Chapter 3: Production and CostsClass 12 Economics — summary, notes, extra questions & MCQ quiz

Summary

A firm transforms inputs into output, and the production function gives the maximum output obtainable from given quantities of inputs such as labour (L) and capital (K), written \(q=f(L,K)\). In the short run at least one factor is fixed; in the long run all factors can be varied. Three product concepts measure the contribution of a variable input: total product (TP), average product \(AP_L=\dfrac{TP_L}{L}\), and marginal product \(MP_L=\dfrac{\Delta TP_L}{\Delta L}\). The law of variable proportions states that as a variable factor is added to fixed factors, marginal product first rises and then falls; both AP and MP curves are inverse-U shaped, and MP cuts AP from above at AP’s maximum. When all inputs change together we examine returns to scale — increasing, constant or decreasing. On the cost side, total cost is the sum of total fixed cost and total variable cost, \(TC=TFC+TVC\). Per-unit costs are average fixed cost, average variable cost and short-run average cost \(SAC=AVC+AFC\), while marginal cost \(SMC=\dfrac{\Delta TC}{\Delta q}\). AFC falls continuously, SMC, AVC and SAC are U-shaped, and SMC cuts both AVC and SAC from below at their minimum points. In the long run there are no fixed costs and the LRAC and LRMC curves are also U-shaped.

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