Chapter 7: Concise

Chapter 7 Production Costs

  • Production: Transformation of inputs into outputs.

    • Example Inputs: Land, Labor, Capital, Equipment, etc.

    • Example Outputs: Apples, Software.

  • Production Function: Q = f(X1, X2, …, X_n)

    • Output Q is dependent on inputs X_i .

Short Run vs Long Run

  • Short Run (SR): At least one input is fixed (e.g., Capital).

    • Labor is flexible; Capital is fixed.

    • Timeframe can be long (e.g., 20 years).

  • Long Run (LR): All inputs variable.

    • Capital can be variable depending on events (e.g., disasters).

Key Concepts in Short Run

  • Total Product of Labor (TPL): TPL = Q

  • Average Product of Labor (APL): APL = \frac{Q}{L}

  • Marginal Product of Labor (MPL): MPL = \frac{\Delta Q}{\Delta L}

  • Law of Diminishing Returns: Beyond a point, additional variable input yields less output.

    • Applies only in Short Run.

Cost Structure

  • Costs:

    • Fixed Cost (TFC): Associated with fixed inputs.

    • Variable Cost (TVC): Associated with variable inputs.

    • Total Cost (TC): TC = TFC + TVC

  • Average Costs:

    • Average Total Cost (ATC): ATC = \frac{TC}{Q}

    • Average Fixed Cost (AFC): AFC = \frac{TFC}{Q}

    • Average Variable Cost (AVC): AVC = \frac{TVC}{Q}

  • Marginal Cost (MC): MC = \frac{\Delta TC}{\Delta Q}

Long Run Considerations

  • Long Run Returns:

    • Increasing Returns to Scale (IRS): LRAC decreases as output increases.

    • Constant Returns to Scale (CRS): Fixed efficiency as output increases.

    • Decreasing Returns to Scale (DRS): LRAC increases as output increases.

  • Optimal Output in Long Run:

    • Q^* represents the equilibrium output for firms in perfect competition.

Types of Profit

  • Profit: A = TR - TC

    • Accounting Profit: TR - ext{Explicit Costs}

    • Economic Profit: TR - ( ext{Explicit Costs} + ext{Implicit Costs})

Decision Making Example

  • Example: Professor considering consulting business:

    • Accounting Profit: $85,000, Economic Profit: -$10,000.

    • Predicts not leaving university due to negative economic profit, despite accounting profit.