Production Theory

(Energy Planning and Management)

Rabin Shrestha
Visiting Faculty
Pulchowk Campus, 2010

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 Production Function
The principal activity of a firm is to turn inputs
into outputs. Output (x) of a particular firm:
x=f(K, L, q1, q2, …, qn, S)

K – capital, L – labor input

qi – other inputs such as raw materials, energy,
etc
S - Technology
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 Cost of Production
Cost Definition
• Opportunity Cost: Foregone cost
• Economic Cost: economic cost of input is
what that input would be paid in its next best
use.
• Accounting Cost: Out of pocket expenses,
cash outflows, depreciation

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 Cost Functions

Total Cost: TC=f(Pk, PL, x)

Average Cost: AC(x) = TC (Pk, PL, x)/x
Marginal Cost: MC(x) = ∂TC/ ∂x

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 TC, AC, and MC
TC
TC
TC

TC

x
x

AC, TC
MC
TC

AC=MC MC

x x
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 Producer Surplus
Price

P1

P2

Q1 Q2 Quantity

The difference between what the producers’ are willing to

sell the product for and what they actually get 6
 Total Cost Minimization
Total Cost of Production
TC=PkK+PLL+P1q1+…+Pnqn

Min total cost of production for a given output x0

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 Total Cost Minimization
Lagrangian Equation:
£ = (PkK+PLL+P1q1+…+Pnqn) + λ (x0-x)

Solving the first order condition for minimum:

K=K(PK, PL, P1, P2, …, Pn, x0)
L=L(PK, PL, P1, P2, …, Pn, x0)
qi = qi(PK, PL, P1, P2, …, Pn, x0)

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 Electricity Demand of a firm

qelec = qelec(Pelec, Poil, Pn, x, S)

• Output is measured in terms of Industrial

GDP

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 Market Demand

• Demand for group of firms are Market

demand

• Requires some form of aggregation

assuming similarity of firms

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 Market Demand
Qelec = ∑qelec = No of firms · qelec

Assuming homogenous firms

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 Markets
• Perfectly Competitive Markets: Large number of
buyers and sellers, perfect information, price
takers
• Imperfectly Competitive Markets or Oligopoly:
Quasi-competitive, Cartel, Cournot (firm A treats
B’s output as fixed), price leadership (B’s output
changes with A’s output)
• Monopoly Market: price setter, no supply curve,
market discrimination
• Bilateral Monopoly: Game Theory
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The End

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