ECONOMICS FOR MANAGERS

PSG INSTITUTE OF MANAGEMENT MBA 2011-13 BATCH I Trimester

Session IX- For Batch C and D Cost function-Long Run & Cost Analysis
1 EFM Faculty P.Uday Shankar 13/09/11

Units of labour (L)

Units of Capital (K)

0 0 1 2 3 4 5 6 7 8 9 10 2 0 0 0 0 0 0 0 0 0 0 0

1 0 25 55 83 108 125 137 141 143 141 137

2 0 52 112 170 220 258 286 304 314 318 314

3 0 74 162 247 325 390 425 453 474 488 492

4 0 90 198 303 400 478 523 559 587 609 617

5 0 100 224 342 453 543 598 643 679 708 722

6 0 108 242 369 488 590 655 708 753 789 809

7 0 114 252 384 511 631 704 766 818 861 887

8 0 118 258 394 527 653 732 800 857 905 935

9 0 120 262 400 535 663 744 814 873 922 953

10 0 121 264 403 540 670 753 825 885 935 967

EFM Faculty P.Uday Shankar

05/09/2011

Cost of labour Lx20

Cost of Capital (K) Kx10

0 0 20 40 60 80 100 120 140 160 180 200 3 0 0 0 0 0 0 0 0 0 0 0

10 0 25 55 83 108 125 137 141 143 141 137

20 0 52 112 170 220 258 286 304 314 318 314

30 0 74 162 247 325 390 425 453 474 488 492

40 0 90 198 303 400 478 523 559 587 609 617

50 0 100 224 342 453 543 598 643 679 708 722

60 0 108 242 369 488 590 655 708 753 789 809

70 0 114 252 384 511 631 704 766 818 861 887

80 0 118 258 394 527 653 732 800 857 905 935

90 0 120 262 400 535 663 744 814 873 922 953

100 0 121 264 403 540 670 753 825 885 935 967

EFM Faculty P.Uday Shankar

05/09/2011

Long Run Cost Schedule

1 2 3 4 5 6 Least Combination of Output Labour Capital Total Cost Long run (w=5, average r=10) cost LAC 120 140 200 300 420 560 720 1.20 0.70 0.67 0.75 0.84 0.93 1.03 Long run marginal cost LMC 1.20 0.20 0.60 1.00 1.20 1.40 1.6013/09/11

100 200 300 400 500 600

4

10 12 20 30 40 52

7 8 10 15 22 30

700EFM Faculty P.Uday Shankar42 60

Long Run Total Cost Curve

EFM Faculty P.Uday Shankar

13/09/11

Long Run Average and Marginal Curve

Exercise

EFM Faculty P.Uday Shankar

13/09/11

Logic for LTC, LAC and LMC

When marginal cost (0.20 and 0.60) is

less than average cost (0.70 and 0.67), each additional unit produced adds less than average cost to the total cost, so average cost should decrease. When marginal cost (1.00,1.20,1.40,1.60) is greater than average cost (0.75, 0.84,0.93,1.03), each additional unit of the good produced adds more than average cost to the total cost, so average cost must be increasing over this range of output. EFM Faculty P.Uday Shankar Thus, marginal cost must be equal 13/09/11 to

Returns to Scale
Q=f(L,K)

Returns to scale is the proportionate change in output to constant proportions of change in inputs. f(cL,cK) = zQ
8 EFM Faculty P.Uday Shankar 13/09/11

Returns to Scale- Stages

1. Increasing Returns to Scale if z > c

(output goes up proportionately more than the increase in input usage) 2. Constant Returns to Scale if z = c (output goes up by the same proportion as the increase in input usage) 3. Decreasing returns to Scale if z < c (output goes up proportionately less than the increase in input EFM Faculty P.Uday Shankar 13/09/11 usage)

Economies of Scale
The economic forces that explain the

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shape of the Long Run Cost curves are Economies and Diseconomies of scale. The two broad forces are: 1) Specialisation and division of labour and 2) technological factors. ( eg. For (1) mechanic's workshop and for (2) man hole cleaning. Economies of scale occur when long run average cost falls as output increases. Diseconomies of scale occur when long EFM Faculty P.Uday Shankar 13/09/11 run average cost rises as output

Various Stages of LAC

rapidly at low volumes of output. One extreme case..could happen in a situation where fresh ITI qualified persons are employed or in a situation where a machine has been just installed and has not yet been optimally utilised. B: Extended Economies: LAC turns up only after large volumes are produced. In cases where specialised labourers are taken up for work and fully utilised or where a machine attains fatigue after being fully utilised. Modest scale of production: Where LAC initially turns down and then goes on steadily for a considerable time enabling a steady output and then increases gradually. Steady scale of production: This is the place EFM Faculty P.Uday 11 where LAC Shankar is equal to LMC and is a steady13/09/11
A: Early Diseconomies of scale: LAC shoots up

Thanks

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EFM Faculty P.Uday Shankar

13/09/11