How Does Productivity Affect Costs?


A good way of understanding how productivity affects costs is by applying the law of diminishing productivity. The law implies that the marginal and average productivities of a variable input first increase, but eventually fall with greater input usage because a fixed input places a constraint on production. For instance, a hospital may hire nurses to produce services which causes an increase in marginal and average productivities. However, if the hospital continues to hire so many nurses that there are too few resourses to be utilized, then nurses are left idle and causing costs to increase. That in turn causes marginal and average productivities to decrease.

References: Santerre, Rexford E. and Neun, Steven P. Health Economics: Theories, Insights, and Industry Studies. Thompson South-Western. 2007. Pgs. 165, 187.

Question- Why do marginal and average productivities rise and then fall with greater input usage given fixed input constraints?
A) Because of economies of scale.
B) Because of efficient resource allocation.
C) Because of the law of diminishing productivity.
D) Because total costs decrease.
E) None of the above.
(Answer: C)


What is the Relationship Between Marginal Product and Marginal Cost?


The marginal product is the change in total output brought about by a one-unit change in a factor input. The marginal cost is associated with the change in total costs brought about by a one-unit change in the production of a product. These two curves are inversely related to each other. For instance, when the marginal product is increasing, the marginal cost is decreasing. Alternatively, when the marginal product falls, the marginal costs increase.

References: Santerre, Rexford E. and Neun, Steven P. Health Economics: Theories, Insights, and Industry Studies. Thompson South-Western. 2007. Pgs. 167, 177, 563.

Question- How do marginal product and marginal cost relate?
A) Directly related.
B) Not related.
C) Inversely related.
D) They are both the same.
(Answer: C)


What is the Relationship Between Average Product, Average Variable Cost, and Total Cost?


The average product is the total output divided by the amount of a factor input, like labor. Average variable cost refers to the total variable costs divided by the quantity of output. The total cost equals the sum of all fixed and variable costs given the quantiy of output. Average product and average variable costs are related inversely. That being when average product is increasing, average variable costs are decreasing and visa versa.

References: Santerre, Rexford E. and Neun, Steven P. Health Economics: Theories, Insights, and Industry Studies. Thompson South-Western. 2007. Pgs. 166, 177, 556, 570.

Question- True/False
Average product and average variable costs are not inversely related.
(Answer: False)


What is Marginal Revenue?


Marginal revenue is the addition to total revenue brought about by the sale of one more unit of output. Marginal Revenue is the change in total revenue/the change in the number of units sold.
The diagram shows the intersection of marginal revenue with marginal cost at point A. If the industry is competitive (as is assumed in the diagram), the firm faces a demand curve that is identical to its Marginal revenue curve, and this is a horizontal line at a price determined by industry supply and demand. The diagram represents a profit maximization, marginal approach.


external image Profit_max_marginal_small.png


References: Santerre, Rexford E. and Neun, Steven P. Health Economics: Theories, Insights, and Industry Studies. Thompson South-Western. 2007. Pg. 563.

Marginal Revenue. (2007) In Wikipedia [Web]. Wikimedia Foundation, Inc. Retrieved April 26, 2007. From,
www.wikipedia.com

Question- What is marginal revenue?
A) The decrease in operational costs.
B) The addition to total revenue by the sale of one more unit of output.
C) The aquirement of a larger facility.
D) None of the above.
(Answer: B)


What Do These Curves Tell You?


The marginal cost curve displays how much each unit costs. This allows us to answer the question of how many units to produce efficiently. The Average Total Cost curve shows the economic profit. As long as the price charged is greater than ATC, a profit is made. If ATC is higher than the price, then an economic loss is incurred. The Average Variable Cost curve shows whether or not to shut down the business. If the price charged is less than the AVC, the firm must shut down.

Question - A health clinic is charging a price that is less than the average variable cost. What should happen?
A) It needs to decrease wages.
B) It should charge a higher price than the competitors.
C) It should shut down.
D) It should see more patients.
(Answer: C)

Question - A dentist is charging a price for cleanings that is higher than the average total cost. What can we conclude?
A) He is making an economic profit.
B) He is making an economic loss.
C) The marginal revenue is higher than total costs.
D) Average variable cost curve is upward sloping.
(Answer: A)



What is Economies of Scale?


For a firm, economies of scale exists when the average cost of production decreases when output increases. This happens because fixed costs are shared over the increased output. For instance, a larger medical firm is able to become more proficient in the use of specialized equipment. This allows the medical firm to produce increased amounts of output at lower per-unit costs.

References: Santerre, Rexford E. and Neun, Stephen P. Health Economics: Theories, Insights, and Industry Studies. Thompson South-Western. 2007. Pg. 183.

Question- What occurs when a firm experiences economies of scale?
A) A decrease in per-unit costs as output increases.
B) An increase in per-unit costs as output increases.
C) An increase in per-unit costs as output decreases.
D) A decrease in per-unit costs as output decreases.
E) None of the above.
(Answer: A)