PRODUCTION

LECTURE
PRODUCTION refers to the transformation
of inputs into marketable outputs
• When a minimum quantity of input is used to
produce a maximum quantity of output, the
production process is said to technically
efficient.
• Economic efficiency is achieved when an
output is produced at the least cost
• A long run period is a period long
enough to allow a firm to adjust ALL
types of input in order to increase or
decrease its volume of output.
• A short-run period only allows the
firm to adjust its variable inputs
EXERCISE SET A
Determine whether the firm cited is making a decision in the SHORT
RUN or LONG RUN Period
1. SM Department Store decides to stay open 24 hours a day rather
than 12 hours a day
2. Gardenia builds another production facility in Cagayan de Oro.
3. Cebu Pacific Airlines increases its flight schedules to
accommodate more passengers.
4. A BPO company hires more call center agents for its grave yard
shift
5. Western Appliances buys more delivery vans to speed up the
delivery of the goods.
• A fixed input is an input whose quantity
remains the same despite changes in
output

• A variable input is an input whose

quantity changes as volume of output
changes
EXERCISE SET B
Tell whether the following are FIXED or VARIABLE inputs
1. Factory Space
2. Electric Consumption
3. A 30 second TV commercial
4. Fiberglass mats for manufacturing desk
5. Ceramic Patter/mold for a particular design
6. Delivery men
7. Fuel to run the machine
8. Heavy Equipment
9. Part-time Worker
10. Managers
• A production function is commonly
expressed as an equation or table that
shows the maximum amount of output a
firm can produce with each set of inputs
Example:
OT-shirt = f ( Fabrics, Sewing Machine, Sewer, Thread,
Buttons, etc.)
 LAW OF DIMINISHING MARGINAL
RETURNS

• It states that the additional product

attributable to the use of an extra variable
input will diminish at a certain point as the
quantity of some variable inputs is
continuously raised while the quantity of fixed
inputs remains the same.
• Marginal Product is the additional output that
is produced as an extra unit of variable input is
employed.
Marginal Product = Change in Total Product
Change in Input
• Average Product is the output per unit of
variable input which is generally viewed as a
measure of productivity of the variable input.

Average Product = Total Output

Input
TOTAL PRODUCT, MARGINAL
PRODUCT & AVERAGE PRODUCT

Quantity of Labor Total Product Marginal Product Average Product

Units
0 0 0 0
1 40 40 40
2 110 70 55
3 200 90 67
4 320 120 80
5 450 130 90
6 550 100 92
7 620 70 89
8 620 0 78
9 600 -20 67
EXERCISE SET C
Complete the Production Table below:

Quantity of Total Product Average Marginal

Labor Product Product
1 A 40 H

2 B E 48

3 138 F I

4 C 44 J

5 D G 24
STAGES OF PRODUCTION

1. Stage of Increasing or Positive Return

2. Stage of diminishing or Decreasing Return
3. Stage of Negative Return
MARGINAL PRODUCT AND THE
STAGES OF PRODUCTION
Quantity of Labor Units Marginal Product
0 0
1 40
2 70
3 90
4 120
5 130
6 100
7 70
8 0
9 -20
Stages of Production
-
Increasing Returns
Increasing Returns
Increasing Returns
Increasing Returns
Increasing Returns
Diminishing Returns
Diminishing Returns
Diminishing Returns
Negative Returns
EXERCISE SET D
Complete the table below:
Quantity of Total Product Marginal Product Stages of
Labor Production
0 0 -
10 50
20 150
30 300
40 550
50 700
60 800
70 850
80 850
90 800
OPTIMUM INPUT HIRING

• Marginal Revenue Product (MRP) is the

additional revenue generated by the sale of
the marginal product of the extra input

• Marginal Resource Cost (MRC) is the extra

cost of hiring the additional input
• A profit maximizing firm should continue
hiring extra worker as long as the said
worker’s MRP > MRC; and stop hiring when
the last worker’s MRP equals its MRC.

• Marginal Revenue Product of Labor = Marginal

Resource Cost of Labor
GIVEN:
MRP = Price of Product x Marginal Product
or Change in Total Product/Change in Quantity of Labor
MRC = Cost of the Variable Input or Wage rate per Person
or Change in Total cost of Labor/Change in Quantity of Labor
Wage Rate = Php 1000 ; Price of Product = Php 10 per piece

Quantity of MP MRP MRC or Wage Comparison

Labor
1 40 400 1000 MRP<MRC
2 70 700 1000 MRP<MRC
3 90 900 1000 MRP<MRC
4 120 1200 1000 MRP>MRC
5 130 1300 1000 MRP>MRC
6 100 1000 1000 MRP=MRC
7 70 700 1000 MRP<MRC
8 0 0 1000 MRP<MRC
EXERCISE SET E
The following data describe a short run
production function for a garment company
that hires workers to sew ready to wear
dresses. Use the Table to answer the following
questions:
1. If wage per unit of labor is Php 500, how
many workers must the firm hire to
maximize profit?
2. How will the firm’s hiring decision change if
the ware rate per worker rises to Php 1,000?
Quantity of Total Marginal P= Php100 W= Php100 W= Php1000
Labor Product Product
0 0 - - - -
10 50
20 150
30 300
40 550
50 700
60 800
70 850
80 850
90 800
100 800
 OPTIMUM Hiring of 2 Variable Inputs

For multiple input usage, like labor and capital,

a profit maximizing firm will employ the input
combination at which:
Wage = MP of labor
cost of capital MP of capital
OPTIMUM Hiring of 2 Variable Inputs

At this input stage, the marginal product per

dollar paid on each input is the same for all.
MP of labor = MP of capital
Wage cost of capital
 OPTIMUM Hiring of 2 Variable Inputs

A firm may rearrange input combinations

to enable it to increase total output
without increasing total cost.
Sample Problem
A small scale weaving factory in Benguet weaves cloth by hand even
though a weaving machine exists. On the average, a weaver can produce
10 yards daily and is paid Php 250 per day. The company believes that the
purchase of one machine will increase output by 20 yards. The cost of
operating a machine is Php 1,000 per day. Can the firm reduce the cost of
weaving 540 units per day by purchasing a machine and using less labor?
Why or why not?
MPL = 10 Wage = Php 250; MPk = 20 Price of Capital = Php1000

MP of Labor = MP of Capital
Wage Cost of Capital
10/250 = 20/100
0.04 > 0.02
The firm should hire more weavers instead of purchasing a machine. The
Marginal Product per peso spent on labor exceeds the Marginal Product
per peso spent on capital.
 CALCULATING THE COST OF
PRODUCTION
COST is the value of inputs that were utilized in
the production process
1. IMPLICIT Cost involves no obvious cash
outlay. It is the value of the next best use of
the unremunerated input
2. EXPLICIT Cost are costs that involve actual
expenditure or actual purchases
• ECONOMIC COST = IMPLICIT COST +
EXPLICIT COST

• ACCOUNTING COST = EXPLICIT COST

 EXERCISE SET F
• Determine whether each of the following is an
EXPLICIT COST or IMPLICIT COST
1. Payment for hiring call center agents
2. The rental payments for using a warehouse that the
business proprietor own.
3. The wages that one could earn if he did not put up
his own business
4. Interest deposit which was used as capital in
business
5. Payment of raw materials that were ordered from a
supplier
 EXERCISE SET G
• Jessie is earning Php 30000 a month as a high school
teacher in a private school. He is contemplating of
quitting his job to start his own business selling
aquarium fishes. He believed his entrepreneurial talent
is worth Php 5000 a month which he foregone as a
teacher. He is considering the withdrawal of his Php
100000 worth of savings which is currently earning 3%
per annum return, for the capital requirement in his first
year of operation. Utility expenses are estimated at Php
4000 a month. One helper will cost Php 8000 a month.
He figured out that he can save Php 7000 monthly rental
if he uses his garage as his business location. Compute
his implicit and explicit cost during the year.
ACCOUNTING AND ECONOMIC PROFITS

• PROFIT (LOSS) = Total Revenue (TR) less Total Cost (TC)

• TOTAL REVENUE = Price x Quantity of Goods sold
• ACCOUNTING PROFIT = Total Revenue less Explicit Cost
• ECONOMIC PROFIT = Total Revenue less (Explicit +
Implicit Cost)
• NORMAL PROFIT = Zero Economic Profit (break-even)
 EXERCISE SET H

• Following the problem in Exercise B, if

Jessie can sell 6000 units of aquarium
fishes at an average price of Php 100 per
unit during the year. Should he continue
with his business venture? Why or why
not?
 EXERCISE SET I
• Ken quits his job as an architect where he was earning
a salary of Php 400000 per year to start his own
business in a unit or space that he owns along the
business district. Someone was renting the unit for Php
200000 per year whose lease has recently expired. He
estimated the following expenses in his first year of
operation: utilities Php 50000, computers and other
office equipment Php 250000, salaries of employees
Php 500000. Total Revenue during the year is
estimated at Php 1200000.
1. Find the accounting cost and economic cost
associated with Ken’s business.
2. Calculate the accounting and economic profit
3. Should Ken put up his own business?
 FIXED AND VARIABLE COST

• A FIXED COST remains the same at ANY level

of output
• A VARIABLE COST varies proportionately with
output
TOTAL COST is equal to the TOTAL FIXED COST at
ZERO output
TOTAL COST = TOTAL FIXED COST + TOTAL VARIABLE
COST
TOTAL VARIABLE COST = TOTAL COST – TOTAL
FIXED COST
TOTAL FIXED COST = TOTAL COST – TOTAL VARIABLE
COST
TOTAL COST, TOTAL FIXED COST & TOTAL VARIABLE
COST SCHEDULE
Quantity Total Fixed Cost Total Variable cost Total Cost
0 40 0 40
1 40 5 45
2 40 8.5 48.5
3 40 11 51
4 40 13 53
5 40 15 55
6 40 17.5 57.5
7 40 21 61
8 40 26 66
9 40 33 73
10 40 42.5 82.5
11 40 55 95
12 40 71 111
13 40 91 131
14 40 115.5 155.5
15 40 185 185
 PER UNIT COST
In general PER UNIT COSTS are used in making
short-run decisions.
Average Total Cost = Total Cost/Q = AFC + AVC
Average Fixed Cost = Total Fixed Cost/Q =ATC – AVC
Average Variable Cost = Total Variable Cost/Q = ATC-AFC
Marginal Cost is the additional cost of producing an
extra unit of output
The MC curve above the MC = AVC output level
serves as the firm’s supply curve.
Marginal Cost = change in total cost/Change in output
Marginal Cost = change in Total Variable Cost/change in output
AVERAGE TOTAL COST, AVERAGE FIXED COST,
AVERAGE VARIABLE COST & MARGINAL COST
Quantity Average Fixed Cost Ave. Variable Cost Average Total Cost Marginal Cost
0 - - - -
1 40 5 45 5
2 20 4.25 24.25 3.5
3 13.33 3.67 17 2.5
4 10 3.25 13.25 2
5 8 3 11 2
6 6.67 2.92 9.58 2.5
7 5.71 3 8.71 3.5
8 5 3.25 8.25 5
9 4.44 3.67 8.11 7
10 4 4.25 8.25 9.5
11 3.64 5 8.64 12.5
12 3.33 5.92 9.25 16
13 3.08 7 10.08 20
14 2.86 8.25 11.11 24.5
15 2.67 9.67 12.33 29.5
• Marginal Cost curve is generally J-shaped
• Average Total Cost and Average Variable
Cost are both U-shaped
• Average Fixed cost is downward sloping
 EXERCISE SET J
Complete the Cost Table below. Show your Solution
Q TFC TVC TC AVC ATC MC

COMPLETE
0 2200 THE
0 TABLE BELOW.
0 SHOW
0 0

SOLUTION
14 400 28.57

36 22.22

66 3400 51.52

92 1600 41.30 15.38

 LINKING COST AND PRODUCT CURVES
The Average Total Cost (ATC) and Marginal cost (MC) are
mirror images of the Average Product (AP) and Marginal
Product (MP) curves.
At the stage in increasing returns, AVC and MC fall as AP and
MP rise.
At the stage of diminishing returns and negative returns, MP
decreases and MC cost increases.
At the stage of negative returns, AP > MP and AVC < MC
 Other Cost Concepts
Sunk cost is a fixed cost. It is past
expenditure that cannot be recovered or
changed by any decision in the future/
Incremental cost is the additional cost a
firm incurs if it takes on a product line or
service other than what is already
engaged in.
The long run average cost curve consists of a series
of short-run cost curves based on selection of the
best scale production for each output level.
Economies of scale occur when the long-run
average cost falls as output increases.
Diseconomies of scale occur when long-run
average cost rises as output increases.
MAXIMIZING PROFIT ( TR-TC APPROACH)

Total Revenue is the total proceeds one receives

from selling a particular quantity of goods at a
specific price.
TR = P x Q
Break-even Point is found at the output level
where Total Revenue and Total cost are equal
As long as revenue exceeds cost, the firm
realizes profit. Total profit is maximized
when the firm produces at an output where
the gap between Total Revenue and Total
Cost is at its widest.
 MARGINAL REVENUE AND MARGINAL COST
APPROACH
Marginal Revenue = change in Total Revenue
change in output
Marginal Cost = change in total cost
change in output
A firm will maximize Profit at the output level
where MR = MC.
To minimize losses in the short run, the firm must
produce at the output level where MR = MC.
 A firm must refer to:
MR = MC level to determine its output level
AR and ATC to calculate profit or loss
If AR > ATC, profit is realized
If AR < ATC, loss is incurred
P and AVC to decide whether to continue operating
or not
If P > AVC, continue producing
If P < AVC, shut down
 BREAK-EVEN QUANTITY

Formula:
Fixed Cost
BEQ = ____________________________
Unit Selling Price - Unit Variable Cost
 EXERCISE SET K

Suppose, Julie’s Bakeshop sells large crunchy chocolate bit

cookies for Php 125 per pack and the following are the cost
associated with its operation:
Fixed cost per month : Rent Php 8,000
Utilities Php 3,000
Labor Php 15,000
Variable cost per cookie : Chocolate Php 30
Special dough Php 80
a. What is the break-even quantity?
 b. Suppose the firm wants to earn Php 5000
above its fixed cost per month. How much
quantity should it sell?
c. Suppose Julie’s Bakeshop is confident that it
can sell 600 cookies per month, yet it still want
to earn Php 5000 above fixed costs per month,
what price must it charge for a cookie?
PROFIT MAXIMIZATION ( Mathematical Approach)

Given a firm’s Total Cost function ( TC = 2000 + Q)

and its demand function ( P = 50 - 0.1Q),
1. Determine the profit maximizing or loss
minimizing output.
2. Calculate its profit or loss.
 Steps to do to solve

1. Derive MR and MC function from TR and TC

2. Get the Derivative of TC
3. Get the Derivative of TR
4. Equate MR to MC
5. Solve for Q and P
6. Solve for TR and TC
7. Compute for Profit
 EXERCISE SET L

1.Find the Profit maximizing output suppose demand for the

product is given as
Qd = 150,000 - 10,000P
Total Cost = 20,000 +2Q
2. The manufacturer of a high-end television set is currently
deciding what price to set for its product. The cost of
production and demand for the product are assumed to be:
TC = 500000 + 0.85Q + 0.015Q
Q = 14166 - 16.6P
Find the firm’s profit maximizing output and price
REFERENCE

Cruz, M. A. (2017). Business Economics.

Mandaluyong, Philippines: Anvil Publishing
House.