5.

Production
and Costs
I. Production Analysis

I.1. Total Product, Marginal Product,

Average Product
I.2. Isoquants
I.3. Isocost
I.4. Cost Minimization
 I.1. Total Product, Marginal
Product, Average Product
Total product
 Q = F(K,L)
 The maximum amount of output that
can be produced with K units of
capital and L units of labour.
 On the short run, capital is constant;
production can be increased only
by increasing the number of workers;
 On the long run, production will
increase by increasing all the factors
(capital and labour)
Marginal product of labour
 MPL = DQ/DL
 Measures the output produced by the last
worker.
 Slope of the production function
Average product of labour
 APL = Q/L
 Measures the output of an “average”
worker.
 Stages of production
1) MP > AP →AP increases;
2) MP = AP → AP is
Q Increasing Diminishing Negative maximum;
Marginal Marginal Marginal 3) MP < AP → AP decreases
Returns Returns Returns 4) MP = 0 → Q = maximum;
5) MP < 0 → Q decreases

Q=F(K,L)
1) AP increases : increasing
average returns; total
product increases more
AP than labour;
L 2) AP decreases: diminishing
MP average returns; total
product increases less than
labour
 I.2. Isoquants
 The combinations of inputs (K, L) that yield the
producer the same level of output.
 Isoquant reflects the way a producer can
substitute among inputs while maintaining the
same level of output.
K
Q3
Kobb Douglas Isoquants Increasing
Q2 Output
 Inputs are not perfectly Q1
replaceable
 Diminishing marginal rate
of technical substitution
 Most production processes
have isoquants of this
shape
L
 I.3. Isocost K

 The combinations of
inputs that cost the
producer the same
amount of money
C0 C1
 For given input prices, L
isocosts farther from the
K
origin are associated New Isocost Line
with higher costs. for a decrease in
the wage (price
 Changes in input prices
of labour).
change the slope of the
isocost line
L
I.4. Cost Minimization
 Marginal product per dollar spent should be equal
for all inputs:
MPL MPK

w r
 Expressed differently: marginal rate of technical
substitution (MRTS) equals the ratio of inputs price:

MPL w
MRTS KL  
MPK r
 TR(Q) = p X Q
Costs

II. Costs Profit TC(Q) = VC + F

II.1. Types of VC(Q)

Costs
 Fixed costs (FC)
 Variable costs (VC)
 Total costs (TC)

FC
Loss

Q
Q*
 II.2. Average and marginal
costs Costs
Average Total Cost MC ATC
ATC = AVC + AFC
ATC = TC(Q)/Q AVC

Average Variable Cost

AVC = VC(Q)/Q

Average Fixed Cost

AFC = FC/Q
AFC

Marginal Cost
Q
MC = DTC/DQ
 Fixed costs
Q0(ATC-AVC) = Q0 AFC = Q0(FC/ Q0) = FC
MC
Costs
ATC

AVC

ATC
AFC Fixed Costs
AVC

Q0 Q
 Variable costs
Q0AVC = Q0[VC(Q0)/ Q0] = VC(Q0)
MC
Costs
ATC

AVC

ATC
AFC

AVC
Variable Costs

Q0 Q
Total costs
MC
Costs
ATC

AVC

ATC

AVC Total Costs

Q0 Q
Economies
Costs versus diseconomies
MC of scale
ATC

(ES)
(DS)

Q1 Q

Economies of scale (ES):

- decreasing average total costs; total costs increase less than total
output
Diseconomies of scale (DS):
- increasing average total costs; total costs increase more than total
output
THANKS! 