1. Chapter 6 Production and Cost
ECONOMICS: Principles and Applications, 4e
HALL & LIEBERMAN, © 2008 Thomson South-Western

2. Production Business firm – an organization Production Technology
Owned and operated by private individuals
Specializes in production
Production
Process of combining inputs to make goods and services
Technology
Method of combining inputs to produce goods or services

3. The Production Function
Indicates the maximum amount of output a firm can produce over some period of time from each combination of inputs
Figure 1 The Firm’s Production Function
Different
Combinations of
Inputs
Different
Quantities
of Output
Production
Function

4. Short-Run versus Long-Run Decisions
A time horizon long enough for a firm to vary all of its inputs
Variable inputs - can be adjusted up or down as the quantity of output changes
Short run
A time period during which at least one of the firm’s inputs is fixed
Fixed inputs - cannot be adjusted as output changes in the short run

5. Production in the Short-Run
Total product
Maximum quantity of output that can be produced from a given combination of inputs
Marginal product of labor: MPL=ΔQ/ΔL
Additional output produced when one more worker is hired

6. Total and Marginal Product
Figure 2 Total and Marginal Product
Units of Output
Number of Workers 6 2 3 4 5 1
196
Total Product
184
160
DQ from hiring fourth worker = 30
130
DQ from hiring third worker = 40 90
DQ from hiring second worker = 60 30
DQ from hiring first worker = 30
increasing marginal returns
diminishing marginal returns

7. Marginal Returns To Labor
Increasing marginal returns to labor
MPL increases as more labor is hired
Diminishing marginal returns to labor
MPL decreases as more labor is hired
Law of Diminishing Marginal Returns
As more and more of any input is added to a fixed amount of other inputs, its marginal product will eventually decline

8. Thinking About Costs Total cost Sunk cost
The opportunity cost of the owners - everything they must give up in order to produce that amount of output
Sunk cost
A cost that has been paid or must be paid, regardless of any future action being considered
Should not be considered when making decisions

9. Explicit vs. Implicit Costs
Explicit cost
Money actually paid out for the use of inputs
Implicit cost
The cost of inputs for which there is no direct money payment

10. Costs in the Short Run Fixed costs Variable costs
Costs of a firm’s fixed inputs
Remain constant as output changes
Variable costs
Costs of a firm’s variable inputs
Change with output

11. Total Costs in the Short Run
Total fixed cost (TFC)
The cost of all inputs that are fixed in the short run
Total variable cost (TVC)
The cost of all variable inputs used in production
Total cost (TC=TFC+TVC)
The costs of all inputs—fixed and variable

12. Total Cost Curves Figure 3 The Firm’s Total Cost Curves Dollars 135
Dollars
135
195
255
315
375
$435 30 90
130
160
Units of Output
184 TC
TVC
TFC
TFC

13. Average Costs Average fixed cost (AFC=TFC/Q)
Total fixed cost divided by the quantity of output produced
Average variable cost (AVC=TVC/Q)
Cost of the variable inputs per unit of output
Average total cost (ATC=TC/Q)
Total cost per unit of output

14. Marginal Cost Marginal Cost (MC) MC curve is U-shaped
Increase in total cost from producing one more unit or output
MC curve is U-shaped
When MPL rises, MC falls
When MPL falls, MC rises.
MPL rises and then falls, MC will fall and then rise.

15. Average And Marginal Costs
Figure 4 Average And Marginal Costs
Units of Output
Dollars $4 3 2 1 30 90
130
160
196 MC
AFC
ATC
AVC

16. Average And Marginal Costs
At low levels of output
MC - below the AVC and ATC curves
AVC and ATC slope downward
At higher levels of output
MC - above the AVC and ATC curves
AVC and ATC slope upward
U-shaped curves
MC curve will intersect the minimum points of the AVC and ATC curves