the picture you won't just see a line on the page. Perhaps you'll also see a story that relates productivity to costs. That way, when we finally come to the point of using these curves to describe the firm's profit-maximizing choice, maybe you'll have some intuition that makes this more than just a technology exercise. I hope so.
So we'll move now to the first concept of cost, and that is the cost of hiring the labor to produce your output, the variable cost of production.
Production and Costs
The Basics of Production
Relating Costs to Productivity Page [1 of 1]