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CHAPTER 5
The theory of firm behavior

01 Theory of production
02 Theory of cost
03 Theory of profit

01 Theory of production
1.1. Several concepts
1.2. Producing in short run
1.3. Producing in long run

1.1. Several concepts

• Production is the process that transforms inputs into
outputs to satisfy human wants.
• Production function: Q = f(K,L)
Where: K = Capital; L = Labour.
• Short run or long run depends on number of variable
inputs
+ Short run: 1 variable imput
+ Long run: all variable inputs

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1.1. Several concepts

• Production is the process that transforms inputs into
outputs to satisfy human wants.
• Production function: Q = f(K,L)
Where: K = Capital; L = Labour.
• Short run or long run depends on number of variable
inputs
+ Short run: 1 variable imput
+ Long run: all variable inputs

1.1. Several concepts

α β
• Cobb – Douglas function: Q = a.K .L
Trong đó: K: capital, L: labor, α: Capital-output
elasticity, β: Labor-output elasticity

1.1. Several concepts

• Short run or long run depends on the number of fixed inputs
+ Short run: at least 1 fixed input
+ Long run: no fixed inputs
• Ex: Tien An Company uses inputs such as factories and workers to
produce costumes. In the first 2 years, the company needs to hire
more workers, however, the quantity of factories is unchanged. In
the third year, besides hiring more workers, Tien An company
decides to build more factories. Which one is the capital (K)?
Which period is the short and the long run?

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1.2. Producing in short run

K
• Asumption: ……………….is fixed, ……………is L
variable
• Production function in the short run:
Q = f(K, L)

1.2. Producing in short run

•
sp TB
Average Product – AP: Average product output per unit
of input. In short run, the firm can adjust production by
quantity of laborers  Average product of labor (APL) tức là 1 ng lao động TB làm đc bn sp?
APL = Q /L

• Marginal Product – MP: the change in output as a

result of one additional unit of input being added to
production. In short run, the firm can adjust production by
quantity of laborers  Marginal product of labor (MPL)
∆Q
nếu thuê thêm 1 người LĐ thì Q thay đổi bn
MPL = MPl = Q'L
∆L

1.2. Producing in short run

L Q MPL
0 0 - The diminishing marginal
product is the property whereby
1 3 3 the marginal product of an input
2 7 4 declines as the quantity of the
3 12 5 input increases.
4 16 4 Relationship of MPL and Q:
5 19 3 MPL > 0  Q
6 21 2 MPL = 0  Qmax
7 22 1 MPL < 0  Q
8 22 0
9 21 -1
10 15 -6

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1.2. Producing in short run

L Q MPL APL
0 0 - -
1 3 3
2 7 3.5
3 12 4 Relationship of MPL and APL :
4 16 4 MPL > APL  APL 
5 19 3,8 MPL = APL  APL max
6 21 3,5 MPL < APL  APL 
7 22 3,14
8 22 2,75
9 21 2,3
10 15 1,5

why? nếu thuê thêm người mà MP của người đó lớn hớn AP của những người còn lại -> AP của tổng lại tăng
vd: >

1.2. Producing in short run

the dimishing product
Relationship of MPL and Q:
Q, MPL, APL

MPL > 0  Q
MPL = 0  Qmax
MPL < 0  Q
Relationship of MPL and APL:
MPL > APL  APL 
MPL = APL  APL max
MPL < APL  APL 

relationship MP - AP

1.3. Producing in long run no fixed inputs

• …….fixed inputs  ……. variable inputs
• Production function: Q = f(K,L)
• Average product (AP): APL = Q/L; APK = Q/K
• Marginal product (MP): MPL = ∆Q/∆L = Q’L;
MPK = ∆Q/∆K = Q’K

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1.3. Producing in long run

đường đẳng lượng, đường đồng lượng
Isoquant: shows all combinations of factors that produce a
certain output
Capital Labor (L)
(K) (1) (2) (3) (4) (5) (6)
(1) 7 10 16 18 19 20
(2) 10 15 20 21 23 25
(3) 14 20 23 25 27 30
(4) 16 21 25 30 33 36
(5) 18 23 27 32 37 42
(6) 20 25 28 34 41 50

1.3. Producing in long run

Đường đẳng lượng

K
 Downward-sloping;
 Do not cross;
Q1 = 20
 Higher indifference curves are
6
5 preferred to lower ones;
 Bowed inward  Marginal rate
3
Q2 = 23 of technical substitution
MRTC: tỷ lệ thay thế kỹ
(MRTS)
L
1 2 3
có nhiều điểm (L;K) show the level of outputvd trên hình là 20

1.3. Producing in long run

• Marginal Rate of Technical Substitution illustrates
the rate at which one factor must decrease so that
the same level of productivity can be maintained
when another factor is increased.

• MRTSLK = ∆K/∆L: slope of isoquant

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1.3. Producing in long run

Đường đẳng lượng

MRTSLK = -2
6
5  To keep the equal output,
-2
3
decreasing 2K  increasing
Q2 = 23
1L

delta Ql= - delta Qk

1.3. Producing in long run
<=> MPl . denltaL = MPk . denlta K
Relationship of MRTS and MPL, MPK:
MRTSLK = -MPL/MPK <=> công thức
∆K/∆L = -MPL/MPK
the reason:

1.3. Producing in long run

đường đẳng phí, đường đồng phí
• Isocost shows all combinations of factors that
cost the same amount.

• Isocost equation:
TC PL
P.PK + L.PL = TC  K = – .L
PK PK

• Slope of isocost: -PL/PK

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1.3. Producing in long run

Kết hợp sản xuất tối ưu

which is the optimal of the supplier

At optimal combination:
K
Isoquant ∩ Isocost điểm E: điểm tối ưu hóa chi phí
P MP minimizing
Optimum =
E2 P MP
MP MP
 =
P P
E At optimal combination: to reach the optimal of selling
MP MP example: Find K, L
=
P P
E1
K.PK+ L.PL = TC
L

02 Theory of cost
2.1. Costs in the short run
2.2. Costs in the long run
2.3. Accounting cost, economic cost,
opportunity cost

2.1. Costs in the short run

2.1. Fixed cost, variable cost, total cost
chi phí cố định
• Fixed costs (FC): Costs that do not vary with the
ex: own coffee shop=> open-> find store-> phí thuê,
quantity of output produced  Incurred even when
producing nothing
• Variable costs (VC): Costs that vary with the quantity ex: pay more water sugar when more products in the coffee shop
of output produced  More product, paying more
• Total costs (TC): Total amount a firm pays
TC = FC + VC

Question: coffee shop pay tax, hire other to manage including accountant and marketer. lương cho ai là FC, lương của ai là VC.
=> accountant là FC, bởi vì lương của họ k bị ảnh hưởng bởi sự
=> marketer là VC: bị ảnh hưởng bởi sự phát triển của sản phẩm
IIN THE LONG-RUN, K CÓ VARIABLE COSTS: vì in the long-run K change, because nothing fixed in the long-run

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$800
example
Q FC VC TC
$700
0 $100 $0
$600
TC, FC, VC

1 100 70
$500
2 100 120
Costs
$400
3 100 160
$300
4 100 210
5 100 280
$200 TFC: Q=0 => TC= TFC= 306
$100
6 100 380
$0 TVC = TC - TFC = 1/3q^3 - 10q^2 + 100q + 306
7 100 520
0 1 2 3 4 5 6 7
Q

Tại sao phải tính giá average?

2.2. Average cost, marginal cost

chi phí cố định TB trên 1 sp
• Average fixed cost (AFC): Fixed cost dived by the
quantity of output  AFC = FC/Q
• Average variable cost (AVC): Variable cost dived by the
quantity of output  AVC = VC/Q chi phí biến đổi TB tính trên 1 sp
• Average total cost (ATC): Total cost dived by the quantity
of output ATC = TC/Q =…………………
• Marginal cost (MC): The increase in total cost that arises
from an extra unit of production
MC = ∆TC/∆Q = ∆TVC/∆Q
ATC = AFC + AVC

Q increase -> AFC decrease

Q TC ATC AFC AVC $200

n/a $175
0 $100 n/a n/a
AC, AVC, AFC

$150
1 170
$125
Costs

2 220
$100
3 260
$75
4 310 $50
5 380 $25

6 480 $0
0 1 2 3 4 5 6 7
7 620
Q
Q rises => AVC may fall initially -> đạt min -> increase
ATC = TC/Q = AFC + AVC
Khoảng cách giữa ATC và AVC giảm dần thì
AFC giảm dần

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TVC và VC giống nhau

Q TC MC $200
$175
0 $100
$150
1 170
$125

Costs
2 220
$100
3 260 MC = (TVC)' theo Q =>
$75
4 310 $50
Từ MC=5, nguyên hàm theo Q -> TVC = 5Q (TVC not TC bởi vì k có
5 380 $25
constant thì FC unchanged
6 480 $0
=> AVC = TVC/Q =5
0 1 2 3 4 5 6 7
7 620
Q
AC, AFC, AVC, MC

$200
$175

AC, AVC, AC is……….. $150

$125
Costs

$100

AFC…………. $75
$50
$25
$0
0 1 2 3 4 5 6 7
Q

MC < AVC: Q  AVC

AC, AFC, AVC, MC

$200 MC
$175
MC= AVC: AVCmin
$150
MC > AVC: Q  AVC $125
Costs

$100 ACmin
MC< AC: Q  AC $75
AVCmin
$50
MC = AC: ACmin $25

MC> AC: Q  AC $0

0 1 2 3 4 5 6 7 AC có FC
Q
AVC k có AFC

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2.2. Costs in the long run

 Long-run total cost (LTC);

 Long-run average cost (LAC);
 Long-run marginal cost (LMC).

Long-run total cost (LTC)

LTC is the cost function

that represents the total
cost of production for all
goods produced.

Long-run average cost (LAC)

LAC is the cost per unit

of output in the long run
LAC = LTC/Q

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Long-run average cost (LAC)

LM is the additional cost of

producing an extra unit of
the output in the long run
LMC = ∆LTC/∆Q

LMC < LAC: q LAC

LMC = LAC: LACmin
LMC > LAC: q  LAC

2.3. Accounting cost, economic cost, opportunity cost

• Sunk cost: a cost that has already been committed and

cannot be recovered  ignoring them when making
decisions
chi phí nổi • Explicit costs: input costs that require an outlay of money có thể nhìn thấy bằng mắt, có đòi hỏi dòng tiền, có số
by the firm
• Implicit costs: input costs that do not require an outlay of k nhìn thấy bằng mắt,
chi phí chìm
money by the firm
• Total opportunity costs = Explicit costs
what you give up when you do sth
+…………………….
implicit costs

mượn xong chia cho 1 năm

Explicit costs, Implicit costs, Opportunity costs

Cost in the view of the Cost in the view of the

accountant economists

Total
Explicit costs Opportunity costs explicit costs: 290

(= Explicit costs + Implicit costs

) implicit costs = 120 + 16 + 40 = 176 million VND
total opportunity costs = 290 + 176 = 466 million VND

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03 Theory of profit
3.1. Definition
3.2. Profit maximization

accounting profit > economic profit

3.1. Definition
• Profit is the firm’s total revenue minus its total cost:
Π = TR – TC
• Accounting profit = Total revenue – explicit cost
• Economic profit = Total revenue – explicit cost -
……………..
- implicit cost

3.1. Definition

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3.1. Definition explicit costs: 60

Mr. A works at a company with a 120 million VND/year salary. This year, Mr. A quit his
job and opened a cafe for business. To start a business, Mr.A has to do a few things:
Borrow VND 100 million from the bank;
implicit costs = 120 + 16 + 40 = 176 million VND
Take out 200 million dongs of savings, which brings in a profit of 16 million VND per
year; accounting profit = 260
Take back the house, which is rented at the price = 40 million VND per year.
After one year, Mr. A has a revenue of 550 million VND and can list his expenses as
follows: economic profit = 84
Cost of raw materials = 60 million VND
Labor costs = 120 million VND
Depreciation = 20 million VND
Operating cost = 20 million VND
Interest expense = 10 million VND
Management cost = 60 million VND
With the data given above, calculate Mr. A's accounting and economic profit.

3.2. Profit maximization

Πmax is the goal of every firm. want to maximize the profit
Πmax  Π’Q = 0
 TR’(Q) - TC’(Q) = 0
 MR – MC = 0
 MR = MC
The firm maximizes its profit at the output where
Marginal revenue = marginal cost

3.2. Profit maximization khi beneficial thì tiếp tục sản xuất đến khi nào đạt max profit

$ $

MC MC

MR
MR
Q Q
beneficial MC < MR: Q  II MC < MR: Q  II beneficial
MC = MR: IImax MC = MR: IImax
losing MC > MR: Q  II MC > MR: Q  II losing

bt: demand equation of a firm: Q = 3000 - 10P, total function is TC = 0,1 Q^2 +180Q + 6000
Finding P*, Q*

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