Liner demand curve can be represented as ;

p=a−bq= p( q)

Numerical representation; p=35−0.6 q ; Find out elasticity at p=29.

Own price elasticity of demand is given by;

e p= ( ΔΔ qp ) qp
∆p
Slope=
∆q

∆ p=−0.6 ∆ q

Δp
=−0.6
Δq

e p=− ( 0.61 ) qp
At q=10 ; p=29

e p=− ( 0.61 ) 1029 =−2.9

0.6
=−4.89(¿)

Note: Find out the values of elasticity for vertical, horizontal liner
demand curve.
 percentage change ∈demand
e p=
percentage change ∈own price

1. If %age change∈demand>%age change∈ price

e p >1=Elastic Demand
Examples: Luxury goods; stock market behavior
2. If %age change∈demand<%age change∈ price
e p <1=Inelastic Demand

Examples: Necessary good, addiction

3. If %age change∈demand=%age change ∈price
e p=1=Unitary Elastic Demand

e p=0 (Perfectly inelastic demand)

Price

e p→ ∞

0 Quantity

Numerical Exercise
i. Consider the following equations for demand and supply;

Supply : q=1800+ 240 p

Demand : q=3550−266 p
 Find out the price elasticity of demand at the equilibrium point.

Solution: The formula for calculating price elasticity of demand requires;

e p= ( ∆∆ qp ) qp
Given the demand function q=3550−266 p and supply functionq=1800+240 p; we
can obtain the equilibrium price as;
3550−266 p=1800+240 p

Re-arranging we get, ( 266+240 ) p=3550−1800=1750

506 p=1750

1750
p= =3.46
506

The corresponding equilibrium quantity will be given by;

q=3550−266 ×3.46=2630

Given the demand function; q=3550−266 p ;∆ q=−266 ∆ p

∆q
=−266
∆p

Hence, the price elasticity of demand at the equilibrium point is given by;

e p= ( ∆∆ qp ) qp =( 2630
3.46
)(−266)=−0.35

Theory of Cost

Production function exhibits the technical relationship between output produced

and the inputs (factors) used in the process.
Q=F (Capital , Land , Labour ; enterprenural skill)

Simplify
q=f (K , L)

MP K , MP L >0

Short-Run: Some factors are fixed (e.g Capital) and some factors are variable (e.g
Labour).

Long-Run: All factors (both Capital and Labour) are variable.

Short-Run

Total cost to the firm is given by;

Total Cost =Total ¿ Cost ( TFC )+Total Variable Cost ( TVC )

TC (q)=TFC +TVC (q) (c.1)

Where TFC is the cost associated with the fixed factor (Capital) and TVC is
associated with the variable factor (Labour). Hence, capital cost is a fixed cost and
‘labour cost’ is a variable cost.

Graphical exploration of the cost-curves

 Total Fixed Cost: In the diagram we plot cost along the vertical axis and
quantity along the horizontal axis. Since Total Fixed Cost do not depend on
the level of output, it’s a horizontal line or parallel to the quantity axis;

TFC
 TFC

0 Quantity (q)

 Average Fixed Cost (AFC): Fixed cost per-unit of production is known as

average fixed cost or AFC.
TFC
AFC=
q
How does the AFC look like?

As quantity increases, AFC decreases and as quantity falls, AFC increases.

As q → 0 ; AFC → ∞ and similarly AFC → 0 as q →∞.

AFC

f0 a

b
 c

AFC

0 qo
Quantity

Total Variable Cost (TVC)

TVC =LABOUR COST =wL(Q)

TVC
TVC

Output
0

The TVC is an inverted-S shape curve which represents the case that law of variable proportion
to the variable factor (labour) operates. Initially TVC increases at a decreasing rate, since output
expands at a greater proportion than labour. But, later on as fixed factor (Capital) gets exhausted,
output increases less than proportion to the change in labour and hence TVC increases at an
increasing rate.

Average variable Cost (AVC)

Average variable cost is the per-unit variable cost of production. Algebraically, this can be
written as;

TVC wL ( Q ) L(Q)
AVC ( Q )=
Q
=
Q (
=ẃ
Q )
AVC
AVC

0 Output

Total Cost

TC,TVC,TFC
TC=TFC+TVC

TVC
 TFC

1 Output

Average Cost (AC)

TC TVC +TFC
AC= = = AFC + AVC
q q

AC,AFC,AVC
AC
 AVC

AFC

0
Output

Marginal Cost (MC): Change in Total cost for the change in quantity of output produced.

Δ C dC
MC= =
Δ Q dQ

AC,AVC,MC

MC
AC

AVC
 0
Quantity

TC=TFC +TVC

Δ TC ∆ (TFC + TVC )
MC= =
ΔQ ΔQ

Δ TFC ΔTVC
MC= +
ΔQ ΔQ

ΔTFC
Since Total fixed cost is constant in the short-run; =0
ΔQ

∆ TC Δ TVC
MC= =
∆Q ΔQ

Long-run Average Cost (LAC):

Long-run average cost or long-run cost is associated with the idea of changing the plant-size of
the firm. In the long-run the expansion of plant-size is feasible by changing both capitals as well
labour.

Production function: Q=F ( K , L)

Imagine that both capital and labour are changed by λ proportion. If the production function is
homogenous of degree ‘n’, then we can write,

Q ' =F ( λK , λL )=λ n F ( K , L )= λn Q

Case I : If n=1 ,Constant Returns ¿ scale(CRS) .

Case II : If n>1 , Increasing Returns ¿ Scale(IRS)

CaseIII :n<1 , Decreasing Returns ¿ Scale (DRS)

Returns to scale and Long-run average cost:

wL+rK
LAC =
Q

How does the LAC changes with respect to the change in quantity?

wλL +rλK wL+rK

LAC ' = n
λ Q
=λ(1−n)
Q { }
=λ(1−n) LAC

In case of CRS; n=1; LAC ' =LAC

LAC

LAC

0\
Quantity