Theories of Production

and Costs
Prof. Mahmoud Touny

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 Producer equilibrium subjects

• Production function (production function, average and marginal

product of labor, stages of production).
• Costs function (cost function, total costs, total fixed and total variable
costs, average costs, marginal costs and the relationships among
production and costs curves).
• Revenue (total revenue, average revenue and marginal revenue).
• Profits (total profit, average and marginal profit).

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 The short run and the long run
The short run
The short run is a period of time within
which one factor of production at least
is fixed (constant) or not changed such
as land and capital.
The long run
The long run is a period of time in
which all factors of production are
changeable, so the quantities of land
and capital used in the production
process can change, or the firm can
increase both land and capital in the
production process.
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 Production function in the short run

Production Function is a relationship between inputs (factors of

production) used in the production process and the amount of output
(Total Production) derived from those inputs.
Assuming we have two factors of production, L (labour) which is the
changeable factor of production and K (Capital) which is the fixed factor
of production, as shown below:
Q = F (K , L)
As Q is the total output (production), K is the fixed factor of production
and L is the changeable factor of production.

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 Production function in the short run

Stage one: Increasing Marginal

Returns (MPL).

Stage two: Decreasing

Marginal Returns.

Stage three: Negative Marginal

Returns:

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Stages of production:

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 Costs of production (short run)

1-total fixed cost:

Fixed costs are those costs that do not vary or
change with any change in total production
(TP) or output (Q) and usually include rents,
insurance, building costs, equipment and
machines, depreciation, set-up costs

Prof. Amany Fakher 7

 Costs of production (short run)

2-total variable cost:

Total Variable cost is the cost of production that
varies with any change in the total of production or
the costs that are related to the total of production
or output, or the direct costs, such as labor costs,
fuel costs, raw materials costs, and spare parts
costs. Total variable costs (TVC) will increase as
output increases.

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 Costs of production (short run)

3-total costs:
• Total costs defined as all payments to the owners
of factors of production.
• Total costs of production are the sum of both
total fixed costs (TFC) and total variable costs
(TVC), as shown:
• Total costs= Total fixed costs + Total variable
costs.
• TC = TFC + TVC.

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Fixed Cost, Variable Cost , and Total Cost

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 Costs of production (short run)

-average fixed cost:

Average Fixed Cost (AFC) is defined as the total
fixed cost (TFC) divided by total production (TP)
or total output (Q):
AFC = TFC
Q

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 Costs of production (short run)

-average variable cost:

• Average Variable Cost (AVC) is defined as the

total variable cost (TVC) divided by total
production (TP) or total output (Q):

AVC= TVC
Q

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 Costs of production (short run)

-average total cost:

Average total cost is the sum of both the

average fixed cost (AFC) and the average
variable cost (AFC), as shown:

• ATC = AFC + AVC.

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 Costs of production (short run)

Marginal cost:
Marginal cost is the cost of producing one extra
unit of output, or the cost of an additional unit of
production, or the cost of the last unit of
production. It can be found by calculating the
change in total cost divided by the change in
output.

MC= TC
Q

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Costs of production (short run)

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Relationship between average total cost,
average variable cost and marginal cost

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 Relationship between AP and MP, and AVC and MC

• MPL = Q
L
• MC = TC VC W .L
= = =W
L
Q Q Q Q

• MC = W/MPL

𝑄
• 𝐴𝑃𝐿 =
𝐿
• AVC = VC/Q = W.(L/Q)
• AVC = AVC = W/APL

Prof. Mahmoud Touny

Prof. Mahmoud Touny 17
 Accounting and economic profits

Total Revenue: Total Revenue is defined as the quantity of sales multiplied by unit price, as
shown below:

TR = Q * P

Average Revenue (AR) is defined as the total revenue (TR) divided by the quantity of sales, as
shown below:

(AR) = TR/Q
Marginal Revenue (MR) is the change in total revenue ∆TR divided by the change in the
quantity of sales ∆Q
MR = ∆TR/ ∆Q

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 Accounting and economic profits

1-Accounting profit: is a company's total revenue reduced by the explicit costs

of producing goods or services. These explicit costs involve direct monetary
movement and include expenses.
• An explicit cost: means clear, obvious cash outflows from a firm that reduce
its bottom-line profitability.
• Accounting Profit = Total Revenue – Explicit Costs.

π = TR – TC

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 Accounting and economic profits

2-Economic profit is the profit that takes into account both implicit and
explicit costs. Implicit costs are considered opportunity
costs and are normally the company's own resources. Examples:
company-owned buildings, equipment, and self-employment resources.

• Economics Profit = Total Revenue – (Explicit costs +Implicit Costs). Or:

• Economics Profit = Total Revenue – (Explicit costs +Opportunity costs).

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 Thank You
For good listening

Prof. Mahmoud Touny

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