PRODUCTION FUNCTION AND COST CURVE

 The Short-Run Versus Long-Run

In the production and cot theory, the distinction is made between the
short-run, in which the quntities of some inputs are variable while
others are in fixed suplly, and the long run, in which all factors may
be varied.
Labor has traditionally been variable and capital is tipycally fixed in
the short run.
Labor = we think of one unit of labor as including, say
one hour of a worker’s time plus a “package” of all the
necessary raw material, fuel, and other variable input
Capital = we should think of capital as including all the plant,
equipment, land, building, maneger’salary, and
other expenses that do not vary with the level of output.
Production in The Short Run
Definition :
A production function is a technical specification
of the relationship that exists between the inputs
and the outputs in the production process.
Q = f (K. L)
Where : Q is the quantity of putput
K is capital
L is labor
The State of Technology.
State of technology refers to the quality of the resouces involved
in the production process.
Motor Vehicle Assembly Production Function

Labor Unit (L) Assembly Production Function

1 2 3 4 5 6 7 8
Capita 1 1 3 7 10 12 13 13.5 13
l (K)
(000s 2 3 8 14 19 23 26 28 29
of 3 8 18 29 41 52 62 71 79
machi
ne 4 11 23 36 50 65 78 90 101
hours)
5 12 26 42 60 80 98 112 124
The Law of Diminshing Return
Definition :
The law of the diminishing return state that as additional units of the variable
factor are added to the fixed factors in the short run, after some point the
increment to total product will decline progressively.

Units of the Varaible Units of Output (for K = Increment to Output Return to the variable
Factor (L) 3) (Total Product) over Preceding Row factor ( for K=3)
(marginal product)
0 0
1 8
2 18
3 29
4 41
5 52
6 62
7 71
8 79
Total Product and Marginal Product
The total output from production function process is
also known as the total product of the inputs to that
production process.
Marginal Product
Definition :
Marginal product is defined as the rate of change
of the total product as labor is increased, and equal
in mathematical terms to the first derivative of the
total product function with respect to labor.
The Total Product and Marginal Product Curves
SHORT-RUN AND LONG-RUN COST CURVE
The Total Variable Cost Curve
The Total Variable Cost (TVC) curve can be derived from the TP curve simply
by multiplying the level of variable inputs by the cost per units inputs and
plotting these cost data againts the total output level.
Average Variable and Marginal Costs
Definition ;
Average variable cost (AVC) is equal tp TVC divided by output Q at every
level of Q, that is
AVC = TVC/Q
Definition :
Marginal cost (MC) is the change in total costs caused by a one-unit change
in output :
MC = ∆TC/∆Q
Realtionship between the Total Product and Total Variable Cost Curve
Derivation of Average Variable and Marginal Cost Curves from Total Variable Cost Curve
SHORT RUN TOTAL AND PER UNIT COST

Q (output) TFC TVC TC AFC AVC ATC MC

0 60 0
1 20
2 30
3 45
4 80
5 135
 PLANT SIZE AND ECONOMIES SCALE

 Economies scale refers to the situation in which

output grows proportionately faster than input.
 Economies of scale or decreasing cost arise
because :
a. Technological reason
b. Financial reason
 CASE STUDY
 Long Run Average Cost (LAC) of small firm as
percentage of LAC of large Firm.
INDUSTRY PERCENTAGE
Hospitals 129
Higher Education 119
Commercial Banking
Demand deposits 116
Installment loans 102
Electric Power 112
Airline (local service) 100
Railroads 100
Trucking 95
 LEARNING CURVE

 The learning curve shows the decline in the

average input cost of production with rising
cumulative total output over time.
Average cost
Learning curve can be expressed
algebraically as follows :

200 C = aQb

100

100 300 Cummulative total output

MINIMIZING COST INTERNATIONALLY- NEW ECONOMIES OF SCALE

Location and Companies that supply specific parts and component for Dell’ PCs
Part/Component Location Company

Monitors Europe and Asia Philips, Nokia, Samsung, Sony, Acer

PCBs Asia, Scotland, and Eastern SCI, Celstica

Europe
Drives Asia, mainly Singapore Saegate, Maxtor, Western Digital

Printers Europe (Barcelona) Acer

Box builds Asia and Eastern Europe Hon Hai/Foxteq

Chassis Asia and Ireland Hon Hai/Foxteq

IMMIGRATION OF SKILLED LABOR