Hi folks, we're finished with the consumer
now, over in the blink of an eye. We're
going to pivot now to the firm, and we'll
be on the firm for the remainder of the
class,  but let's start out with some
basic production realities and we'll
dovetail that in with some costs towards
the end.  So let's call this chapter 11,
part 1, and we're going to be looking at
production with a specific emphasis on
short-run realities and what that means
for how much we can get out of factor of
production.  Brass tacks,
firms want to minimize cost relative to
output,  so they are going to go and
figure out the proper Q to create,
we'll deal with that in Chapter 12, but
for any given Q they want to minimize
the costs that are associated with
creating it.  They're not particularly
choosy about which production method
they pick either, so long as it minimizes
costs.  So they may actively seek out a
labor-intensive solution or they might
you know stray in the direction of more
machines and a capital intensive
production method.  It doesn't matter as
long as its cheapest,  right????... but once they
choose a method they're going to run in to
diminishing marginal returns to a factor
in the short-run... and there's that phrase
again,  in the short-run.  So what is the
short-run?  We need to establish that. Okay, so the short-run is defined in economics as
a time period where there's at least one
factor of production that's fixed, by
fixed I mean you can't easily change it. 
Ao a good example of this would be a
factory and the size of the factory and
the machines in the factory are not
easily changeable, but you could hire
more labor or lay labor off relatively
easy.  Usually the fixed factor is capital..
It doesn't have to be, but it's often the
example.  You can think of other scenarios
though like agriculture where land,
the thing that might not be easily
changeable,  but you could you know easily
hire more tractors or more workers.  Okay
so the point of this short run is that
once you've got one of those factors of
production; land, labour or capital....that
are fixed... you can add more of the others, 
but you're going to essentially run out
of the fixed factor that they need to
work with.....So going back to our
agriculture example,  if in fact you only
have ten acres of land,
you can keep buying more and more
tractors,  but you are not going to
continue to keep generating the same
amount of crops per tractor that you
hire.  Your marginal contribution, or your
marginal product from the tractor is
going to decline, Okay???.... or in the case of
our factory,  you could hire more and more
workers, but eventually they run out of
machines and space,  so you're going to
get less and less out of each new worker
that you hire.  This is essentially a
physical reality that goes all the way
back into the 1800s,  or that's when they
realized it anyways,  and this was a
cornerstone for understanding how
production would work.  The way that they
formalized that reality is with the law
of diminishing returns and the law of
diminishing returns basically says that
if you've got capital or some other
factor that's fixed,  and you hire more
and more labor to work,  that labor is
eventually going to start generating
less and less output for you.   So let's
take a real simple example of a dog wash.
Let's say that they've got a
thousand square feet. They've got a
couple of tables,  couple of sinks, cash
register,  and you know we'll call this
the pretty puppy Emporium.   People bring
their dogs in to wash..to have you washed
them.  If you hire a laborer,  that first
laborer might be able to crank out ten
dog washes in the day
and their contribution would be 10 dog
washes.   When you hire the second one
they're going to be able to specialize
they're going to split their time a
little bit.   We're going to see that they
actually were able to generate more,  and
that's fine in the short run.  You can get
13 dog washes out of this one,
but if you continue to hire people by
the time you hire the third one you
might only get an extra 10 dog washes
Now in total you're generating 33, but by
having three people around the addition
of that third worker brought in 10 extra
washes completed... and if you keep going
you can see here that they are going to
start generating less and less... to the
point where to keep hiring them there's
nothing for them to do and they start
tripping all over each other--it goes
negative, okay?? So you can graph these
it's real similar to total utility,  right?
Total product's got the same kind of
basic shape.  It might go... increase at an
increasing rate early on,  but eventually
it's going to start increasing at a
decreasing rate and will eventually
start going negative...right?... if you hire
too many units of labour.   So that's
what's going on with total product.  Now
on the marginal side you're going to be
able to start talking about graphing
this set of numbers with the quantity of
labor that you're hiring,  and of course
at the beginning here in this first
region of the total product curve we saw
that the marginal contribution was
rising and then afterwards total product
kept going up so the marginal
contributions are still positive but they
are in decline until we get to this spot
here.... and eventually we reach the zero , and if
you continue to hire labor it will
actually go even lower,  right? ....you'll go
negative, they'll start getting in each
other's way.  This is the marginal product
of labor,  and marginal as you know just
means one additional,  and what we're
interested in here is when we hire one
additional unit of labour
how much extra product does that Labour
generate for us.  Our product in this case
is the dog washes... okay?....this Q is the
quantity of labour we're hiring and we
are measuring, say for our third unit of
labor,
how many dog washes they did for us.
They would have done ten, and our fourth unit
would have generated seven, right?... make
sense?  So you can graph both of them like
this,  and this is just a reality that in
the short-run you're going to get less
and less out of factors of production as
you continue to hire. Now eventually we'll
talk about the long-run,
where I'll let you change everything, but for
right now let's just stick with the
short-run.  The reason I'm so keen to have
you stick with the short-run is that the
short-run is going to help us understand
what's happening with costs in the
short-run, and of course when we are
talking about production the reality of
production is going to influence what
our cost structure looks like at the
firm.   So when the firm's start thinking
about the correct Q to choose, the
correct amount of output to produce.... as
they produce more and more output it's
going to cost them more, but what the
diminishing returns in production
insures is going to happen is that as
you start getting less and less out of
labor as you continue to hire them ...right?--
you start running out of machines and
land for them to work with ---that labor is
getting less and less product created
for you, per unit of labour.  That means
that what they're actually creating, the
output over here, is going to start
costing you more and more per unit to
create.  You have to keep paying the wages,  but for every wage bill that you
pay, as you expand the amount of labour,
you're getting less out of your labour,
which means that your output is now
costing you more and more.
So when MP l flips over like this
MC is going to spike.  MC is just your
marginal cost, and we'll revisit this in
our next lecture when we start to talk
about costs.  Hopefully this helps to
understand production.  Firms want to
minimize cost...right?... for any given level
of Q,  but they're always going to run
into diminishing marginal returns to a
fixed factor....with a fixed factor
