Topik 5

PRODUCTION AND COST
THEORY
Topic 5
© Normala Ismail 2022

1
Learning Objectives
• At the end of this topic, you are
expected to?
– Differentiate short run and
long run
– Understand stages of
production
– Know the Law of Diminishing
Marginal Return
– Explore the types of costs in the
short run
– Understand the long run
average cost
– Differentiate between
economies of scale and
diseconomies of scale

2
Topic Overview
• SHORT RUN PRODUCTION1
– Definition
– Production Function
– Elements in the Process of Production
• STAGES OF PRODUCTION2
• LAW OF DIMINISHING MARGINAL
RETURN3
• SHORT RUN COSTS4
– Total Cost (TC), Total Variable Cost
(TVC), Total Fixed Cost (TFC), Average
Cost (AC), Average Variable Cost
(AVC), Average Fixed Cost (AFC) and
Marginal Cost (MC)
– Diagram
• LONG RUN AVERAGE COST4
– Economies of Scale
– Diseconomies of Scale

3
SHORT RUN PRODUCTION1
Short Run
Production
Production Elements in
Definition Function the Process
of Production

4
Definition Production Function
• A process of transforming input • The relationship between input
into output in the production and output
process • It is written as Q = f (I) = f (Ld,
• Inputs are factors of production Lb, C, E) where Q (output), f
which consist of land (Ld), labor (functions of) and I (input)
(Lb), capital (C) and entrepreneur • They are directly (positively)
(E) related
• Output are goods (tangible) and • When input increases, output
services (intangible) produced to also increases (vice versa)
satisfy unlimited human wants • Example : To produce breads (Q),
the inputs (I) used are flour, eggs
and butter

5
Elements in the Process of Production
#1 Firm #2 Industry
• A small unit in the process of • Combinations of firms (factories)

production producing same goods and
• Output produced is small services
• Example : National Panasonic • Output produced is large
factory • Example : Consumers electrical
products industries such as
National Panasonic, Toshiba, LG,
Philips and Samsung

6
#3 Factors of Production
• Fixed inputs
– Inputs that are fixed and
cannot change
– Example : Land and capital Factors of
(equipment, factories, Production
machines and tools)
• Variable inputs
– Inputs that are not fixed and
can vary (change) Fixed Inputs Variable Inputs
– Example : Labor, raw
materials and utilities
(electricity, gas and water)

7
#4 Time Range
• Short run
– A period where there is a
combination between fixed
input and variable input Time Range
– To increase output, the firm
can change labor but not
land
• Long run
– A period where there is no
fixed input
– All are variable inputs Short Run Long Run
inclusive of land and capital
which are considered as fixed
inputs in the short run

8
STAGES OF PRODUCTION2
Stages of
Production
Short Run Assumptions Concepts Schedule Diagram

Definition
Total Product Average Marginal

of Labor Product of Product of
(TP) Labor (AP) Labor (MP)

9
Short Run Definition Assumptions
• A period where there is a • Fixed level of technology
combination between fixed • One fixed input (land) with
input (land) and variable one variable input (labor)
input (labor) • Labor is homogeneous
(labor’s productivity is the
same)

10
Concepts
#1 Total Product of Labor (TP)

• Total output produced by a
#1 Total Product of Labor labor
(TP) • Also called output (Q)
• TP = AP x L
#2 Average Product of
• NOTE
Labor (AP) – AP = Average Product of
Labor
– L = Labor
#3 Marginal Product of
Labor (MP)

11
#2 Average Product of Labor #3 Marginal Product of Labor
(AP) (MP)
• Total output per unit of a • Additional output produced
labor as a result of additional one
• AP = TP ÷ L unit increase in labor
• MP = ∆TP ÷ ∆L
• NOTE
– ∆TP = TPn – TPn – 1
– ∆L = Ln – Ln – 1
– n = 1, 2, 3, …, n labor

12
Schedule
Total Product Average Product Marginal Product
Labor (unit) of Labor (unit) of Labor (unit) of Labor (unit) Stages of
(L) (TP) (AP) (MP) Production
TP = AP x L AP = TP ÷ L MP = ∆TP ÷ ∆L
0 0 – –
1 40 40 40 Stage 1
2 90 45 50
3 126 42 36
4 150 37.5 24
5 165 33 15 Stage 2
6 174 29 9
7 174 24.857 0
8 168 21 –6 Stage 3

13
Stage 1 Stage 2 Stage 3
Also known as increasing Also known as decreasing Also known as negative

marginal return marginal return marginal return
Starts from the origin until Starts from AP maximum Starts from MP zero until
AP maximum until MP zero MP negative
The range of labor is 7 to 8
The range of labor is 0 to 2 The range of labor is 2 to 7
when MP = 0 and
when TP = 0 and AP = 45 when AP = 45 and MP = 0
MP = – 6

14
Diagram
Production
(unit)
Stage 1 Stage 2 Stage 3
TP maximum
Point of inflection
MP maximum TP
AP maximum (AP = MP)

AP
0 MP = 0
MP Labor (unit)
15
Stage 1 Stage 2
• Begins from the origin until AP • Begins from AP maximum until

maximum MP = 0 (TP is at its maximum
• Also called increasing marginal point)
return because TP is increasing at • Also called decreasing marginal
an increasing rate return because TP is increasing at
• Not rational to choose because a decreasing rate (MP starts to
the combination between fixed decrease, yet positively related)
and variable inputs are not • Rational to choose because the
efficient where land area is not combination between fixed and
utilize fully because labor is not variable inputs are efficient
enough where no wastage of land and
no unemployment of labor

16
Stage 3 Conclusion
• Begins from MP = 0 until MP • The most rational stage is Stage 2

negative (TP is decreasing) • TP is at maximum point
• Also called negative marginal • The combination between fixed
return and variable inputs are efficient
• Not rational to choose because where there is no wastage of
the combination between fixed labor and no unemployment of
and variable inputs are not labor
economical where the land area
is fixed and cannot support
excessive labor
17
LAW OF DIMINISHING MARGINAL
RETURN 3
• As the number of labor increases continuously, the additional
output produced starts to diminish (decrease)
• This is because as variable input (labor) is added
continuously to fixed input (land), the additional output
produced starts to decline
• The Law of Diminishing Marginal Return (LDMR) is illustrated
by the decreasing portion of the MP curve, yet positively
related
• The law starts when MP is maximum point, then begins to fall
slowly until MP = 0 (the combination of Stage 1 and Stage 2)

18
ACTIVITY 1
The following schedule shows the diminishing marginal
returns in respect of labor
L 0 1 2 3 4 5 6 7 8 9 • Copy and complete the table.
Ld 8 8 8 8 8 8 8 8 8 8 • Sketch a diagram for the situation
indicating the curves and stages of
TP
production.
AP • Does the firm operate in the short
MP – 5 15 12 10 8 5 3 0 –2 run or long run? Justify your answer.
• At what number of labor does the
where law of diminishing marginal return
L = Labor set in? Justify your answer.
Ld = Land • At what number of labor does the
TP = Total Product firm produce maximum output? How
AP = Average Product much is the output?
MP = Marginal Product • For a rational producer, what stage
will he choose to produce in? Justify
your answer.

19
SHORT RUN COSTS4
Definition of Cost of
Production
Types of Cost of
Production
Types of Short Run Costs

of Production

20
Definition of Cost of Production Types of Cost of Production
• Costs of production is
defined as money spent in
the process of production in
Types of Cost of
transforming input into Production
output
#1 Explicit Cost #2 Implicit Cost

21
#1 Explicit Cost #2 Implicit Cost
• Money spent on inputs that • Money spent on inputs that
do not belong to the firm belong to the firm
• It is out of pocket money • It is the value of self owned
• Example : Rental expenses, (self employed) inputs
wages expenses, interest on utilized in the process of
bank loan, utilities expenses production
and maintenance expenses • Example : Wages forgone,
rental forgone and interest
rate forgone from own
savings

22
Types of Short Run Costs of Production
#1 Total Fixed Cost (TFC)
#2 Total Variable Cost (TVC)
Short Run
Costs #3 Total Cost (TC)
#4 Average Fixed Cost (AFC)
Short Run Types of Short #5 Average Variable Cost (AVC)
Definition Run Costs of

Production #6 Average Cost (AC)
#7 Marginal Cost (MC)

23
Short Run Definition
• A period where there is a
combination between fixed
input (land) and variable
input (labor)

24
Schedule
TFC TVC TC AFC AVC AC MC
Q (RM) (RM) (RM) (RM) (RM) (RM) (RM)
(unit)
TC – TVC TC – TFC TFC + TVC TFC ÷ Q TVC ÷ Q TC ÷ Q ∆TC ÷ ∆Q
AFC x Q AVC x Q AC x Q AC – AVC AC – AFC AFC + AVC ∆TVC ÷ ∆Q
0 12 0 12 – – – –
1 12 6 18 12 6 18 6
2 12 8 20 6 4 10 2
3 12 9 21 4 3 7 1
4 12 10 22 3 2.5 5.5 1
5 12 14 26 2.4 2.8 5.2 4
6 12 21 33 2 3.5 5.5 7

25
#1 Total Fixed Cost (TFC)
• Money spent on fixed input (land Cost (RM)

OR capital)
• Example : Rent
• Formula : TFC = TC – TVC OR
TFC = AFC x Q
• The TFC curve is horizontal and
perfectly elastic
12 TFC
• As Q increases, TFC is fixed
• When Q = 0, TFC ≠ 0
• Example : At Q = 0, TFC = RM12
and as Q increases, TFC remains 0 Q (unit)
unchanged (constant) at RM12

26
#2 Total Variable Cost (TVC)
• Money spent on variable input

(labor, raw materials and Cost (RM)
utilities) TVC
• Example : Wage
• Formula : TVC = TC – TFC OR
TVC = AVC x Q
• The TVC curve is quadratic and
starts from the origin
• As Q increases, TVC also
increases
• When Q = 0, TVC = 0
0 Q (unit)
• Example : At Q = 0, TVC = RM0
and as Q increases, TVC also
increases

27
#3 Total Cost (TC)
• Money spent on fixed input
(land) and variable input • As Q increases, TC also
(labor) increases
• Example : Rent and wage • When Q = 0, TC ≠ 0 and
• Formula : TC = TFC + TVC TC = TFC
OR TC = AC x Q • Example : At Q = 0, note
• The TC curve is quadratic that TC = TFC = RM12 and
shaped and when Q = 0, as Q increases, TC also
the TC curve intersects with increases
the TFC curve

28
Cost (RM)
• As Q increases, TC and TVC
TC also increases but TFC is
TVC
fixed (constant)
• When Q = 0, TC = RM12
and TC ≠ 0 and TVC = RM0
12
(TC = TFC)
TFC
NOTE
TC = TFC + TVC
0
Q (unit)
TC = RM12 + RM0
TC = RM12 = TFC

29
#4 Average Fixed Cost (AFC)
• Fixed cost per unit of output Cost (RM)

• Formula : AFC = TFC ÷ Q
OR AFC = AC – AVC
• The AFC curve is convex
(bowed inside)
• As Q increases, AFC
decreases
• Example : As Q increases,
AFC
the AFC curve keeps on
0
decreasing Q (unit)

30
#5 Average Variable Cost
(AVC)
Cost (RM)
• Variable cost per unit of

AVC
output
• Formula : AVC = TVC ÷ Q
OR AVC = AC – AFC
• The AVC curve is U shaped
due to the law of
diminishing marginal
return (LDMR)
0 Q
Q (unit)

31
• As labor increases, Q also • As labor increases
increases, the combination continuously, Q also
between fixed and variable increases, the combination
inputs are efficient, the between fixed and variable
variable cost per unit of inputs are inefficient, the
output will decrease until variable cost per unit of
minimum output starts to increase

32
#6 Average Cost (AC)
• Total cost per unit of output Cost (RM)
on both fixed and variable AC (SRAC)

inputs AVC
• Formula : AC = TC ÷ Q OR
AC = AFC + AVC
• The AC curve is situated
above the AVC curve AC minimum
• It is also U shaped because AVC minimum
of the law of diminishing AFC
marginal return (LDMR) 0 Q Q1 Q (unit)

33
• As Q increases, the • Also note that the AC curve
decrease in AFC is greater is the Short Run Average
than the decrease in AVC Cost (SRAC) Curve
(AFC > AVC), this pulls
down the AC curve until
minimum
• As Q increases continuously,
the increase in AVC is
greater than the decrease
in AFC (AVC > AFC), the
AC curve starts to increase

34
#7 Marginal Cost (MC)
• Additional cost as a result • The MC curve is also U
of additional one unit shaped but more steeper
increase in output than the AC and AVC
• Formula : MC = ∆TC ÷ ∆Q curves because of the law
OR MC = ∆TVC ÷ ∆Q of diminishing marginal
• NOTE return (LDMR)
– ∆TC = TCn – TCn – 1 OR • This can be explained by
∆TVC = TVCn – TVCn – 1 the relationships between
– ∆Q = Qn – Qn – 1 MC, AC and AVC curves
– n = 1, 2, 3, …, n output

35
• As Q increases, if MC is less than AC
and AVC curves (MC < AC and AVC), Cost (RM)
the AC and AVC curves will decrease MC
until minimum (at Q1 and Q
AC (SRAC)
respectively)
AVC
• As Q increases continuously, if MC is
greater than AC and AVC (MC > AC
and AVC), the AC and AVC curves
will start to increase Optimum point
• At Q, if MC intersects with AVC at
Shut down point
AVC’s minimum point (MC = AVC), the
point is called the shut down point AFC
• At Q1, if MC intersects with AC at AC’s
minimum point (MC = AC), the point is 0 Q Q1 Q (unit)
called the optimum point

36
What is SHUT DOWN POINT? What is OPTIMUM POINT?
• The firm is making a loss in the • The point illustrates that factors of
short run, thus in dilemma whether production are fully utilized
to continue or stop (cease) (efficient) in the short run
production • There is no wastage of land and
• The firm continues production if no unemployment of labor
the price (P) of goods and services
sold is proportionate OR higher
than the average variable cost
(AVC) (P = AVC OR P > AVC)
• The firm will stop (cease)
production if the price (P) of
goods and services sold is lower
than the average variable cost
(AVC) (P < AVC)

37
ACTIVITY 2
Based on the table below, answer the following questions
Q TC AC TVC MC AFC AVC • Define TC. Give one (1)
(unit) (RM) (RM) (RM) (RM) (RM) (RM)
0 24 – 0 – – –
example of TC faced by a
1 9
bakery outlet.
2 8 • Determine the firm’s TFC. Show
3 7 your workings.
4 6 • Copy and complete the table.
5 7
• Sketch the AFC, AVC, AC and
6 8
MC curves in one diagram.
where
Q = Output
• Is the firm producing in the short
TC = Total Cost run or long run? Justify your
AC = Average Cost answer.
TVC = Total Variable Cost
MC = Marginal Cost • At Q = 7 units, calculate the
AFC = Average Fixed Cost firm’s TC given MC for the
AVC = Average Variable Cost seventh output is 9.
38
LONG RUN AVERAGE COST5
Definition of Long How to Choose the The Long Run

Best Plant (Logy) Average Cost (LRAC)
Run Size? Curve
Diseconomies of Economies of Scale

Scale (DEOS) (EOS)

39
How to Choose the Best Plant (Logy)
Definition of Long Run
Size?
• A period where there is no • NOTE that plant (logy) size
fixed inputs refers to the Short Run
• All (land, labor, capital and Average Cost (SRAC) curve
entrepreneur) are variable • Assume that in the long run,
inputs there are three SRAC
curves represented by
SRAC1, SRAC2 and SRAC3
curves
• Which is the best plant
(logy) size?

40
Cost (RM)
#1 At Q = 100 units
• The costs of production are
SRAC1
RM10 (point A) at plant size
SRAC2
10 A SRAC2 and RM7 (point B) at
9 D
SRAC3 plant size SRAC1
8 C
7
• NOTE that the cost of RM7
B
(SRAC1) is lower than RM10
(SRAC2) (RM7 < RM10)
5
E • Thus, the best plant size to
operate is SRAC1 (point B) when
Q = 100 units and AC = RM7
0 100 200 450 Q (unit)

41
#2 At Q = 200 units #3 At Q = 450 units
• The costs of production are • The costs of production are
RM8 (point C) at plant size RM9 (point D) at plant size
SRAC1 and SRAC2 SRAC2 and RM5 (point E) at
• NOTE that the cost (RM8) is plant size SRAC3
proportionate (same) • NOTE that the cost of RM5
• Thus, the firm is indifferent either (SRAC3) is lower than RM9
to choose plant size SRAC1 OR (SRAC2) (RM5 < RM9)
SRAC2 because the cost is the • Thus, the best plant size to
same operate is SRAC3 (point E) when
• Normally, the firm will operate Q = 450 units and AC = RM5
at a higher plant size (SRAC2)
due to efficiency in production

42
The Long Run Average Cost (LRAC)
Curve
• The LRAC curve is a planned • The LRAC curve is a U
curve where the firm will shaped because of the laws
choose the best plant (logy) of returns to scale which can
size from the SRAC curves be explained by the
that not only maximize economies of scale (EOS)
output but also minimize and diseconomies of scale
cost of production (DEOS)
• The LRAC curve is built by • Assume that in the long run,
millions of SRAC curves there are three SRAC
• It is also called the curves represented by the
enveloped curve SRAC1, SRAC2 and SRAC3
curves
43
Cost (RM)
SRAC3
SRAC2
SRAC1 LRAC
C
A
Increasing returns to scale Decreasing returns to
B scale
Constant returns to scale
ECONOMIES OF SCALE DISECONOMIES OF SCALE

Q (unit)
0 Q1 Q2 Q3

44
Economies of Scale (EOS)
• The advantages of large scale of
production
• The LRAC curve is sloping
downward where cost decreases Types
as output increases
• It associates with the INCREASING
RETURNS TO SCALE where an
increase in inputs will bring
about a more than proportionate
increase in output Internal External
• It also means that the percentage Economies of Economies of
Scale Scale
change in output is more than
double than the percentage
change in input

45
Internal Economies of Scale #1 Labor Economies
#1 • Labor Economies • Specialization can increase

the efficiency of labors
• They become more skilled
#2 • Managerial
Economies • They are able to produce
more output with low cost
#3 • Technical
Economies of production
#4 • Marketing
Economies
#5 • Financial
Economies

46
#2 Managerial Economies #3 Technical Economies
• The departmentalization • Technological
and the employment of improvements in production
professionals will ensure and more machines that
higher productivity and are modern and
greater efficiency sophisticated are used
• Works become smooth and • The machines are able to
organized produce more output with
• They are able to produce low cost of production
of production

47
#4 Marketing Economies #5 Financial Economies
• The firm will buy raw • It is easy to obtain loans at
materials in bulk and lower interest rates and
obtain it at a cheaper rate with longer repayment
• With low cost of production, periods
more output is produced • Producers have extra capital
to expand the business
• They are able to produce
of production

48
#1 Economies of Government
External Economies of Scale
Action
• The government create
#1 Economies of necessary infrastructure to
Government Action encourage production
• This allows producer to give
#2 Economies of full attention to increase
Concentration production
• More output produced
#3 Economies of means low cost of
Information production

49
#2 Economies of
#3 Economies of Information
Concentration
• Concentration in one • Means many collective and
location would allow firm to cooperative ventures
• Firm can organize and conduct
enjoy common benefits seminars and conferences to
such as transportation and share knowledge
communication • Through the sharing of knowledge,
• This enables firm to produce firms can learn the latest
more output at low cost of techniques of production in the
market
production • Thus, the firm is able to produce
more output with low cost of
production

50
Diseconomies of Scale (DEOS)
• The disadvantages of large scale
of production
• The LRAC curve is sloping
upward where cost increases as
output increases
• It associates with the Types
DECREASING RETURNS TO
SCALE where an increase in
inputs will bring about a less
than proportionate increase in
output Internal External
• It also means that the percentage Diseconomies Diseconomies
change in output is less than
double than the percentage
change in input
51
Internal Diseconomies of #1 Problem of Labor
Scale Economies
• Labor feels disinterest and
#1 Problem of Labor Economies
boredom because they keep
#2 Problem of Managerial
doing the same job and
Economies routine every day
#3 Problem of Technical
• They become less efficient
Economies and disorganized
#4 Problem of Marketing
• Although they are able to
Economies produce more output, cost
of production increases
#5 Problem of Financial Economies

52
#2 Problem of Managerial #3 Problem of Technical
Economies Economies
• Difficulties of managing • Technology and machines
large firms because lack of become obsolete where a
cooperation and damaged machine needs
miscommunication time and money to fix
• Work is interrupted because • This slows down the
of bureaucratic delays production work
• Although they are able to • Although they are able to
produce more output, cost produce more output, cost
of production increases of production increases

53
#4 Problem of Marketing #5 Problem in Financial
Economies Economies
• The firms buy raw materials • It is difficult to obtain loans
in bulk and obtain it at an • They are obtained at higher
expensive rate interest rates and with
• Although they are able to shorter repayment periods
produce more output, cost • Producers do not have extra
of production increases capital to expand the
business
• Although they are able to
produce more output, cost

54
External Diseconomies of
#1 Scarcity of Raw Materials
Scale
• It is difficult to obtain raw
#1 materials
Scarcity of Raw Materials • They have to be bought
from abroad at an
#2
expensive price
Wage Differentials • Although they are able to
#3
Concentration Problems

55
#2 Wage Differentials #3 Concentration Problems
• The firm has to increase • Congestion caused the cost
wage to prevent existing of transportation and
employees from leaving communication to increase
• The production cost when industries are
increases concentrated in one location
• Although they are able to • This slows down the
produce more output, cost production work
of production increases • Although they are able to

56
ACTIVITY 3
Fill in the blanks with appropriate answers
• In ………., the firm can alter • ………. refers to the

its scale operation. advantages of the industry
• ………. is the curve that as a whole.
shows the minimum cost of • ………. refers to the
producing any given output disadvantages of the
when all of the input are industry as a whole.
variable.
• The Long Run Average Cost
(LRAC) curve is U shaped
due to ……….

57
Summary
• Short run is a period where there is a • The most rational stage is Stage 2
combination between fixed and because the output produced is
variable inputs maximum showing that the
• Long run is a period where there is no combination between fixed and
fixed input, all are variable inputs variable inputs are efficient
• Production is a process of • The Law of Diminishing Marginal
transforming input (in a raw form) Return (LDMR) states that as the
into output (goods and services) number of labor increases
• In the short run, the three stages of continuously, the additional output
production are Stage 1 (begins from produced will start to diminish
the origin until AP maximum), Stage 2 • The short run costs of production
(from AP maximum until MP = 0) and consist of Total Fixed Cost (TFC), Total
Stage 3 (from MP = 0 until MP is Variable Cost (TVC), Total Cost (TC),
negative) Average Fixed Cost (AFC), Average
Variable Cost (AVC), Average Cost
(AC) and Marginal Cost (MC)

58
• The AVC, AC and MC curves are U • The LRAC curve is also U shaped and
shaped because the influence of the influenced by economies of scale and
Law of Diminishing Marginal Return diseconomies of scale
(LDMR) • Economies of scale is the advantages
• The AC curve in the short run is also of large scale of production while
called as the Short Run Average Cost diseconomies of scale is the
(SRAC) curve disadvantages of large scale of
• The Long Run Average Cost (LRAC) production
curve is a planned curve (built by • Factors influencing economies of
millions of the SRAC curves) where the scale are labor economies,
firm will choose to operate at the managerial economies, technical
best plant (logy) size economies, marketing economies and
• The best plant (logy) size means that financial economies
the firm not only maximize • Factors influencing diseconomies of
production but also minimize the cost scale are labor diseconomies,
of production managerial diseconomies, technical
diseconomies, marketing diseconomies
and financial diseconomies

59
Reference
• Study Manual on Introductory Economics, Topic 5, page 141 – 147 and
page 147 – 158

60
ACTIVITY 4
Multiple choice questions
Question 1 Question 2
Which of the following is most As output increases, average
likely to be a variable cost? fixed costs ……….
A. Property insurance premiums. A. Fall.
B. Interest on bonded B. Increase.
indebtedness. C. Remain constant.
C. Rental payments on D. Initially fall, then increase.
Company’s X equipment.
D. Payment for raw materials
purchased from Company Y.

61
If a firm decides to produce no Economies of scale are indicated
output in the short run, its cost will by
be ………. A. The rising segment of the
A. Zero. average variable cost curve.
B. Its total fixed cost. B. The decline segment of the
C. Its total variable cost. long run average cost curve.
D. Its marginal cost. C. The difference between total
revenue and total cost.
D. A rising marginal cost curve.

62
In the long run Economies and diseconomies of
A. All costs are fixed costs. scale explain
B. All costs are variable costs. A. The profit maximization level
C. At least one is a fixed cost. of production.
D. None of the above occurs. B. The distinction between fixed
and variable costs.
C. Why the firm’s long run
average cost curve is U
shaped.
D. Why the firm’s short run
marginal cost curve cuts the
short run average variable
cost curve at its minimum point.
63
END OF TOPIC 5
THANK YOU

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PRODUCTION AND COST

© Normala Ismail 2022

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© Normala Ismail 2022

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• A small unit in the process of • Combinations of firms (factories)

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Short Run Assumptions Concepts Schedule Diagram

Total Product Average Marginal

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#1 Total Product of Labor (TP)

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Also known as increasing Also known as decreasing Also known as negative

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Stage 1 Stage 2 Stage 3

AP maximum (AP = MP)

• Begins from the origin until AP • Begins from AP maximum until

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• Begins from MP = 0 until MP • The most rational stage is Stage 2

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Types of Short Run Costs

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#1 Explicit Cost #2 Implicit Cost

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#1 Total Fixed Cost (TFC)

#2 Total Variable Cost (TVC)

#4 Average Fixed Cost (AFC)

Short Run Types of Short #5 Average Variable Cost (AVC)

Definition Run Costs of

#7 Marginal Cost (MC)

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• Money spent on fixed input (land Cost (RM)

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• Money spent on variable input

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• Fixed cost per unit of output Cost (RM)

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• Variable cost per unit of

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• Total cost per unit of output Cost (RM)

on both fixed and variable AC (SRAC)

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Definition of Long How to Choose the The Long Run

Diseconomies of Economies of Scale

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