W05 - Production and Cost in The Short Run-FJO

Creating the great business leaders
Managerial Economics
By
Team Teaching FEB
Chapter 08 - Production and Cost in the Short Run
Christopher Thomas, S. Charles Maurice
2020
Fakultas Ekonomi dan Bisnis
School of Economic and Business Learning Objectives
Telkom University
After reading this chapter, you will be able to:
8.1 Explain general concepts of production and cost analysis.
8.2 Examine the structure of short-run production based on the relation
among total, average, and marginal products.
8.3 Examine the structure of short-run costs using graphs of the total cost
curves average cost curves, and the short-run marginal cost curve.
8.4 Relate short-run costs to the production function using the relations
between (i) average variable cost and average product, and (ii) short-run
marginal cost and marginal product.

School of Economic and Business
Basic Concepts of Production Theory

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■ Production function
● Maximum amount of output that can be produced from any specified
set of inputs, given existing technology
■ Technical efficiency
● Achieved when maximum amount of output is produced with a given
combination of inputs
■ Economic efficiency
● Achieved when firm is producing a given output at the lowest possible
total cost


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■ Inputs are considered variable or fixed depending on how readily their

usage can be changed
■ Variable input
● An input for which the level of usage may be changed quite readily
■ Fixed input
● An input for which the level of usage cannot readily be changed and which must be paid
even if no output is produced
■ Quasi-fixed input
● A “lumpy” or indivisible input for which a fixed amount must be used for any positive
level of output
● None is purchased when output is zero


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■ Short run
● At least one input is fixed
● All changes in output achieved by changing usage of variable
inputs
■ Long run
● All inputs are variable
● Output changed by varying usage of all inputs

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Sunk Costs
■ Sunk cost
● Payment for an input that, once made, cannot be recovered
should the firm no longer wish to employ that input
● Not part of the economic cost of production
● Should be ignored for decision making purposes

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Avoidable Costs
■ Avoidable costs
● Input costs the firm can recover or avoid paying should it no
longer wish to employ that input
● Matter in decision making and should not be ignored
● Reflect the opportunity costs of resource use

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Short Run Production
■ In the short run, capital is fixed

● Only changes in the variable labor input can change the level of
output
■ Short run production function
Q = f (L, K) = f (L)

School of Economic and Business Production Function
Telkom University
8-9 Creating the great business leaders

School of Economic and Business Average & Marginal Products
Telkom University
■ Average product of labor

● AP = Q/L
■ Marginal product of labor
● MP = Q/L
■ When AP is rising, MP is greater than AP
■ When AP is falling, MP is less than AP
■ When AP reaches it maximum, AP = MP
■ Law of diminishing marginal product
● As usage of a variable input increases, a point is reached beyond which its
marginal product decreases

Total, Average, & Marginal Products of Labor, K = 2 (Table 8.2)

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Number of Total product (Q) Average product Marginal product

workers (L) (AP=Q/L) (MP=Q/L)
0 0 -- --
1 52 52 52
2 112 56 60
3 170 56.7 58
4 220 55 50
5 258 51.6 38
6 286 47.7 28
7 304 43.4 18
8 314 39.3 10
9 318 35.3 4
10 314 31.4 -4

Total, Average, & Marginal Products K = 2 (Figure 8.1)

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Total, Average, & Marginal Product Curves

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Q2
Q1 Total product
Panel A
Q0
L0 L1 L2
Panel B
Average product
L0 L1 L2
Marginal product
School of Economic and Business Law of Diminishing Marginal Product (Returns)
Telkom University
■ Only holds in the short-run

■ As the quantity of the variable input (labor) increases, the capital to
labor ratio declines
■ Eventually an incremental increase in the variable input adds less to
output than the previous incremental increase in the variable input

School of Economic and Business Change in Capital Stock
Telkom University

School of Economic and Business Change in Capital Stock
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School of Economic and Business Short Run Production Costs
Telkom University
■ Total variable cost (TVC)

● Total amount paid for variable inputs
● Increases as output increases
■ Total fixed cost (TFC)
● Total amount paid for fixed inputs
● Does not vary with output
■ Total cost (TC)
TC = TVC + TFC

Short-Run Total Cost Schedules (Table 8.4)

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Output (Q) Total fixed cost (TFC) Total variable cost (TVC) Total Cost
(TC=TFC+TVC)
0 $6,000 $ 0 $ 6,000
100 6,000 4,000 10,000
200 6,000 6,000 12,000
300 6,000 9,000 15,000
400 6,000 14,000 20,000
500 6,000 22,000 28,000
600 6,000 34,000 40,000

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Total Cost Curves (Figure 8.3)

School of Economic and Business Average Costs
Telkom University
• Average variable cost (AVC)

TVC
AVC 
Q
• Average fixed cost (AFC)
TFC
AFC 
Q
• Average total cost (ATC)
TC
ATC   AVC  AFC
Q
School of Economic and Business Short Run Marginal Cost
Telkom University
■ Short run marginal cost (SMC) measures rate of change in total cost
(TC) as output varies
TC TVC
SMC  
Q Q

Average & Marginal Cost Schedules (Table 8.5)

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Output Average fixed Average variable Average total cost Short-run marginal
(Q) cost cost (AVC=TVC/Q) (ATC=TC/Q= cost (SMC=TC/Q)
(AFC=TFC/Q) AFC+AVC)
0 -- -- -- --
100 $60 $40 $100 $40
200 30 30 60 20
300 20 30 50 30
400 15 35 50 50
500 12 44 56 80
600 10 56.7 66.7 120

Average & Marginal Cost Curves (Figure 8.4)

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Short Run Average & Marginal Cost Curves (Figure 8.5)

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Short Run Cost Curve Relations
■ AFC decreases continuously as output increases

Equal to vertical distance between ATC & AVC
●
■ AVC is U-shaped
Equals SMC at AVC’s minimum
●
■ ATC is U-shaped
● Equals SMC at ATC’s minimum

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Short Run Cost Curve Relations
■ SMC is U-shaped
● Intersects AVC & ATC at their minimum points
● Lies below AVC & ATC when AVC & ATC are falling
● Lies above AVC & ATC when AVC & ATC are rising

Relations Between Short-Run Costs & Production

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■ In the case of a single variable input, short-run costs are related to

the production function by two relations
w w
AVC  and SMC 
AP MP
Where w is the price of the variable input

School of Economic and Business Marginal Cost and Marginal Product
Telkom University
C
MC 
q
VC ( wL) wL
MC   
q q q
 L   1 
MC  w   w
 q   MP 
   L 
Marginal cost is inversely related to marginal product

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Marginal Cost and Marginal Product
■ W = $10
■ MP = 10
■ MC =$1
■ MP = 5
■ MC = $2

School of Economic and Business Average Variable Cost and Average Product
Telkom University
C
AVC 
q
VC wL
AVC  
q q
 L  1 
AVC  w
q  w
 AP 
   L 
Average variable cost is inversely
related to average product

School of Economic and Business Short-Run Production and Total Cost
Telkom University

School of Economic and Business Short-Run Production and Marginal cost
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Short-Run Production & Cost Relations (Figure 8.6)

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Relations Between Short-Run Costs & Production

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■ When marginal product (average product) is increasing,

marginal cost (average cost) is decreasing
■ When marginal product (average product) is decreasing,
marginal cost (average variable cost) is increasing
■ When marginal product = average product at maximum AP,
marginal cost = average variable cost at minimum AVC

School Economics and Business
TERIMA KASIH….
35 Creating the great business leaders

W05 - Production and Cost in The Short Run-FJO

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Creating the great business leaders

Creating the great business leaders

Basic Concepts of Production Theory

Creating the great business leaders

Basic Concepts of Production Theory

■ Inputs are considered variable or fixed depending on how readily their

Creating the great business leaders

Basic Concepts of Production Theory

Creating the great business leaders

Creating the great business leaders

Creating the great business leaders

■ In the short run, capital is fixed

Creating the great business leaders

8-9 Creating the great business leaders

■ Average product of labor

Creating the great business leaders

Total, Average, & Marginal Products of Labor, K = 2 (Table 8.2)

Number of Total product (Q) Average product Marginal product

Creating the great business leaders

Total, Average, & Marginal Products K = 2 (Figure 8.1)

Creating the great business leaders

Total, Average, & Marginal Product Curves

■ Only holds in the short-run

8-14 Creating the great business leaders

8-15 Creating the great business leaders

8-16 Creating the great business leaders

■ Total variable cost (TVC)

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Short-Run Total Cost Schedules (Table 8.4)

Creating the great business leaders

Creating the great business leaders

• Average variable cost (AVC)

Creating the great business leaders

Average & Marginal Cost Schedules (Table 8.5)

Creating the great business leaders

Average & Marginal Cost Curves (Figure 8.4)

Creating the great business leaders

Short Run Average & Marginal Cost Curves (Figure 8.5)

Creating the great business leaders

■ AFC decreases continuously as output increases

Creating the great business leaders

Creating the great business leaders

Relations Between Short-Run Costs & Production

■ In the case of a single variable input, short-run costs are related to

Creating the great business leaders

Marginal cost is inversely related to marginal product

Creating the great business leaders

8-29 Creating the great business leaders

Creating the great business leaders

8-31 Creating the great business leaders

8-32 Creating the great business leaders

Short-Run Production & Cost Relations (Figure 8.6)

Creating the great business leaders

Relations Between Short-Run Costs & Production

■ When marginal product (average product) is increasing,

Creating the great business leaders

35 Creating the great business leaders

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