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Chapter 5 Production
Chapter 5 Production
Q
APL =
L
Production function
n Marginal product labour, or MPL, is the change
in total output resulting from the use of an extra
unit of labour, given the other production factor
(K) held constant
ΔQ
MPL =
ΔL
Production function
n If production function is continuous, the we have
MPL = Q(L
")
à Q max when MPL = 0
MPL measures the slope of the output curve.
L Q MPL APL
0 0
1 5
2 12
3 7
4 28
5 4
6 32
L Q MPL APL
0 0 - -
1 5 5 5
2 12 7 6
3 21 9 7
4 28 7 7
5 32 4 6.4
6 32 0 5.3
Production function
n The law of diminishing marginal product
Diminishing marginal product is the property whereby the
marginal product of an input declines as the quantity of
the input increases, holding the other input fixed.
For example, if a firm holds the number of its equipment
constant, hiring more workers would make the capital-
labour ratio fall. Thus, each additional worker would
contribute less and less to the whole production process.
è MPL first rises and then falls.
Production function
n The relationship between average product of
labour and marginal product of labour
MPL > APL : APL é
MPL < APL : APL ê
MPL = APL : APL max
Production function
# Q &" Q' L − Q
APL" = % ( = 2
$ L' L
Q
Q" − L MPL − APL
= =
L L
€
Production function
Q
Q = f (L)
0 L1
MPL,APL L
MPL L2
0 L
2. Production cost
2.1 Economic cost versus accounting cost
- 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.
2. Production cost
- Total Accounting cost is the sum of explicit costs that
a firm incur.
- Total Economic cost is the sum of both implicit and
explicit costs.
è Economic cost is often greater than accounting
cost.
Production cost
n Sunk costs are costs that a firm have already
incurred and cannot be recovered
è Sunk cost fallacy
Production cost
2.2 Short run production cost
§ Fixed costs (FC) are those costs that do not vary
with the output level.
§ Variable cost( VC) are those costs that do vary with
the output level.
Production cost
§ Total cost (TC) is the sum of both fixed costs and
variable costs
§ TC = FC +VC
è The vertical distance between total cost curve and
variable cost curve remains constant.
Production cost
C
TC
VC
FC
FC
FC
0 Q
Production cost
n Average fixed cost is the fixed cost of each
typical unit of product
n Average variable cost is the variable cost of each
typical unit of product.
n Average total cost is the total cost of each typical
unit of product.
Production cost
n TC = FC + VC
à ATC = AFC + AVC
Production cost
n Relationship between AVC and APL
VC wL w w
AVC= = = =
Q Q (Q /L) APL
n As average product falls, average variable cost will
rise substantially
Production cost
n Relationship between MC and MPL
ΔVC wΔL w w
MC= = = =
ΔQ ΔQ (ΔQ /ΔL) MPL
n MPL first rises and then falls
èMC first declines and then goes up
èMC curve is U- shaped
Production cost
n Relationship between MC and AVC
MC > AVC : AVC é
MC < AVC : AVC ê
MC = AVC : AVC min
Production cost
# VC &" VC' ×Q − VC
AVC" = % ( = 2
$Q' Q
MC × Q − AVC × Q MC − AVC
= 2 =
Q Q
Production cost
n Relationship between MC and ATC
MC > ATC : ATC é
MC < ATC : ATC ê
MC = ATC : ATC min
Production cost
MC
MC,P
ATC
ATCmin AVC
AVCmin
AFC
0
Q
Profit maximization
n Total revenue is the amount of money that a
firm receive from the sale of its output.
n Average revenue can be determined by dividing
total revenue by total quantity.
TR
AR =
Q
Profit maximization
n Marginal revenue is the change in total revenue
resulting from the sale of an extra product.
ΔTR
MR =
ΔQ
Profit maximization
n If the total revenue function is continuous, the we
have
MR = TR (Q)
n Marginal revenue thus measures the slope of the
total revenue curve
n TR max è MR = 0 (E = -1)
Profit maximization
P
P = αQ +β
β èTR = PQ = αQ2 + βQ
èMR = 2αQ +β
E = -1
0 -β/ -β/ Q
2α α
MR
Profit maximization
∫ MRdQ = TR = TRQ0
0 0
€
MR
Profit maximization
§ Profit is the firm s total revenue minus its total cost