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Lecture 5. Production Theory and The Costs of Production
Lecture 5. Production Theory and The Costs of Production
Lecture 5. Production Theory and The Costs of Production
cost analysis
• Profit maximization
• Profit = Revenue-Costs = P*Q – TC(Q)
• Cost minimization
Output
Costs
Price
Firm’s decision
• Profit maximization
• Profit = Revenue-Costs = P*Q – TC(Q)
• Cost minimization
Output
Costs
Price
WHAT HAPPEN TO THE FIRM’S PROFITS
IF IT CONTINUTES RECRUTING LABOR?
Basic Concepts of Production
v Production function
v Maximum amount of output that can be produced from any
specified set of inputs, given existing technology
v Q = f(L, K)
v Technical efficiency
v Achieved when maximum amount of output is produced with
a given combination of inputs
v Economic efficiency
v Achieved when firm is producing a given output at the lowest
possible total cost
Basic Concepts of Production Theory
v Short run
v At least one input is fixed
MP for each
No of workers Plant size: 10 MP for 10
worker
10 93 93 9.3
20 135 42 4.2
30 180 45 4.5
40 230 50 5
50 263 33 3.3
60 293 30 3
70 321 28 2.8
80 346 25 2.5
90 368 22 2.2
100 388 20 2
110 400 12 1.2
120 403 3 0.3
130 391 -12 -1.2
140 380 -11 -1.1
Optimal use of an input
Average costs
MC = DTC
DQ
Short-term costs
100
($/Q)
MC
75
50 ATC
AVC
25
AFC
Q
0 1 2 3 4 5 6 7 8 9 10 11
Short Run Cost Curve Relations
v ATC is U-shaped
v Equals MC at ATC’s minimum
Restructuring Short-Run Costs
- Building and operating a new facility twice the size of the firm’s
existing plant ahieve a doubling (or more than doubling) of output?
Returns to Scale
Average
Total
Cost
ATC in long run
0 Quantity of
Cars per Day
Reasons for EOS