Production and Cost Theory – focus on the supply side of the

market.

- How the producers make choices – and how these choices affect the market.

Theory of Firms – states that firms exist for the purpose of profit maximization – individuals put
up businesses because they want to earn profit, at the same time they want to maximize their
profit (and for them to be able to do it, they have to understand the concept Production Theory
and Cost Theory)
Production Function – mathematical expression that shows the technical relationship between
the firms’ input and output.
Output = f (inputs)
Output – dependent variable
Input – independent variable
Anything that will happen to your input will affect your output.
Input – refers to your factors of production such as land, labor, capital, and entrepreneurship.
2 kinds of Input (Fixed and Variable)
Fixed Input – inputs whose quantity is not changed by the firm, regardless of its reason.

- Inputs which do not vary throughout the production process, we cannot easily decrease
or increase the number of our fixed input during the production process.
- Ex. You have 1hec land, during the production of your palay, you cannot easily increase
the amount of your land because it’s too costly on your part to buy another hectare of
land during the production process, therefore, land can be considered as a fixed input.
- Ex. Capital – assets, machineries, or other tools that can directly produce goods and
services. – we cannot easily increase or decrease the number of inputs.
Variable Input – inputs whose quantities can really be changed like labor and raw materials.

- Referring to the inputs that vary throughout the production process, we can easily
increase or decrease the number of our variable input.
- Ex. Planting Palay – when you realize that one farmer is not enough to fill your land,
therefore you can hire more farmers. – therefore, we can say that labor can be
considered as variable inputs.
Production Period – refers to how firms adjust their inputs which may also depend on the
available money to pay for inputs such as land, labor, capital, and entrepreneurship.

- Refers to the adjustment of the firm from using fixed input to variable input.
- When we say production period, we are not referring to the duration of time of the
production process, instead, we are referring to the adjustment of the firm from using
fixed input to variable input.
- We can say that a firm is on a long-run period, but it’s been on the business for only 10
years.
 - We can also say that the firm is already 20 years in the business but still on the short-run
period.
3 types of Production Period
Very Short – Run Period or the Immediate Period – the firm uses fixed input and only uses
fixed input in producing goods and services.
Short – Run Period – the firm gradually adjusts from using fixed input to variable input.
Long – Run Period – the firm only uses variable input.
Production table – is used to further understand the production theory, stages of production,
and the law of the diminishing marginal return.

- Let’s say you have 1 hectare of land, and 1 hectare of land is considered as fixed input –
as you may notice, throughout the production process, it is only 1 hectare. And let’s use
labor as variable input, throughout the production process, we increase the number of
farmers.
- Always remember that when we say Marginal Product, that is the output produced by the
last worker wherein we have the formula – MP = TP/L – MP = TP2- TP1/L2-L1
- We have the formula for the average product – AP = TP/Labor

Marginal Product – what did the last worker contribute. Is he more productive than the first
one.
Average Product – we want to determine how much a worker produces.
Stages of Production – Law of Diminishing Marginal Return
1. Increasing Return Stage – as additional variable input is added to your fixed input, the
total product increases at an increasing rate (marginal product).
  Marginal product > average product
 On stage 1, we say that there is an underutilization of the fixed input – because
we aren’t able to maximize yet the capacity of the 1-hectare land – and the
capacity of the land is 52 cavans of palay.
2. Decreasing Return Stage – others also call this as Diminishing Return Stage – as
additional variable input is added to your fixed input, the total product increases at a
decreasing rate.
 TP is increasing but MP is decreasing
 MP < AP
 Reaches the maximum capacity of the land
 Rationalization stage – we have to determine what combination of inputs
maximizes the output.
3. Negative Return Stage – we have decreasing return stage wherein total product
declines.
 MP is negative while the AP is still positive
Graphs
TP Curve – y axis TP x axis L

When your MP = 0, we can assume that your TP = maximum

AP in relation with MP (MP>AP) – AP is below MP
AP>MP – AP is above MP
Theory of Cost
Economic cost – payment made by the firm from using the different economic resources.

- payment for the inputs that the firm uses in the production processes.

Two Kinds of Economic Cost

Explicit Cost – payment made by the firm from using outside resources.
Ex. Labor – we pay for employee’s wages
Implicit Cost - payment made by the firm from the use of its own resources.
Ex. You have a truck – we earn from it by rental but we use it for own business – the implicit
here is the forgone rent (sacrificed rent that’s supposedly to be earned)
When we say explicit and implicit cost, they are both considered as opportunity cost (the
amount of something that is sacrificed to gain something). We sacrifice money in explicit cost.
We sacrifice forgone opportunity in implicit cost.
Profit = Total Revenue – Total Cost
Accounting Profit = Total Revenue – Explicit Cost
Economic Profit = Total Revenue – (Explicit Cost + Implicit Cost) (need i-add yung forgone
revenue kasi that is your normal profit)
Different Kinds of Cost Based on the Production Period of the Firm

Immediate Period – TC = TFC

Short-run Period – TC = TFC+TVC
Long-run Period – TC = TVC
TFC – Total Fixed Cost – cost of the firm which does not vary throughout the production
process.
TVC – Total Variable Cost – cost of production wherein it varies throughout the production
process and it depends upon the output produced.
TC – Total Cost – summation of all the cost of production.
Marginal Cost – additional cost incurred by the firm from producing one more output.

Short-run Period
0 Output = 0 TVC
If TFC is horizontal, TVC fluctuates, and TC imitates the movement of the TVC.
TVC gives the moment for TC.
Undefined – do not include in y.
AFC – downward – as numerator remains the same and denominator increases.
AVC – fluctuates – TC imitates.
MG – J-shaped
Long-run Period – microscopic view ng short-run.

- pinagsama-samang short-run average cost curve

Economies of Scale –  AVC  Output – a company always aims for economies of scale –
through the use of technology.

Diseconomies of Scale -  AVC  Output – it is not favorable on the part of producer – he has
to pay more to produce an output.

MARKET STRUCTURE
Derivative Notation – newton and Leibniz form
Differentiation – process
Derivative – result

Newton form – we only add prime to our function.

Rules of Differentiation
Higher-order Derivatives

Increasing and Decreasing Function

Concavity and Convexity

Relative Extrema
Inflection Points

Optimization of Functions
Marginal Cost
Optimizing Function

CHAPTER 1
Managerial Economics
Managerial Economics
- the analysis of major management decisions using the tools of economics.
- applies many familiar concepts from economics to aid managers in making better
decisions.
 demand and cost
 marginal analysis
 monopoly and competition
 the allocation of resources
 economic trade-offs
The Nature, Scope, and Practice of Managerial Economics
1.1 Definition of Managerial Economics and its Nature
- Economics
 it is the study of production, distribution, and consumption of goods and services.
(indicates that economics includes any business, nonprofit organization, or
administrative unit)
 it is the study of choice related to the allocation of scarce resources. (establishes that
economics is at the core of what managers of these organizations do.
 we use economics to examine how managers can design organizations that motivate
individuals to make choices that will increase a firm’s value.
- Managerial Economics
 is a branch of economics that applies microeconomic concepts, methods, and
analysis to examine how an organization or business can achieve its aims and
objectives most efficiently through decision-making.
 its purpose is to provide economic method and scientific reasoning to solve
managerial decision problems.
- These economic theories and methods involved with two different conceptual
approaches to the study of economics such as:
  Microeconomics
- studies phenomena related to goods and services from the perspective of
individual decision-making entities – that is, households and businesses.
- is essential for understanding the behavior of atomic entities in an economy.
- however, understanding the systematic interaction of the many households and
businesses would be too complex to derive from descriptions of the individual
units.
 Macroeconomics
- approaches the same phenomena at an aggregate level, for example, the total
consumption and production of a region.
- provides measures and theories to understand the overall systematic behavior
of an economy.
- Since the purpose of managerial economics is to apply economics for the
improvement of managerial decisions in an organization, most of the subject material in
managerial economics has a microeconomic focus. However, since managers must
consider the state of their environment in making decisions and the environment
includes the overall economy, an understanding of how to interpret and forecast
macroeconomic measures is useful in making managerial decisions.
- Managerial economics
 deals with microeconomic reasoning on real-world problems such as pricing and
production decisions in selecting best strategy in different competitive environments.
These business decisions can be analyzed through:
 Risk Analysis
- various uncertainty models, decision rules, and risk qualification techniques are
used to assess the riskiness of a decision.
 Production Analysis
- microeconomic techniques are used to analyze production efficiency, optimum
resource allocation, costs, economies of scale, and to estimate the firm’s costs of
production.
 Pricing Analysis
- microeconomic techniques are used to examine various pricing decisions
including transfer pricing, joint product pricing, price discrimination, price
elasticity estimations, and optimal pricing method.
 Budgeting
- investment theory is used to examine a firm’s capital and purchasing decisions.

1.2 Why Managerial Economics Is Relevant for Managers

- the sources of those goods and services are usually not other individuals but
organizations created for the explicit purpose of producing and distributing goods and
services.
- Executives and managers are the ones responsible for overseeing and making decisions
for the organizations in our society, whether it is a business, nonprofit entity, or
governmental unit, as long as it provides set of goods, services, or both.
- We live in a world with scarce resources, which is why economics is a practical science.
We cannot have everything we want. Further, others want the same scarce resources
we want.
 - And even if the goods or services are of value, when another organization can meet the
same need with a more favorable exchange for the customer, the customer will shift to
the other supplier.
- The organization must create value for their customers, which is the difference between
what they acquire and what they produce.
- Those managers who understand economics have a competitive advantage in creating
value.
1.3 Managerial Economics Is Applicable to Different Types of Organizations
- organization providing goods and services will often be called a “business” or a “firm,”
terms that connote a for-profit organization.
- underlying goal of the organization is to create profit.
- Managerial economics also addresses another class of manager: the regulator.
- Economics provides a framework for analyzing regulation, both the effect on decision
making by the regulated entities and the policy decisions of the regulator.
1.4 Social Responsibility of Business

Different Steps in Decision Making

Demand Forecasting
Standard Error of Estimate

Smaller – Mas Fit

Another Formula