No Free Lunch: Economics for A Fallen World

7 | Production: Man At Work

Relationship between Cost and Product Curves

If you look at our product and cost curves carefully, you’ll see the same explanation for the changing shapes in the curves—indeed, product and cost curves are closely related. If you compare Figure 7.9 to Figure 7.5, you’ll see that as production efficiency increases due to division of labor and gains from specialization, production rises at an increasing rate, and costs are decreasing. As diminishing returns ultimately set in, we see production efficiency decrease and costs rise. This gives us clues as to how to maximize profit: increasing production efficiency both increases output and decreases costs. This explains entrepreneurs' relentless pursuit of efficiency—those companies that don’t become more efficient will go the way of the dodo bird. Investment capital tends to flee companies that do not innovate or become more efficient.

Product Curves and Cost Relationship
Figure 7.9, Product Curves and Cost Relationship. Notice how gains from specialization and diminishing returns drive the cost curves: as production efficiency is increasing via the gains from specialization, costs are decreasing. When production efficiency is decreasing due to diminishing returns, costs are rising. Compare this to the shape of our product curve in Figure 7.5.

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