Unit 01:Business Economics

QCF Level: 4
Credit Value: 20
Lecturer: Harshani Chathurika

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 Microeconomics of the product market
with demand, supply, elasticity and cost of
production
(Session 10, 11 & 12)

LEARNING OUTCOME 03
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HD in Business Management

Module: Business Economics

Lesson: Cost of Production –Short &
Long Run

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 Production

Output
Inputs Production
process (goods and
(resources)
services)
 Short Run and Long
Run
• Short Run: Fixed Plant
– Period too brief for a firm to adjust plant capacity,
yet long enough to permit a change in the fixed
plant use.
– Plant capacity is fixed
– Can change output by using different amount of
labor. Material, other resources
– Use existing plant capacity more or less intensively

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 Short-Run Production
Relationship
• Total Product (TP)
– Total quantity or output produce
• Marginal Product (MP)
– Extra output or added product associated
with adding a unit of a variable resource, (ex.
Labor)
– MP = change in total product / change in
(labor) input
• Average Product (AP)
– Call labor productivity, output per unit of
labor input
– AP =TP / Units of Labor
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 TP,MP and AP:
Law of Diminishing Cost

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Graphical
Portrayal

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Theory of Production

Cost of production – Short run and Long Run

 Explicit and Implicit Cost

Implicit
Economic cost
cost Explicit
cost

Explicit cost – Monetary payments to those who supply

labor, materials, fuel, transportation (cash payment)
Implicit cost – Opportunity costs of using self owned, self
employed resources

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Economic Profit
vs.
Accounting Profit

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 Short Run Production
Cost
• Fixed cost (TFC)– Cost that do not change
when the output change (rent, interest on
debt)
• Variable Cost (TVC)– Cost that change with
level of output (payment for materials, fuel,
power)
• Total cost (TC)– sum of the fixed cost and
variable cost at each level of out put
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 Total Cost
Data
TFC (2) TVC (3) TC = TFC+TVC (4)
0 100 0 100
1 100 90 190
2 100 170 270
3 100 240 340
4 100 300 400
5 100 370 470
6 100 450 550
7 100 540 Total Product (1)
8 100 650 750
9 100 780 880
10 100 930 1030

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 Per Unit or Average
Cost
• Average Fixed Cost (AFC)
– AFC =TFC / Q
– By definition as output  TFC spread on large number of outputs so
AFC
must 
• Average Variable Cost (AVC)
– AVC=TVC/Q
– When resources added output  AVC and reaches the minimum and
then  again (AVC is Ushape curve)
• Average Total Cost (ATC)
– ATC =TC =TFC + TVC=AFC +AVC
• Q Q Q
• Marginal Cost (MC)
– Extra or additional cost of producing 1 more unit ofoutput
– MC=Δ in TC / Δ in Q
– Firm can control the MCdirectly andimmediately

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 Total Average MC
Total Cost TC =
AFC = CostAVC = ATC =
MC= Δ in
TFC (2) TVC (3) TFC+TVC TC / Δ inQ
Product (1) TFC/Q (5) TVC/Q (6) TC/Q (7)
(4) (8)
0 $100 $0 $100 $90
1 100 90 190 $100 $90 $190 80
2 100 170 270 50 85 135 70
3 100 240 340 33.33 80 113 60
4 100 300 400 25 75 100 70
5 100 370 470 20 74 94 80
6 100 450 550 16.67 75 91.67 90
7 100 540 640 14.29 77.14 91.43 110
8 100 650 750 12.50 81.25 93.75 130
9 100 780 880 11.11 86.67 97.78 150
10 100 930 1030 10 93 103

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 MC&
MP
• Recall from slide 11
– Assume all the workers hired for $10 because 1st workers MP is
10
units
• MC=$10/10 U=$1
– 2nd worker hired and MP is 15 units
– MC= $10/15 U=$0.67
– 3rd worker MC= $10/20 U= $0.50
• But 4th worker hired and MCrise and gives diminishingreturns
– 4th worker MC= $10/15 U=$0.67
– 5th worker MC=$10/10 U=$1
– 6th worker MC= $10/5 U=$2
• Marginal Returns  MCand MP MC (Mirror Images)

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Relationship between
productivity curves and
cost curves
AP

MP

MC

AV
C

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 Long-Run (LR)
Production Costs

• Long run ATC

– Contains several short run ATC curves
– Shows lowest ATC at any output level (enough time to adjust)
– Also call as planning curve
ATC
LR
AT
C

Q
Output
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 Economies and
Diseconomies of
Scale
• Economies of scale Explain downward slope part of the Long-run ATC
curve. Plant size  average cost of production 
– Labor specialization –use of labor become more achievable, job can divide, each
one
has their own duty
– Managerial Specialization –large scale of production means better use of,
greater specialization of management, greater efficiency, lower unitcost
– Efficient capital –applied most improve equipment and advance technology,
larger
scale and volume of production
• Diseconomies of scale difficulty of efficiently
controlling and
coordinating a firm’s operations as it becomes a large-scale
• Company expand  high average total cost  diseconomies
of
scale
• Constant return to scale some industries exist in wide range of
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output. Some of them in economies of scale and other in