INF 313:

Fundamentals
of Economics

Dr. Rashed Refaat

‫ راﺷﺪ رﻓﻌﺖ‬.‫د‬
 Lecture 08

Theory of Production
 Production

Production in economics generally refers to

the transformation of inputs into outputs

Inputs = the raw materials or other

productive resources used to produce final
products
 Production

In technical terms,

Production = the creation of utility or creation

of want-satisfying goods and services.

Any good become useful for us or satisfies our

want when it is worth consumption.
 Utility
• a good can be made useful by adding
utility. For instance, we cannot consume
“wheat flour” raw when we are hungry
(want), unless it is turned into bread
(output).

• This conversion of wheat flour into bread is

the process of creating utility
 1) By changing form or shape and
size of a good.

2) Using the scarce goods and

Utility services in proper time when they
creation are most required.
3) By transferring a good from one
place to another where its use is
worthwhile.
Utility creation

Production is the process of

adding utility to a good through:
1. Form utility,

2. Place utility,

3. Time utility.
Production Function

the production function is name given to the

relationship between the rates of input of
productive services and the rate of output of
product.

(According to Stigler)
 Production Function

Where:
stands for output,
…. are the productive resources
refers to function.
Thus, is the function of
which means depends upon
 Production Function
Objective

a production function shows the

maximum amount of output that
can be produced from a given
set of inputs in the existing state
of technology.
 • Fixed costs (FC): are those that do not vary
with output and typically include rents,
Fixed costs insurance, and set-up costs,.

• called also overheads or indirect costs.

 • Variable costs (VC): are costs that do vary
with output, and they are

• called also direct costs.

variable costs • Examples of typical variable costs include
fuel, raw materials, packaging, and some
labor costs (labor directly involved in a
company's manufacturing process).
 • Total fixed costs (TFC): The total fixed
costs are constant as output
increases; the curve is a horizontal
Total
Fixed and line on the cost graph.
variable
costs
• Total variable costs (TVC): The total
variable cost (TVC) curve slopes up
at an accelerating rate.
 • Total costs (TC): The total cost (TC)
curve is found by adding total fixed
and total variable costs.
Total costs
• Its position reflects the amount of
fixed costs, and its gradient reflects
variable costs.
 • Average fixed costs (AFC): Average
fixed costs are found by dividing total
Average fixed costs by output.
Fixed Costs
• As fixed cost is divided by an
increasing output, average fixed
costs will continue to decrease.
 Average variable costs (AVC): Average
Average variable costs are found by dividing total
Variable Costs variable costs by output.
 Average Total costs (ATC): Average total costs
Average are found by dividing total costs by output.
Total Costs
Fixed and
Variable Costs
 Example:
Consider the following hypothetical example of
a boat building firm. The total fixed costs, TFC,
Fixed and needed to construct boats, are £100, Total
variable costs (TVC) will increase as output
variable costs increases as shown in the Attached table.
Output Total fixed cost Total variable cost Total cost
0 100 0 100
1 100 50 150
2 100 80 180
3 100 100 200
4 100 110 210
5 100 150 250
6 100 220 320
7 100 350 450
8 100 640 740
Fixed and variable costs
 Example: If you know that with 10 units
of output, average fixed cost is $15 and
Fixed and average variable cost is $81, Calculate
variable total cost at this output level is:
costs
Q= $10 AFC= $15 AVC= $81

TC @ 10 units = ?
 Example: If you know that with 10 units of
output, average fixed cost is $15 and average
variable cost is $81, then total cost at this
Fixed and output level is:
variable Q=10 AFC=15 AVC=81 TC @ 10 units = ?
costs
 Example: If you know that with 10 units of
output, average fixed cost is $15 and average
variable cost is $81, then total cost at this
Fixed and output level is:
variable Q=10 AFC=15 AVC=81 TC @ 10 units = ?
costs
 Example: With fixed costs of $500, a firm has
average total costs of $5 and average variable costs
of $3. Its output is:

Fixed and
variable
costs
 Total Fixed Total Variable Total Cost
Output
Cost (£000) Cost (£000) (£000)
1 100 50 150

2 100 80 180
Total Fixed 3 100 100 200
and variable 4 100 110 210

costs 5 100 150 250

6 100 220 320

7 100 350 450

8 100 640 740

 Total Fixed Cost Average Fixed Cost
Output
(£000) (£000)

1 100 100
2 100 50
Average 3 100 33.3
4 100 25
Fixed Cost 5 100 20
6 100 16.6
7 100 14.3
8 100 12.5
 Total Variable Cost Average Variable Cost
Output
(£000) (£000)

1 50 50

2 80 40

3 100 33.3
Average 4 110 27.5
Variable Cost 5 150 30

6 220 36.7

7 350 50

8 640 80
 Average Fixed Average Variable Average Total
Output
Cost (£000) Cost (£000) Costs (£000)

1 100 50 150
2 50 40 90

Average 3 33.3 33.3 67

Fixed and 4 25 27.5 52.5

Variable Cost 5 20 30 50
6 16.6 36.7 53.3
7 14.3 50 64.3
8 12.5 80 92.5
Average Fixed ATC

and variable
AVC
costs
AFC
 Factors affecting costs of production

• Wage costs: For labor intensive industry (service sector/manufacturing of

clothes) a small change in wage costs has a big impact on overall costs of
firms.

• Labor productivity: New technology which improves output per worker

enables the firm to cut back on employing workers, leading to lower costs.
 Factors affecting costs of production

• Exchange rate: A rise in the exchange rate makes imports cheaper. If

the firm needs to import raw materials, an appreciation can reduce the
cost of production.

• Raw materials: A rise in the cost of raw materials, e.g., oil, plastic,
and metal – will increase the cost of firms
 Factors affecting costs of production

• Transport costs

• Interest rates: Firms who borrowed to invest will be affected by an

increase in interest rates – which raises the cost of loan repayments.