l3 Micro Wou

UNIT 3
Production Function
Production function describes the relationship between
inputs and output

Inputs
Output
Assumptions:
Production function in the short run
only two factors are involved capital & labour
Capital
Fixed
FixedFactor
Factor
Variable
Variable
factor
factor
TOTAL PRODUCT[TP] is the whole amount of

output produced by all the factors employed.
AVERAGE PRODUCT[AP]: is the output per unit of
the variable factor employed.
AP = TP/Q
MARGINAL PRODUCT [MP]: the change in output
resulting from employing an additional unit of the variable
factor.
MP = TP/L
Activity on TP, AP & MP

Labour
TPP
16
30
50
80
96
107
114
117
10
115
MP
AP
Answer
Labour
TPP
MP
AP
6.0
16
10
8.0
30
14
10.0
50
20
12.5
80
30
16.0
96
16
16.0
107
11
15.3
114
14.3
117
13.0
10
115
-2
11.5
Relationship between TP, AP & MP
TP
AP
MP
The law of diminishing returns
The law of diminishing returns

states that if a variable factor is added continuously to a
given amount of fixed factors, the total product increases at

rate of decreasing. Diminishing returns can be recognised by
referring to MP. When MP starts to decrese than diminishing
returns starts to occur.
Identify diminishing returns
COST
THE VARIOUS MEASURES OF COST
Costs of production may be
divided into fixed costs and

variable costs.
Fixed costs are those costs
that do not vary with the
quantity of output produced.
Variable costs are those
costs that do vary with the
Total Costs consists of

Total Fixed Costs (TFC)
Total Variable Costs
(TVC)
TC = TFC + TVC
Average Costs
Average costs can be determined by
dividing the firms costs by the

quantity of output it produces.
The average cost is the cost of each
typical unit of product.
Types Average Costs
Average Fixed Costs (AFC)
Average Variable Costs (AVC)
Average Total Costs (ATC)
ATC = AFC + AVC
Marginal Cost
Marginal cost (MC) measures the increase in
total cost that arises from an extra unit of

production.
Marginal cost helps answer the following
question:
How much does it cost to produce an
additional unit of output?
ACTIVITY
ACTIVITY
ANSWER
TFC
TVC
TC
AFC
AVC
800
800
800
500
1300
800.00
500.00
800
850
1650
400.00
425.00
800
1100
1900
266.67
366.67
800
1300
2100
200.00
325.00
800
1400
2200
160.00
280.00
800
1460
2260
133.33
243.33
800
1600
2400
114.29
228.57
800
1900
2700
100.00
237.50
800
2400
3200
88.89
266.67
10
800
3400
4200
80.00
340.00
COSTS IN THE SHORT RUN AND IN THE LONG RUN

For many firms, the division of total costs
between fixed and variable costs depends on

the time horizon being considered.
In the short run, some costs are fixed.
In the long run, all fixed costs become variable
costs.
Because many costs are fixed in the short run
but variable in the long run, a firms long-run

cost curves differ from its short-run cost
curves.
Economies
Diseconomies
of Scale
Economiesand
of scale
refer to the property
whereby long-run average total cost falls as

the quantity of output increases.
Diseconomies of scale refer to the property
whereby long-run average total cost rises as
the quantity of output increases.
Constant returns to scale refers to the
property whereby long-run average total cost
stays the same as the quantity of output
increases.
Average Total Cost in the Short and

Long Run
Average
Total
Cost
ATC in short
ATC in short ATC in short
run with
run with
run with
small factory medium factorylarge factory
ATCin long run
$12,000
10,000
Economies
of
scale
Constant
returns to
scale
1,000 1,200
Diseconomies
of
scale
Quantity of
Cars per Day
Total Revenue, Total Cost, and Profit

Total Revenue
The amount a firm receives for the sale
of its output.
Total Cost
The market value of the inputs a firm
uses in production.
Profit is the firms total revenue minus
its total cost.
Profit = Total revenue - Total cost
Explicit and Implicit Costs
A firms cost of production include explicit costs
and implicit costs.

Explicit costs are input costs that require a
direct outlay of money by the firm.
Implicit costs are input costs that do not require
an outlay of money by the firm.
Economists versus Accountants

How an Economist
Views a Firm
How an Accountant
Views a Firm
Economic
profit
Accounting
profit
Revenue
Implicit
costs
Explicit
costs
Revenue
Total
opportunity
costs
Explicit
costs

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UNIT 3

Production function describes the relationship between

inputs and output

Production function in the short run

only two factors are involved capital & labour

TOTAL PRODUCT[TP] is the whole amount of

Activity on TP, AP & MP

Relationship between TP, AP & MP

The law of diminishing returns

The law of diminishing returns

given amount of fixed factors, the total product increases at

Identify diminishing returns

THE VARIOUS MEASURES OF COST

Costs of production may be

divided into fixed costs and

Total Costs consists of

dividing the firms costs by the

total cost that arises from an extra unit of

COSTS IN THE SHORT RUN AND IN THE LONG RUN

between fixed and variable costs depends on

Because many costs are fixed in the short run

but variable in the long run, a firms long-run

whereby long-run average total cost falls as

Average Total Cost in the Short and

ATCin long run

Total Revenue, Total Cost, and Profit

Explicit and Implicit Costs

A firms cost of production include explicit costs

and implicit costs.

Economists versus Accountants

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