Production and Cost Analysis in

the Short-Run

Chapter 5
 Production Function

 A production Q = f(L, K, M, …)
function describes the where
relationship between a Q = quantity of output
flow of inputs and the L = quantity of labor
resulting flow of input
outputs in a production K = quantity of capital
process during a given input
period of time. M = quantity of materials
input

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 Fixed and Variable Inputs

 A fixed input is an  A variable input is an

input whose quantity input whose quantity
a manager cannot a manager can
change during a change during a
given period of time. given period of time.

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 Short-Run vs. Long-Run

 The short-run is a period of time during which

at least one input is fixed, while the long-run is
a period of time during which all inputs are
variable.

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 Total Product

 The total quantity of TP or Q = f(L, K ), where

output produced with TP or Q = total product
given quantities of or total quantity
fixed and variable produced
inputs. L = quantity of labor
input (variable)
K = quantity of capital
(fixed)

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 Average Product

 The amount of output

per unit of variable APL = TP÷L or Q÷L,
input. where
APL = average product
of labor

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 Marginal Product

 The additional output MPL = ΔTP÷ΔL or

produced with an ΔQ÷ΔL
additional unit of where
variable input.
MPL = marginal
product of labor

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 Total Product Curve

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 Average and Marginal Product
Curves

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 Law of Diminishing Marginal
Returns

 The phenomenon illustrated by that region of

the marginal product curve where the curve is
positive, but decreasing, so that total product is
increasing at a decreasing rate.

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 Cost Function

 A mathematical or graphic expression that

shows the relationship between the cost of
production and the level of output, all other
factors held constant.

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 Opportunity Cost

 The economic measure of cost that reflects the

use of resources in one activity, such as a
production process by one firm, in terms of the
opportunities forgone in undertaking the next
best alternative activity.

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 Explicit and Implicit Costs

 A cost is explicit if it is  A cost that represents

reflected in a payment the value of using a
to another individual, resource that is not
such as a wage paid to explicitly paid out and
a worker, that is is often difficult to
recorded in a firm’s measure because it is
bookkeeping or typically not recorded
accounting system. in a firm’s accounting
system.

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 Profit

 The difference between the total revenue a firm

receives from the sale of its output and the
total cost of producing that output.

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 Accounting vs. Economic Profit

 Accounting profit is  Economic profit is the

the difference difference between
between total total revenue and
revenue and total total cost where cost
cost where cost includes both the
includes only the explicit and any
explicit costs of implicit costs of
production. production.

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 Short Run Cost Function

 A cost function for a short-run production

process in which there is at least one fixed
input of production.

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 Fixed vs. Variable Costs

 Fixed cost is the total  Variable cost is the

cost of using the total cost of using
fixed input, which the variable input,
remains constant which increases as
regardless of the more output is
amount of output produced.
produced.

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 Short Run Costs

COST FUNCTION DEFINITION

Total fixed cost TFC = (PK) x (K)
Total variable cost TVC = (PL) x (L)
Total cost TC = TFC + TVC
Average fixed cost AFC = TFC ÷ Q
Average variable cost AVC = TVC ÷ Q
Average total cost ATC = TC ÷ Q = AFC + AVC
Marginal cost MC = ΔTC ÷ ΔQ = ΔTVC ÷ ΔQ

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 Total Cost Curves

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 Average and Marginal Cost Curves

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 Relationship Between Short Run
Production and Cost

MC

AC

Q1 Q2

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