THEORY OF PRODUCTION

AND COST
 LEARNING
OBJECTIVES:
• To explain the input output relationship
• To describe the Importance of Law of Diminishing
Return
• To analyze the Different Cost in Production; and
• To know the meaning of Economies and Diseconomies
of Scale.
 what is theory of
production?
The theory involves some of the most fundamental principles
of economics. It is an effort to explain the principle, by which
a business firm decides how much of each commodity that it
sells, it will produce and how much of labour, raw material,
fixed capital good, etc., it will use.
 FIXED
a factor of production that cannot be changed in the
INPUT
short-run.

VARIABLE
INPUT
a factor of production that depends upon the level of
production
Profit

Total Profit = TR - TC

Total Revenue
TR = P X Q
 TOTAL
COST

EXPLICIT IMPLICIT
COST COST
ECONOMIC PROFIT VERSUS
ACCOUNTING PROFIT
THE VARIOUS MEASURES
OF COST

Variable Fixed Costs

Costs
Fixed costs
Fixed costs often include rent, buildings,
machinery, etc.

Variable costs
Variable costs may include wages,
utilities, materials used in production,
etc.
Most of the time, economist deals with the average total cost. Average total cost is the quotient of total cost and total output.
ATC = TC / Q

Average total cost is important to determine because it depicts the cost incurred of 1 unit of product. Hence, it can be used as
the basis for your pricing. Remember that your price must be greater than ATC.

Average fixed cost is the quotient of fixed cost and the quantity. This depicts the fixed cost incurred of ever unit of product.
AFC = TFC / Q

Average variable cost is the quotient of variable cost and quantity. It denotes the variable cost incurred of 1 unit of product.
AVC = TVC / Q

Marginal cost (MC) measures the increase in total cost that arises from an extra unit of production. Marginal cost helps
answer the following question:
How much does it cost to produce an additional unit of output?
MC= =