Question

Labor costs represent a large percentage of total costs for many firms. According to data from the Bureau of Labor Statistics, U.S. labor costs were up \(0.8 \%\) in 2013 , compared to \(2012 .\) a. When labor costs increase, what happens to average total cost and marginal cost? Consider a case in which labor costs are only variable costs and a case in which they are both variable and fixed costs. An increase in labor productivity means each worker can produce more output. Recent data on productivity show that labor productivity in the U.S. nonfarm business sector grew by \(1.7 \%\) between 1970 and 1999 . by \(2.6 \%\) between 2000 and 2009 , and by \(1.1 \%\) between 2010 and 2013 b. When productivity growth is positive, what happens to the total product curve and the marginal product of labor curve? Illustrate your answer with a diagram. c. When productivity growth is positive, what happens to the marginal cost curve and the avernge total cost. curve? Illustrate your answer with a diagram. d. If labor costs are rising over time on average, why would a company want to adopt equipment and methods that increase labor productivity?

Short answer

Question: Explain the impact of increased labor costs and positive productivity growth on a firm's costs and productivity. Answer: An increase in labor costs leads to an increase in both the average total cost (ATC) and marginal cost (MC) when labor costs are purely variable. Positive productivity growth, on the other hand, causes an upward shift in the total product curve and the marginal product of labor curve, reducing the marginal cost curve (MC) and the average total cost curve (ATC). Adopting equipment and methods that improve labor productivity can help a company offset the rising labor costs, maintain competitiveness, and ensure long-term growth.

Step-by-step solution

a. Impact of increased labor costs

Labor costs can affect a firm's costs in two scenarios. If labor costs are only variable costs, an increase in labor costs will lead to an increase in both average total cost (ATC) and marginal cost (MC) since variable costs are directly related to the level of production. In case labor costs also include fixed costs, an increase in labor costs will lead to a rise in average total cost but not necessarily to a change in marginal costs, as fixed cost does not depend on the production level.

b. The effect of positive productivity growth on total product curve and marginal product of labor curve

When productivity growth is positive, the total product curve will shift upward, as workers can produce more output for a given level of input. This also leads to an upward shift in the marginal product of labor curve, as the additional output generated by employing one extra unit of labor will increase. To illustrate this with a diagram, both the total product curve (TP) and marginal product of labor curve (MPL) will move upwards.

c. The impact of positive productivity growth on the marginal cost curve and the average total cost curve

Positive productivity growth leads to a decrease in both the marginal cost curve (MC) and the average total cost curve (ATC). As the marginal product of labor increases, the amount of additional costs associated with producing one more unit decreases, causing the marginal cost curve to shift downwards. Similarly, average total cost is reduced due to increased labor efficiency, leading to a downward shift for the ATC curve. To illustrate this with a diagram, both the marginal cost curve (MC) and the average total cost curve (ATC) will move downwards.

d. The rationale for a company to adopt equipment and methods that increase labor productivity

If labor costs are rising over time on average, a company would want to adopt equipment and methods that increase labor productivity for several reasons: 1. Enhanced labor productivity helps offset the increased labor costs and maintain profitability. 2. It can also help the firm stay competitive in the market by lowering its costs, providing an opportunity to either expand its market share or increase profit margins. 3. Lastly, increased productivity contributes to the overall efficiency of the company, leading to long-term sustainability and growth.

Key concepts

Average Total Cost

The average total cost (ATC) is a measure that calculates the total cost per unit of output produced. It is determined by adding up both fixed costs (costs that do not change with the level of output) and variable costs (costs that do change with output) and then dividing by the quantity of output. When labor costs, which are often a substantial part of variable costs, increase, the average total cost also rises. This is because higher labor costs drive up the variable costs portion of ATC.
However, if labor costs also include a fixed component, like salaries that remain the same regardless of output, the change in ATC will depend on how these fixed costs are spread across different levels of production. Thus, at lower levels of output, the increase in fixed costs has a more pronounced effect on ATC than at higher levels of production.

Marginal Cost

Marginal cost (MC) refers to the additional cost incurred to produce one extra unit of output. It is determined by the change in total costs when the quantity produced changes by one unit. The marginal cost is particularly sensitive to changes in variable costs, such as labor costs. When labor costs increase, the marginal cost typically rises as well, since each additional unit produced costs more due to the higher price of labor.
Interestingly, if labor costs include a fixed component, these do not directly affect marginal cost. This is because marginal cost responds only to changes in variable production-related costs. However, when productivity increases, the marginal cost can decrease, since each worker produces more output, lowering the cost of extra units.

Marginal Product of Labor

The marginal product of labor (MPL) signifies how much additional output is produced by adding one more worker or labor unit. This concept is crucial as it reflects the efficiency and productivity of labor within a firm. When productivity growth is positive, the MPL improves, which means workers are producing more with the same resources. This translates to a shift upward in the MPL curve because each additional worker contributes more to the overall production. It's essential to note that changes in MPL significantly impact both marginal cost and average total cost. As labor becomes more productive, the costs associated with producing additional output decrease, benefiting firms by allowing them to operate more cost-effectively.