You are Here: Home

# Why does AC initially decrease with more labor? watch

1. If there is more labor, then I don't understand why the average cost decreases.

Average cost = Total cost / quantity

Total cost = fixed cost + variable cost

Workers' wages are a variable cost, so variable cost increases which is a part of total cost, which also means total cost increases

This means a higher total cost value.

Let's assume that previously it was 100 / 10 = 10

Now it's 110 / 10 = 11

The 110 value indicates the increase in total cost caused by an extra labor worker.

10 and 11 are the average cost values. You can see that as an extra worker is added, the average cost increases.

However on an AC graph it shows the AC as decreasing.

Could somebody explain where I have gone wrong in my logic?

Perhaps could it be that the extra worker produces more quantity so therefore the average cost figure is actually lower than initially and thus cost decreases?

Thanks
2. More workers means more specialised workers. Division of labour/Adam Smith?

Posted from TSR Mobile
3. [QUOTE=JediArron;44801633]

...[QUOTE]

In the short-term, we assume capital is fixed, this means the cost of the capital equitment falls under fixed costs. The only way of increasing output is by employing more workers. If you initaly had 5 workers and ten machines, with each machine requring 1 worker to be operational, by employing more 5 more workers, you will be spreading you fixed costs across more output, causing average total costs to fall.

So now you have ten workes and ten machines, meaning all of your machines are operating at maximum capicity, if you employ anothet ten workers, they will be of no use in the production process, in fact, they may just get in the way of exisiting workers, causing output per worker to fall; this means to increase output, you have to pay more than you would have done when production was smaller, you begin to get demishing returns. This is why the marginal costs curve and the Average total cost curve are U shaped.

In the long-term, capital, along with all other factors of production are varible, this means you can buy anther 5 machines for the existing workers to use and as a result, you begin to get returns to scale. There are a number of reasons for this, such as the ability to build up networks using existing machinery and the new capital equipment, this is what normally leads to economies of scale. However, as the firm grows and begins to operate across multiple plants, output per worker may start to fall, due to issues in communication and management, this is what leads to diseconomies of scale.

The shape of the curves is all to do with production theory, and how in the long-term and the short-term, costs get spread across more output initially and then as the factors of production you employ increase, due to ineffintcey, the ratio of costs and output increases.
4. Yeah, specialization and division of labor, AC decreases due to effects of economies of scale. The average cost of producing one unit decreases with the increased efficiency with more units of labor. Although theoretically in the short-term if say another factor of production such as land stay constant and you keep adding labor, you will start to see diminishing returns to scale and AC goes up again (dis-economies of scale)as there may not be be enough work space. That's why the graph is a smiley face :P
5. (Original post by Abdul-Karim)
Yeah, specialization and division of labor, AC decreases due to effects of economies of scale. The average cost of producing one unit decreases with the increased efficiency with more units of labor. Although theoretically in the short-term if say another factor of production such as land stay constant and you keep adding labor, you will start to see diminishing returns to scale and AC goes up again (dis-economies of scale)as there may not be be enough work space. That's why the graph is a smiley face :P
To be honest, this is slightly convoluted. Economies of scale are a long-term concept, concerned with changes (reductions) in cost, typically brought about by returns to scale-a fall in the ratio of factor inputs to output. By extension, Dis-economies of scale is also a long term concept.

So, if you double the amount of all factors of production and output also doubles, then you have constant returns to scale. If output more than doubles, you have increasing returns to scale. If output less than doubles, you have decreasing returns to scale.

If doubling output can be achieved with total cost less than doubling, you can achieve economies of scale. If doubling output can only be achieved with total costs more than doubling, you are faced with dis-economies of scale. But, increasing returns to scale or decreasing returns to scale don't always lead to economies or dis-economies of scale. Say you double all of your factors of production and increase your output by a factor of 2.5, but your costs go up by a factor of 3, you then have increasing returns to scale and dis-economies of scale.

However, diminishing returns are a short term concept, assuming all but one of your factors of production is fixed and not increasing.
6. (Original post by Liamnut)
To be honest, this is slightly convoluted. Economies of scale are a long-term concept, concerned with changes (reductions) in cost, typically brought about by returns to scale-a fall in the ratio of factor inputs to output. By extension, Dis-economies of scale is also a long term concept.

So, if you double the amount of all factors of production and output also doubles, then you have constant returns to scale. If output more than doubles, you have increasing returns to scale. If output less than doubles, you have decreasing returns to scale.

If doubling output can be achieved with total cost less than doubling, you can achieve economies of scale. If doubling output can only be achieved with total costs more than doubling, you are faced with dis-economies of scale. But, increasing returns to scale or decreasing returns to scale don't always lead to economies or dis-economies of scale. Say you double all of your factors of production and increase your output by a factor of 2.5, but your costs go up by a factor of 3, you then have increasing returns to scale and dis-economies of scale.

However, diminishing returns are a short term concept, assuming all but one of your factors of production is fixed and not increasing.
There's both short run and long run. Say you have 1 unit of labour which can produce 2 goods an hour. You employ another unit of labour and now you can produce 6 goods an hour due to specialization of labour so by working together efficiency has increased 1.5x, you've decreased your marginal cost and therefore average cost goes down, until you've reached the point where MC = AC, the lowest point in the average cost curve.

I'm also studying a2, that's how I've understood it to be.

Here's the graph :
7. (Original post by Abdul-Karim)
There's both short run and long run. Say you have 1 unit of labour which can produce 2 goods an hour. You employ another unit of labour and now you can produce 6 goods an hour due to specialization of labour so by working together efficiency has increased 1.5x, you've decreased your marginal cost and therefore average cost goes down, until you've reached the point where MC = AC, the lowest point in the average cost curve.

I'm also studying a2, that's how I've understood it to be.

Here's the graph :
To be honest it's unlikely that employing 1 extra worker will lead to specialisation. In the short-term, it's more to do with fixed costs being spread over more output.

In the graph, you've shown several short run cost curves and one long run cost curve, mathematically, this is know as an envelope of curves. Just showing the curves doesn't really explain why they are the way they are though.

On each of the short-run cost curves, all but one factor of production is fixed and so, the only way of increasing output is by employing more workers. At the start, this leads to increases in output and slowly, the rate of increases in output falls. Assuming the cost of labour is fixed, this will lead to decreases and then increases in average costs. We then assume firms operate at the minimum points of SRATC. When they increase capital or land, they SRATC shifts to SRATC1 and the minimum point falls, this is typically down to increasing returns to scale and constant costs. These minimum points are used to form the LRATC curve.
8. (Original post by Liamnut)
To be honest it's unlikely that employing 1 extra worker will lead to specialisation. In the short-term, it's more to do with fixed costs being spread over more output.

In the graph, you've shown several short run cost curves and one long run cost curve, mathematically, this is know as an envelope of curves. Just showing the curves doesn't really explain why they are the way they are though.
I was trying to show the short run and long run
9. [QUOTE=Liamnut;44806239][QUOTE=JediArron;44801633]

...

In the short-term, we assume capital is fixed, this means the cost of the capital equitment falls under fixed costs. The only way of increasing output is by employing more workers. If you initaly had 5 workers and ten machines, with each machine requring 1 worker to be operational, by employing more 5 more workers, you will be spreading you fixed costs across more output, causing average total costs to fall.

So now you have ten workes and ten machines, meaning all of your machines are operating at maximum capicity, if you employ anothet ten workers, they will be of no use in the production process, in fact, they may just get in the way of exisiting workers, causing output per worker to fall; this means to increase output, you have to pay more than you would have done when production was smaller, you begin to get demishing returns. This is why the marginal costs curve and the Average total cost curve are U shaped.

In the long-term, capital, along with all other factors of production are varible, this means you can buy anther 5 machines for the existing workers to use and as a result, you begin to get returns to scale. There are a number of reasons for this, such as the ability to build up networks using existing machinery and the new capital equipment, this is what normally leads to economies of scale. However, as the firm grows and begins to operate across multiple plants, output per worker may start to fall, due to issues in communication and management, this is what leads to diseconomies of scale.

The shape of the curves is all to do with production theory, and how in the long-term and the short-term, costs get spread across more output initially and then as the factors of production you employ increase, due to ineffintcey, the ratio of costs and output increases.

Thank you very much for this excellent explanation. One thing I don't understand is why capital is assumed to be fixed in the short run but I don't think I need to know that, aswell as the justification for why AC decreases initially. I like to understand things, now I understand that AC = TC/Q and if we assume capital to be fixed and more workers, the cost is spread out and thus the average cost goes down 10/5 = 2 10/10 = 1 (decrease)
10. (Original post by Abdul-Karim)
Yeah, specialization and division of labor, AC decreases due to effects of economies of scale. The average cost of producing one unit decreases with the increased efficiency with more units of labor. Although theoretically in the short-term if say another factor of production such as land stay constant and you keep adding labor, you will start to see diminishing returns to scale and AC goes up again (dis-economies of scale)as there may not be be enough work space. That's why the graph is a smiley face :P
Cheers!
11. (Original post by Liamnut)
To be honest it's unlikely that employing 1 extra worker will lead to specialisation. In the short-term, it's more to do with fixed costs being spread over more output.

In the graph, you've shown several short run cost curves and one long run cost curve, mathematically, this is know as an envelope of curves. Just showing the curves doesn't really explain why they are the way they are though.

On each of the short-run cost curves, all but one factor of production is fixed and so, the only way of increasing output is by employing more workers. At the start, this leads to increases in output and slowly, the rate of increases in output falls. Assuming the cost of labour is fixed, this will lead to decreases and then increases in average costs. We then assume firms operate at the minimum points of SRATC. When they increase capital or land, they SRATC shifts to SRATC1 and the minimum point falls, this is typically down to increasing returns to scale and constant costs. These minimum points are used to form the LRATC curve.
I guess I had to assume that quantity doesn't increase at a 1:1 ratio with an increase in labour. I.e. An extra worker means that 2 extra quantity is produced

So:

Previous VC (wages) for 5 workers was £500, £100 each.

An extra worker means that there's now 6 workers and VC is £600.

I would have previously assumed that quantity/output only icreases by 1, making ATC stay the same but I guess you have to assume that in most cases it increases more to make the AC decrease.
12. [QUOTE=JediArron;44878028][QUOTE=Liamnut;44806239]
(Original post by JediArron)

...

Thank you very much for this excellent explanation. One thing I don't understand is why capital is assumed to be fixed in the short run but I don't think I need to know that, aswell as the justification for why AC decreases initially. I like to understand things, now I understand that AC = TC/Q and if we assume capital to be fixed and more workers, the cost is spread out and thus the average cost goes down 10/5 = 2 10/10 = 1 (decrease)
I believe the short term is defined like that because that's the situations most firms find themselves in, and it makes the A2 less difficult.

In the short-term, you have fixed costs and variable costs, the cost of employing workers is variable and the cost of capital is fixed. Say you have 1 worker, by employing 1 extra worker, your output may go from 5 to 10 and your variable costs from 2 to 4, your fixed costs however stay the same. This means they get spread across more output and thus, they fall, dragging ATC (AC) down too.

TSR Support Team

We have a brilliant team of more than 60 Support Team members looking after discussions on The Student Room, helping to make it a fun, safe and useful place to hang out.

This forum is supported by:
Updated: October 21, 2013
Today on TSR

### Cambridge interviews

Find out which colleges are sending invitations

### University open days

Wed, 21 Nov '18
• Buckinghamshire New University
Wed, 21 Nov '18
• Heriot-Watt University