Managerial Economics
PRODUCTION
& COST
ANALYSIS
Production
01 Functions
Short-run &
02
long-run costs
Economic of
03
scale
Technology is
constant.
Factors of production are
imperfect substitutes.
There are only two factors
of productionarter.
Both inputs and
outputs are divisible.
Assumptions of Production Function
Graphical
Representation of
Production Function
In graph, X-axis
represents inputs that are
being used in the
production process and
Y-axis represents outputs
that get produced. Q is
the Production Function.
“Variable Factor” “Fixed Factors”
Variable Factors are the factors Fixed Factors are the factors
that can be changed during the that can not be changed in the
course of the short run. Variable short run. The number of fixed
factors vary with the level of factors always remains
output. An increase in variable constant even when is zero
factors leads to more production.
production and vice-versa.
Features of
Production
Function
1. Complementary: A
producer will have to
combine the inputs to
produce outputs.
Outputs can not get
generated without the
use of inputs.
2. Specificity: For any
given output, the
combination of inputs that
may be used is clearly
defined. What type of
factors are needed for the
production of a particular
product is clearly
mentioned before the
actual production gets
started.
3. Production Period:
The period of the
production process is
clearly explained to the
production unit. Each
stage of production is
given some specific
time.
“Short Run Production Function”
“Long Run Production Function”
Concept
of
Product
1. Total Product: Total
Product (TP) refers to
the total quantity of
goods that the firm
produced during a
given course of time
with the given number
of inputs.
2. Average Product:
Average Product refers to
output per unit of a
variable input. AP is
calculated by dividing TP
by units of the variable
factor.
3. Marginal Product:
Marginal Product refers to
the addition to the total
product when one more
unit of a variable factor is
employed. It calculates the
extra output per additional
unit of input while keeping
all other inputs constant.
THE COST
FUNCTION
SHORT-RUN COST
LONG-RUN COST
What is cost function?
- It indicates the firm's total cost of producing
any level of output.
- To determine the "least-cost method" of
producing any given level of output.
- Can be described by means of table, a graph
or an equation.
TYPES OF COST OF PRODUCTION
• SHORT-RUN COST • LONG-RUN COST
SHORT-RUN COST
- It define as the period over which the
amounts of some input are fixed.
- The total cost of producing output in the
short consist of :
• Fixed Costs
• Variable Costs
SHORT-RUN COST
- It define as the period over which the
amounts of some input are fixed.
- The total cost of producing output in the
short consist of :
• Fixed Costs
• Variable Costs
FIXED COSTS VARIABLE COST
- denoted "FC", are - denoted "VC(Q)", are
cost that do not vary cost that change
with output. wgen output is
change.
- it includes the costs
of fixed inputs used in - it includes the costs
production. of inputs that vary
with output.
AVERAGE & MARGINAL COSTS
Average Fixed Cost
- It is define as fixed costs
(FC) divided by the
number of units of
output.
Where as;
AFC = Average Fixed Cost
- fixed cost does vary with
FC = Fixed Cost
output.
Q = Number of units of output
AVERAGE & MARGINAL COSTS
Average Fixed Cost
- It is define as variable
costs (VC) divided by the
Where as; number of units of
AVC = Average Variable Cost output.
FC = Variable Cost
Q = Number of units of output
AVERAGE & MARGINAL COSTS
Average Fixed Cost
- It is define as total costs
(TC) divided by the
Where as; number of units of
ATC = Average Total Cost output.
C(Q) = Total Cost
Q = Number of units of output
AVERAGE & MARGINAL COSTS
Average Fixed Cost
- is the cost of producing
an additional unit of
Where as; output, that is, the change
MC = Marginal Cost in cost attributable to the
ΔC = Change of Cost last unit of output.
ΔQ = Change of number of
units of output
RELATION AMONG COST
SUNK COST
- A related concept, called sunk
cost is a that is lost forever once
it has been paid.
Algebraic Forms of Cost Functions
In practice, cost functions may take many forms, but the cubic
cost function is frequently
encountered and closely approximates any cost function. The
cubic cost function is
given by
where a, b, c, and f are constant. Note that f represents fixed
costs.
LONG-RUN COSTS
Long-run costs are the costs a company faces
when it has enough time to change its size and
operations. This means it can adjust its factory
size, equipment, and other resources to produce
more or less.
Economies of Scale refer to the
cost advantage experienced by a
company when it increases its
level of output.
Inverse relationship between per-unit fixed cost and the quantity produced:
Quantity of Per-Unit Average
Output Produced Fixed Cost Variable Costs
Increase in the scale of production results in greater operational efficiencies
and synergies.
When a firm expands its output
from Q to Q2, its long run
average costs falls from C to C1.
The firm experiences economies
of scale up to output level Q2.
Internal External
Economies of Scale Economies of Scale
Economies that are unique to a Economies of scale faced by an
firm entire industry
Example: a firm may hold a Example: the government
patent over a mass production announces a 20% tax break on
machine, which allows it to steel producers who employ
lower average cost of 10,000+ workers, lowering the
production average cost of production
Purchasing Managerial Technological
Companies can lower Companies can lower Technological
average costs by buying average costs by advancement might
inputs required for improving the drastically change the
production process in bulk management structure production process.
or from special within the firm (hiring
wholesalers. skilled and experienced
managers).
Diseconomies of scale occur
when a company gets too big
and its costs per unit of output
start to increase.
Diseconomies of Scale is a rise in
average costs due to an increase in
the scale of production.
Consider the graph on the left, any
increase in output beyond Q2 leads
to a rise in average costs.
Firms need to balance the economies
of scale against the diseconomies of
scale in different divisions or
business functions.
Imagine a small bakery. They can easily manage
everything, from baking to customer service.
They're efficient and their costs are low.
Now, imagine that bakery becomes a giant
chain. It's hard to keep track of everything,
communication gets messy, and they might
have to hire more managers just to keep things
running smoothly. This means their costs per
loaf of bread go up, even though they're
making more bread.
