Production and Cost Function
Production and Cost Function
Production and Cost Function
The Firm
Firm
An organization that brings together factors of productionlabor, land, physical capital, human capital, and entrepreneurial skillto produce a product or service that it hopes can be sold at a profit
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
The Firm
The goal of the firm: profit maximization
Firms are expected to try to make the positive difference between total revenues and total costs as large as they can.
PRODUCTION INPUTS
PRODUCTION PROCESS
PRODUCTION OUTPUT
or
Q = (K,L)*
*Q = output/time period K = capital L = labor
Examples
When one of the factors of production is held fixed in supply, successive additions of other factors will lead to an increase in returns up to a point, but beyond this point returns will diminish
2
3 4 5
30
90 120 130
30-10=20
90-30=60 120-90=30 130-120=10
15
30 30 26
120
120-130=-10
20
Diminishing Returns, the Production Function, and Marginal Product: A Hypothetical Case
Variable Cost : are expenses incurred in production that tend to change directly as production increases Fixed Cost : are expenses that do not change or vary with production
TR = (Sp/u) (u)
14
12
10 8 6 4 2 ATC AVC
AFC AVC
ATC AVC
TP
Output (calculators per day)
change in output
0 1 2 3 4 5 6 7 8 9 10 11
0 5 8 10 11 13 16 20 25 31 38 46
10 15 18 20 21 23 26 30 35 41 48 56
5 3 2 1 2 3 4 5
12 10
8 6 4 2 MC
6 7 8
4
2 0
MC =
DTC DOutput
MC =
W MPP
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.
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.
The Relationship Between Diminishing Marginal Returns and Cost Curves TVC AVC = output W AVC = AP
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
200x= 200,000 + 80 x; 2,000 (P/L) Profit= how much profit 200(2,000) = 200,000 + 80 (2,000) 400,000 = 200,000 + 160,000 TR= 400,000 TC =360,000 P/L = 400,000-360,000 P= 40,000
SAC8 SAC7
SAC6 SAC5
SAC1 C2 C4
SAC2
C1
C3
SAC4 LAC
SAC3
LAC A
0 Figure 22-6
1,000
End