AAT Economics Lesson 05: Behavior of Production Process

Concepts related to the behavior of the production process, including cost structures, time periods, and laws of returns.

Production firm

A unit that combines necessary resources and organizes production within an economy.

Production

The process of converting production resources to goods and services through a technical approach where inputs are converted to output.

Production function

The technical relationship between inputs and outputs within a market economy.

Cost of production

A financial phenomenon expressing the monetary value of all factors of production forgone during a production process, representing the actual value of opportunity cost.

Opportunity cost

The value of the next best alternative that was able to produce using the same resources when utilizing them for a particular use.

Direct cost

The amount of money spent to purchase inputs from outside of the firm for the production process, such as wages of workers or energy costs.

Indirect cost

The opportunity cost of resources owned by the firm which are used in the production process, including forgone income, forgone interest, economic depreciation, and normal profit.

Economic depreciation

The reduction in the market value of capital assets at a given period of time.

Normal profit

The minimum or average profit an entrepreneur receives for production activity, considered an indirect cost as it shows the opportunity cost of an entrepreneur.

Accounting cost

The cost of production as calculated by an accountant, which is equal to direct costs.

Accounting profit

The profit estimated by deducting direct costs from the total revenue.

Economic cost

Also known as real cost, it consists of both direct and indirect costs.

Economic profit

The profit calculated by deducting economic cost from total revenue.

Short Run

The time period during which some inputs of the production process (at least one production factor) cannot be changed.

Long Run

The time period sufficient to change all inputs relevant to a production process, meaning all inputs are variable.

Short-run production function

The technical relationship between input and output following a change in variable inputs while technology and capacity remain constant.

Law of Diminishing Marginal Returns

The principle that in the short run, when increasing only variable inputs mixed with fixed inputs, the marginal product and average product of the variable factor will decrease after a certain point.

Marginal product

The change in total product due to a change in one unit of variable input, calculated by dividing the change in total product by the change in variable inputs.

Law of Returns to Scale

The behavior of output following a change in all inputs in the long run.

Increasing returns to scale

A situation where a proportionate increase in output is more than the proportionate increase in all inputs.

Decreasing returns to scale

A situation where a proportionate increase in output is less than the proportionate increase in input.

Constant returns to scale

A situation where there is a proportionate increase in output by the same percentage of increase in input.

Total Fixed Cost (TFC)

The cost bearing for fixed factors that does not change with the output level and cannot be eliminated by a firm during the short run.

Average Fixed Cost (AFC)

The fixed cost per unit, obtained by the formula: $\frac{\text{Total Fixed Cost}}{\text{Output}}$.

Total Variable Cost (TVC)

The cost for variable factors such as labour and raw materials that changes with the output level.

Total Cost (TC)

The total expenditure for all variable and fixed inputs, calculated as $TC = TFC + TVC$.

Average Total Cost (ATC)

The total cost per unit of output.

Marginal Cost (MC)

The additional cost added to the total cost when the output is increased by one unit.

Economies of Scale

The decrease in average cost (cost per unit) when expanding production in the long run due to increased efficiency or lower input prices.

Diseconomies of Scale

The increase in average cost (cost per unit) when expanding production in the long run, often due to financial losses or production factor inefficiencies.