Production and Cost: Lecture Notes

Profit Measurement

  • Accounting Profit: Total revenue - accounting costs (explicit costs + accounting depreciation).
  • Economic Profit: Total revenue - opportunity cost.
  • Opportunity Cost: Explicit costs + implicit costs (including normal profit and economic depreciation).
  • Normal Profit: Minimum profit to cover all costs and remain in business; it's an opportunity cost of production.

Short Run vs. Long Run

  • Short Run: At least one fixed input.
  • Long Run: All inputs are variable.
  • Fixed Input: Quantity doesn't change with output.
  • Variable Input: Quantity changes with output.

Short-Run Production

  • Total Product (TP): Total quantity produced.
  • Marginal Product (MP): Change in TP from a one-unit increase in labor. MP=ΔTPΔLabourMP = \frac{\Delta TP}{\Delta Labour}
  • Law of Decreasing Marginal Returns: MP of additional worker is less than the previous worker's MP.
  • Average Product (AP): Total product per worker. AP=TPLabourAP = \frac{TP}{Labour}
    • When MP > AP, AP is rising.
    • When MP < AP, AP is falling.

Short-Run Costs

  • Total Fixed Costs (TFC): Don't vary with output.
  • Total Variable Costs (TVC): Vary with output; zero when output is zero.
  • Total Cost (TC): TFC + TVC. TC=TFC+TVCTC = TFC + TVC
  • Marginal Cost (MC): Change in TC from a one-unit increase in TP. MC=ΔTCΔTPMC = \frac{\Delta TC}{\Delta TP}
  • Average Total Cost (ATC): Average fixed cost (AFC) + Average variable cost (AVC). ATC=AFC+AVCATC = AFC + AVC; TCQ=TFCQ+TVCQ\frac{TC}{Q} = \frac{TFC}{Q} + \frac{TVC}{Q}
    • AFC decreases as output increases.
    • MC curve intersects AVC and ATC at their minimum points.
    • When MC < ATC, ATC is falling; when MC > ATC, ATC is rising.

Long-Run Costs

  • All inputs are variable; no diminishing returns.
  • Economies of Scale: Output increases as average total cost decreases (specialization).
  • Constant Returns to Scale: Output increases as average total cost remains constant (replication of production facility).
  • Diseconomies of Scale: Output increases as average total cost increases (coordination difficulties, management complexity).