1. Introduction to Production and Resource Use
Chapter 6

2. Topics of Discussion Conditions of perfect competition
Classification of inputs
Important production relationships (assume one variable input in this chapter)
Assessing short-run business costs
Economics of short-run decisions

3. Conditions for Perfect Competition
Homogeneous products
No barriers to entry or exit
Large number of sellers
Perfect information
Page 86

4. Classification of Inputs
Land: includes renewable (forests) and non-renewable (minerals) resources
Labor: all owner and hired labor services, excluding management
Capital: manufactured goods such as fuel, chemicals, tractors and buildings
Management: production decisions designed to achieve specific economic goal
Pages 86-87

5. Production Function Output = f(labor | capital, land, and management)
Start with
one variable
input
Page 88

6. Production Function Output = f(labor | capital, land, and management)
Start with
one variable
input
assume all other inputs
fixed at their current
levels…
Page 112

7. Coordinates of input and
output on the TPP curve
Page 89

8. Total Physical Product (TPP) Curve
Variable input
Page 89

9. Law of Diminishing Marginal Returns
“As successive units of a variable
input are added to a production
process with the other inputs held
constant, the marginal physical
product (MPP) eventually declines”
Page 93

10. Other Physical Relationships
The following derivations of the TPP curve play
An important role in decision-making:
Marginal
Physical =  Output ÷  Input
Product
Pages 90

11. Other Physical Relationships
The following derivations of the TPP curve play
An important role in decision-making:
Marginal
Physical =  Output ÷  Input
Product
Average
Physical = Output ÷ Input
Pages 90-91

12. Change in output as
you increase inputs
Page 89

13. Marginal physical product is .45 as labor is increased from 16 to 20
Total Physical Product (TPP) Curve
Marginal physical product is .45 as labor is increased from 16 to 20
output
input
Page 89

14. Output per unit
input use
Page 89

15. Average physical product is .31 if
Total Physical Product (TPP) Curve
Average physical product is .31 if
labor use is 26
output
input
Page 89

16. Plotting the MPP curve Page 91 Change in output associated with a
change in inputs
Page 91

17. Marginal Physcial Product
Change from point A to point B on the production function is an MPP of 0.33
Page 91

18. Plotting the APP Curve Page 91 Level of output divided by the level
of input use
Page 91

19. Average Physical Product
Output divided
by labor use is equal to 0.19
Page 91

20. Three Stages of Production
Average physical
product (yield) is
increasing in Stage I
Page 91

21. product falls below the
Three Stages of Production
Marginal physical
product falls below the
average physical
product in Stage II
Page 91

22. Three Stages of Production
MPP goes negative
in stage III…
Page 91

23. Three Stages of Production
Why are Stage I and
Stage III irrational?
Page 91

24. Productivity rising so why stop???
Three Stages of Production
Productivity rising so why stop???
Output falling
Page 91

25. The question therefore is where should I operate in Stage II?
Three Stages of Production
The question therefore is
where should I operate in Stage II?
Page 114

26. Economic Dimensions We need to account for the price of the product
We also need to account for the cost of the inputs

27. Key Cost Relationships
The following cost derivations play a key
role in decision-making:
Marginal cost =  total cost ÷  output
Page

28. Key Cost Relationships
The following cost derivations play a key
role in decision-making:
Marginal cost =  total cost ÷  output
Average
variable = total variable cost ÷ output
cost
Page

29. Key Cost Relationships
The following cost derivations play a key
role in decision-making:
Marginal cost =  total cost ÷  output
Average
variable = total variable cost ÷ output
cost
fixed = total fixed cost ÷ output
total = total cost ÷ output = AVC+AFC
Pages 94-96

30. From TPP
curve on
page 113
Page 94

31. Fixed costs are
$100 no matter
the level of
production
Page 94

32. Column (2)
divided by
column (1)
Page 94

33. Costs that vary
with level of
production
Page 94

34. Column (4) divided by column (1)
Page 94

35. Column (2) plus
column (4)
Page 94

36. Change in column (6) associated with a change in column (1)
Page 94

37. Column (6) divided
by column (1) or
Page 94

38. or column (3) plus
column (5)
Page 94

39. Let’s graph the cost series in this table

40. Plotting costs for levels of output
Plotted cost relationships
from table 6.3 on page 94
Plotting costs for levels of output
Page 95

41. Now let’s assume this firm can sell its product for $45/unit

42. Key Revenue Concepts Page 98
Notice the price in column (2) is identical to marginal revenue in column
(7). What about average revenue, or AR? What do you see if you divide
total revenue in column (3) by output in column (1)? Yes, $45. Thus,
P = MR = AR under perfect competition.
Page 98

43. Let’s see this in graphical form

44. $45 11.2 Page 99 Profit maximizing level of output, where MR=MC
P=MR=AR
Profit maximizing
level of output,
where MR=MC
11.2
Page 99

45. Average
Profit = $17, or AR – ATC
P=MR=AR
$45-$28
$28
Page 99

46. 11.2  ($45 - $28) = $190.40 Grey area represents
total economic profit
if the price is $45…
P=MR=AR
11.2  ($45 - $28) = $190.40
Page 99

47. Firm would only produce output OBE . AR-ATC=0
P=MR=AR
Zero economic profit
if price falls to PBE.
Firm would only produce
output OBE . AR-ATC=0
Page 99

48. Economic losses if price falls to PSD. Firm would shut down
P=MR=AR
Economic losses
if price falls to PSD.
Firm would shut down
below output OSD
Page 99

49. Where is the firm’s supply curve?
P=MR=AR
Page 99

50. Marginal cost curve above AVC curve?
P=MR=AR
Page 99

51. Key Revenue Concepts Page 98
The previous graph indicated that profit is maximized at 11.2
units of output, where MR ($45) equals MC ($45). This occurs
between lines G and H on the table above, where at 11.2 units
of output profit would be $ Let’s do the math….
Page 98

52. Doing the math…. Produce 11.2 units of output (OMAX on p. 123)
Price of product = $45.00
Total revenue = 11.2 × $45 = $504.00

53. Doing the math…. Produce 11.2 units of output
Price of product = $45.00
Total revenue = 11.2 × $45 = $504.00
Average total cost at 11.2 units of output = $28
Total costs = 11.2 × $28 = $313.60
Profit = $ – $ = $190.40

54. Doing the math…. Produce 11.2 units of output
Price of product = $45.00
Total revenue = 11.2 × $45 = $504.00
Average total cost at 11.2 units of output = $28
Total costs = 11.2 × $28 = $313.60
Profit = $ – $ = $190.40
Average profit = AR – ATC = $45 – $28 = $17
Profit = $17 × 11.2 = $190.40

55. Profit at Price of $45? $ Revenue = $45  11.2 = $504.00
Total cost = $28  11.2 = $313.60
Profit = $ – $ = $190.40
Since P = MR = AR
Average profit = $45 – $28 = $17
Profit = $17  11.2 = $190.40 MC
P =45
ATC 28
AVC
11.2 Q

56. Profit at Price of $45? $190.40 $ Revenue = $45  11.2 = $504.00
Total cost = $28  11.2 = $313.60
Profit = $ – $ = $190.40
Since P = MR = AR
Average profit = $45 – $28 = $17
Profit = $17  11.2 = $190.40 MC
P =45
$190.40
ATC 28
AVC
11.2 Q

58. Price falls to $28.00…. Produce 10.3 units of output (OBE on p. 123)
Price of product = $28.00
Total revenue = 10.3 × $28 = $288.40

59. Price falls to $28.00…. Produce 10.3 units of output
Price of product = $28.00
Total revenue = 10.3 × $28 = $288.40
Average total cost at 10.3 units of output = $28
Total costs = 10.3 × $28 = $288.40
Profit = $ – $ = $0.00

60. Price falls to $28.00…. Produce 10.3 units of output
Price of product = $28.00
Total revenue = 10.3 × $28 = $288.40
Average total cost at 10.3 units of output = $28
Total costs = 10.3 × $28 = $288.40
Profit = $ – $ = $0.00
Average profit = AR – ATC = $28 – $28 = $0
Profit = $0 × 10.3 = $0.00

61. Profit at Price of $28? $ Revenue = $28  10.3 = $288.40
Total cost = $28  10.3 = $288.40
Profit = $ – $ = $0
Since P = MR = AR
Average profit = $28 – $28 = $0
Profit = $0  10.3 = $0 (break even) MC 45
ATC
P=28
AVC
10.3
11.2 Q

63. Price falls to $18.00…. Produce 8.6 units of output (OSD on p. 123)
Price of product = $18.00
Total revenue = 8.6 × $18 = $154.80

64. Price falls to $18.00…. Produce 8.6 units of output
Price of product = $18.00
Total revenue = 8.6 × $18 = $154.80
Average total cost at 8.6 units of output = $28
Total costs = 8.6 × $28 = $240.80
Profit = $ – $ = – $86.00

65. Price falls to $18.00…. Produce 8.6 units of output
Price of product = $18.00
Total revenue = 8.6 × $18 = $154.80
Average total cost at 8.6 units of output = $28
Total costs = 8.6 × $28 = $240.80
Profit = $ – $ = – $86.00
Average profit = AR – ATC = $18 – $28 = – $10
Profit = – $10 × 8.6 = – $86.00

66. Profit at Price of $18? $ Revenue = $18  8.6 = $154.80
Total cost = $28  8.6 = $240.80
Profit = $ – $ = -$86
Since P = MR = AR
Average profit = $18 – $28 = –$10
Profit = –$10  8.6 = –$86 (Loss) MC 45
ATC 28
AVC
P=18
8.6
10.3
11.2 Q

67. Price falls to $10.00….
Produce 7.0 units of output (below OSD on p. 123)
Price of product = $10.00
Total revenue = 7.0 × $10 = $70.00

68. Price falls to $10.00…. Produce 7.0 units of output
Price of product = $10.00
Total revenue = 7.0 × $10 = $70.00
Average total cost at 7.0 units of output = $30
Total costs = 7.0 × $30 = $210.00
Profit = $70.00 – $ = – $140.00
Average variable costs = $19
Total variable costs = $19 × 7.0 = $133.00
Revenue – variable costs = –$ !!!!!
(not covering variable costs)

69. Profit at Price of $10? $ Revenue = $10  7.0 = $70.00
Total cost = $30  7.0 = $210.00
Profit = $70.00 – $ = $140.00
Since P = MR = AR
Average profit = $10 – $30 = –$20
Profit = –$20  7.0 = –$140
Average variable cost = $19
Variable costs = $19  7.0 = $133.00
Revenue – variable costs = –$63
Not covering variable costs!!!!!! MC 45
ATC 28
AVC 18
P=10
7.0
8.6
10.3
11.2 Q

70. The Firm’s Supply Curve$ MC 45
ATC 28
AVC 18
P=10
8.6
10.3
11.2 Q
7.0

71. Now let’s look at the demand for a single input: Labor

72. Key Input Relationships
The following input-related derivations also play a key role in decision-making:
Marginal
value = marginal physical product × price
product
Page 100

73. Key Input Relationships
The following input-related derivations also play a key role in decision-making:
Marginal
value = marginal physical product × price
product (MVP)
input = wage rate, rental rate, etc.
cost (MIC)
Page 100

74. D
Wage rate represents
the MIC for labor C B E F G 5 I H J
Page 101

75. Use a variable input like
labor up to the point where the value received from the market equals the cost of another unit of
input, or MVP=MIC D C B E F G 5 I H J
Page 101

76. Page 101 The area below the green lined MVP curve and above the
red lined MIC
curve represents
cumulative net benefit. C B E F G 5 I H J
Page 101

77. MVP = MPP × $45
Page 100

78. Profit maximized where MVP = MIC
or where MVP =$5 and MIC = $5
Page 100

79. = – Marginal net benefit in column (5)
is equal to MVP in column (3) minus
MIC of labor in column (4)
Page 100

80. The cumulative net benefit in
column (6) is equal to the sum
of successive marginal net benefit
in column (5)
Page 100

81. For example…
$25.10 = $ $15.25
$58.35 = $ $33.25
Page 100

82. – =
Cumulative net benefit
is maximized where
MVP=MIC at $5
Page 100

83. D
If you stopped at point E on the MVP curve, for example, you would be foregoing all of the potential profit lying to the right of that point up to where MVP=MIC. C B E F G 5 I H J
Page 101

84. D
If you went beyond the point where MVP=MIC, you begin incurring losses. C B E F G 5 I H J
Page 101

85. A Final Thought One final relationship needs to be made. The level
of profit-maximizing output (OMAX) in the graph on
page 99 where MR = MC corresponds directly with
the variable input level (LMAX) in the graph on page
101 where MVP = MIC.
Going back to the production function on page 88,
this means that:
OMAX = f(LMAX | capital, land and management)

86. In Summary… Features of perfect competition
Factors of production (Land, Labor, Capital and Management)
Key decision rule: Profit maximized at output MR=MC
Key decision rule: Profit maximized where MVP=MIC