8/10/2019 production5.pdf
1/35
PRODUCTION ND COST
THEORY
8/10/2019 production5.pdf
2/35
The Firm:
Production FunctionCost Function
BASIC PRODUCTION
CONCEPTS
8/10/2019 production5.pdf
3/35
The Firm
Firm
An organization that brings together factors of
productionlabor, land, physical capital,
human capital, and entrepreneurial skilltoproduce a product or service that it hopes can
be sold at a profit
8/10/2019 production5.pdf
4/35
The Firm
Profit and costs
Accounting profits = total revenues - explicit costs
Explicit Costs
Costs that business managers must take account of because they
must be paid
8/10/2019 production5.pdf
5/35
The Firm
The goal of the firm: profit maximization
Firms are expected to try to make the
positive difference between total revenuesand total costs as large as they can.
8/10/2019 production5.pdf
6/35
The Relationship
Between Output and Inputs
Production Function
The relationship between inputs and output
A technological, not an economic, relationship
The relationship between inputs and
maximum physical output
8/10/2019 production5.pdf
7/35
The Relationship
Between Output and Inputs
Production
Any activity that results in the conversion of
resources into products that can be used in
consumption
8/10/2019 production5.pdf
8/35
PRODUCTIONINPUTS
PRODUCTION
PROCESS
PRODUCTIONOUTPUT
Land
Labor
CapitalRaw Materials
Entrepreneur
Manufacturing
Assembly
ProcessingService
Finished Products
Semi-processed products
Services
8/10/2019 production5.pdf
9/35
The Relationship
Between Output and Inputs
*Q = output/time periodK= capital
L = labor
Q = (K,L)*
or
Output/time period = some function of capital and labor inputs
8/10/2019 production5.pdf
10/35
Two types of Production Inputs
Fixed Input
Variable Input
Point of comparison Fixed Input Variable Input
Necessity in Production Supplementary; even in
their absence some
amount of productioncan be carried out
Without these factors no
production can be
carried out
Examples Plant, machinery,
manager, land, factorypremises
Labor, raw materials,
transport, frieght
8/10/2019 production5.pdf
11/35
THE LAW OF DIMINISHING RETURNS
When one of the factors of production is
held fixed in supply, successive additionsof other factors will lead to an increase in
returns up to a point, but beyond this point
returns will diminish
8/10/2019 production5.pdf
12/35
The Law of Diminishing Returns
NUMBER OF
WORKERS
TOTAL
PHYSICAL
PRODUCT (TPP)
MARGINAL
PHYSICAL
PRODUCT (MPP)
AVERAGE
PHYSICAL
PRODUCT (APP)
1 10 10 10
2 30 30-10=20 15
3 90 90-30=60 30
4 120 120-90=30 30
5 130 130-120=10 26
6 120 120-130=-10 20
8/10/2019 production5.pdf
13/35
The Relationship
Between Output and Inputs
Marginal Physical Product
The physical output that is due to the additionof one more unit of a variable factor of
production The change in total product occurring when a
variable input is increased and all other inputsare held constant
Also called marginal productor marginalreturn
8/10/2019 production5.pdf
14/35
Diminishing Returns, the Production Function,
and Marginal Product
8/10/2019 production5.pdf
15/35
Diminishing Returns, the Production Function,
and Marginal Product: A Hypothetical Case
Figure 22-2, Panel (b)
8/10/2019 production5.pdf
16/35
Figure 22-2, Panel (c)
Diminishing Returns, the Production Function,
and Marginal Product
8/10/2019 production5.pdf
17/35
COST & PROFIT CONCEPT
Types of Cost
Variable Cost : are
expenses incurred in
production that tend tochange directly as
production increases
Fixed Cost : are
expenses that do notchange or vary with
production
TC = TFC + TVC
TVC = (VC/u) (u)
8/10/2019 production5.pdf
18/35
Revenue : sales generatedby an enterprise
TR = (Sp/u) (u)
Profits : difference between thetotal revenue and total cost
TP = TR- TC
TR= TC (Break Even)
TR> TC (Profit)
TC>TR (Losses)
8/10/2019 production5.pdf
19/35
Cost of Production: An Example
Figure 22-2, Panel (a)
8/10/2019 production5.pdf
20/35
Costs(dollarperday)
2
4
6
8
12
2 4 6 8 100 1 3 5 7 9 11
16
Output (calculators per day)
10
14
ATC
AVC
AFC
Cost of Production: An Example
8/10/2019 production5.pdf
21/35
AFC
AVC
Costs(dollar
perday)
Output (calculators per day)
ATC
Cost of Production: An Example
TP
ATC = AVC + AFC
AFC = ATC - AVC
AVC
8/10/2019 production5.pdf
22/35
Short-Run Costs to the Firm
Marginal Cost
The change in total costs due to a one-unit
change in production rate
Marginal costs (MC) =
change in total cost
change in output
8/10/2019 production5.pdf
23/35
TotalTotal Variable Total Marginal
Output Costs Costs Cost(Q/day) (TVC) (TC) (MC)
0 0
1 5
2 8
3 10
4 11
5 13
6 16
7 20
8 25
9 31
10 38
11 46
10
15
18
20
21
23
26
30
35
41
48
56
5
32
1
2
3
45
6
7
8
C
osts(dollarper
day)
2
4
6
8
12
2 4 6 8 100 1 3 5 7 9 11
16
Output (calculators per day)
10
14
MC
Cost of Production: An Example
8/10/2019 production5.pdf
24/35
Cost of Production: An Example
1110
AFC
AVC
MC
ATC
9876543210
2
4
6
8
Panel (c)
16
14
12
10
Output (recordable DVDs per day)
Costs(d
ollarsperrecordableDVD)
8/10/2019 production5.pdf
25/35
8/10/2019 production5.pdf
26/35
The Relationship Between Diminishing
Marginal Returns and Cost Curves
Labor cost assumed constant
MC =DTC
D
Output
Recall: labor is the variable input
MC =
W
MPP
8/10/2019 production5.pdf
27/35
The Relationship Between Diminishing
Marginal Returns and Cost Curves
8/10/2019 production5.pdf
28/35
Figure 22-3, Panels (b) and (c)
The Relationship Between
Physical Output and Costs
8/10/2019 production5.pdf
29/35
The Relationship Between
Physical Output and Costs
Figure 22-3, Panels (c) and (d)
8/10/2019 production5.pdf
30/35
The Relationship Between Diminishing
Marginal Returns and Cost Curves
Firms short-run cost curves are a
reflection of the law of diminishing
marginal returns.
Given any constant price of the variable
input, marginal costs decline as long as
the marginal product of the variable
resource is rising.
8/10/2019 production5.pdf
31/35
The Relationship Between Diminishing
Marginal Returns and Cost Curves
At the point at which diminishing marginal
returns begin, marginal costs begin to rise
as the marginal product of the variable
input begins to decline.
8/10/2019 production5.pdf
32/35
The Relationship Between Diminishing
Marginal Returns and Cost Curves
AVC =TVC
output
AVC =W
AP
8/10/2019 production5.pdf
33/35
TR = TC
TR =100; TC= 100; TR=TC
TR=100; TC =50, P/L= TR-TC= 100-50= 50Profit
TR=100; TC=200, P/L =TR-TC = 100-200= (100) Breakeven?
P200price shirt; P200,000(machine)); (80/hr labor)
TR= TC
(sp/u) (u)= TFC+TVC 200(x) = 200,000 + 80(x)
200x-80x = 200,000
120x = 200,000
X= 200,000/120 1,667 pairs will have to be sold to break even
< = profit; >=loss
8/10/2019 production5.pdf
34/35
8/10/2019 production5.pdf
35/35
The Firm: Cost and Output
Determination
End
Top Related