3.1: Production Function and Costs

Inputs And Outputs

• Production: Converting Inputs Into Output
• To Earn Profit, Firms Must Make Products (output)
• Input (aka factor): A Resource Used To Make Output
  • Ours Will Always Be Workers In Today’s Examples
• Total Physical Product (TP): Total Output Or Quantity Produced
• Marginal Product (MP): The Additional Output Generated By Additional Inputs (workers)
  • Marginal Product = [change In Total Product]/[change In Inputs]
• Average Product (AP): The Output Per Unit Of Input
  • Average Product = [total Product]/[units Of Labor]

Fixed Vs Variable

• Fixed Resource: A Resource That Doesn’t Change With The Quantity Produced
  • Eg. Tables, Scissors, Staplers
• Variable Resource: A Resource That Does Change With The Quantity Produced
  • Eg. Workers, Papers, Staples
• Law Of Diminishing Marginal Returns: As Variable Resources (workers) Are Added To Fixed Resources (ovens, Machinery, Tools, Etc.), The Additional Output Produced From Each Additional Worker Will Eventually Fall

Graphing Production

• The Three Stages Of Returns

  1. Increasing Marginal Returns
  2. Decreasing Marginal Returns
  3. Negative Marginal Returns

The “short-run”

• Not A Specific Amount Of Time
• Short-run: The Period In Which At Least One Resource Is Fixed
  • Eg. Capacity/size Is Not Changeable
• Long-run: The Period In Which All Resources Are Variable
  • No Fixed Resources
  • Eg. Capacity/size Is Changeable

Different Economic Costs

• Total Costs
  • FC: Total Fixed Costs
  • VC: Total Variable Costs
  • TC: Total Costs
• Per Unit Costs
  • AFC: Average Fixed Costs
  • AVC: Average Variable Costs
  • ATC: Average Total Costs
  • MC: Marginal Cost
• Fixed Cost: The Cost For Fixed Resources That Don’t Change With The Amount Produced
  • Eg. Rent, Insurance, Salaries
  • Average Fixed Cost = [fixed Cost]/[quantity]
• Variable Cost: The Cost For Variable Resources That Do Change With The Amount Produced
  • Eg. Raw Materials, Labor, Electricity
  • Average Variable Cost = [variable Cost]/[quantity]
• Total Cost: The Sum Of Fixed And Variable Costs
  • Average Total Cost = [total Cost]/[quantity]
• Marginal Cost: The Additional Costs Of An Additional Output
  • Eg. If The Production Of Two More Units Of Output Increases Total Cost From $100 To $120, The Marginal Cost Is $10
  • Marginal Cost = [change In Total Costs]/[change In Quantity]

The “long-run”

• Not A Specific Amount Of Time
• Short-run: The Period In Which At Least One Resource Is Fixed
  • Eg. Capacity/size Is Not Changeable
• Long-run: The Period In Which All Resources Are Variable
  • No Fixed Resources
  • Eg. Capacity/size Is Changeable
  • Used For Planning So That Firms Can Identify Which Size Factory Results In The Lowest Per-unit Cost

Returns To Scale

• Three Things That Can Occur To Input

  1. increasing Returns To Scale — Output More Than Doubles

  2. constant Returns To Scale — Output Exactly Doubles

     1. The Long-run Average Total Cost Is As Low As It Can Get

  3. decreasing Returns To Scale — Output Less Than Doubles

• “returns To Scale” Only Looks At Production, Not Costs

Average Total Cost (ATC) In The Long Run

• The Long Run ATC Curve Is Made Up Of All The Different Short Run ATC Curves Of Various Plant Sizes

Economies Of Scale

• Firms That Produce More Can Better Use mass Production Techniques And specialization
  • Eg. A Car Company That Makes 50 Cars Will Have A Very High Average Cost Per Car
  • A Car Company That Can Produce 100,000 Cars Will Have A Low Average Cost Per Car
  • Using Mass Production Techniques, Like Robots, Will Cause Total Cost To Be Higher But The Average Cost For Each Car Will Be Significantly Lower
• Long-run Average Cost Falls Because Mass Production Techniques Are Used
• diseconomies Of Scale: Long-run Average Costs Increase As The Firm Becomes Too Large And Difficult To Manage [decreasing Returns To Scale]
• Big Idea — The Law Of Diminishing Marginal Returns Doesn’t Apply In The Long Run Because There Are No Fixed Resources.

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