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Short quiz 2

Question

Compare and contrast the relationship between the short run production (SRP) and short run cost (SRC)

i.e: the economic explanation of the short run production function and short run production cost in

brief. Show graph.

Answer

Short Run Production

The short run production function involves the use of at least one fixed input which is capital. It

illustrates the law of diminishing returns where the marginal product or the additional output produced

with an additional unit of variable input, eventually decreases. It is a production process that uses at

least one fixed input. In measuring the productivity (relationship between inputs and output), 3

measures are used, Total Product (TP), Average Product (AP) and Marginal Product (MP).

The relationship of these 3 measures illustrated in graph as below.

TP/MP/AP

TP

AP

MP

L1 L2 L3 L

From the curve we can see that there is an increasing in marginal returns when the marginal product

increases up to labor input level L1. Once L1 employed, the marginal product of labor begins to decline

and keeps decreasing until it become zero when L3 units of labor are utilized. This called law of

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diminishing marginal returns or law of diminishing marginal product where the curve of MP is positive

but decreasing so that total product is increasing at a decreasing rate. The law of diminishing marginal

returns occurs because the capital input and the state of technology are held constant when defining a

short-run production function. As more units of labor input are added to the fixed capital input, the

marginal product may increase at first (zero to L1, units of labor), but the curve will eventually decline

and possibly reach zero or negative values (beyond L3, units of labor). Beyond L3, units of labor, the

marginal product of labor is negative so that total product is decreasing. This region is called negative

marginal returns.

Short Run Cost

Short run cost is a cost function for a short-run production process in which there is at least one fixed

input of production. It shows the relationship between output and cost for a firm based on the

underlying short-run production function. The shapes of the marginal and average product curves

influence the shapes of the short-run cost curves, or how costs change as production is increased or

decreased. Short run function consist of several cost function, total fixed cost (TFC), total variable cost

(TVC), total cost (TC), average variable cost (AVC), average total cost (ATC) and marginal cost (MC).

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Marginal Cost refers to the change in the total cost (or total variable cost) that results from producing

another unit of output. That means, it is the additional cost incurred in producing an additional unit. MC

is obtained by calculating the change in total cost as a result of a change in the total output. The

marginal cost curve will initially fall, reach a minimum and finally rise due to an increase in the variable

cost as shown in graph above. The formula of Marginal Cost is as below;

MC = changes in TC / changes in Q or = changes in TVC/changes in Q

As mentioned before, theres a relationship between short run production and cost. Marginal cost and

marginal product are inversely related to each other, as are average variable cost and average product.

This relationship can be shown in graph as below.

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Short-run Production

P MP max

AP max

AP

MP

L1 L2 L

Short-run Cost

Cost MC

AVC

AVC min

MC min

Q1 Q2 Q

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From the graph, there is an inverse relationship between AVC and MC with AP and MP where MP

intersects AP when AP is at maximum causes MC intersects AVC when AVC is at minimum. The graph

shows labor input level L1 is used to produce output level Q1 while labor input L2 is used to produce

output level Q2. The MP of labor increases up to L1 input level so the MC of production decreases up to

Q1 units of output. The decrease MP beyond L1 units of labor (diminishing return) causes the MC curve

to rise beyond Q1 units of output.