Production and Costs
Class 12 Economics · Introductory Microeconomics · Chapter 3
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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.
Key terms
Production function
The relation giving maximum output for each combination of inputs, \(q=f(L,K)\).
Marginal product
The change in output from employing one more unit of a variable input, \(MP_L=\dfrac{\Delta TP_L}{\Delta L}\).
Law of variable proportions
Marginal product of a variable factor first rises, then falls, as more of it is used with fixed factors.
Returns to scale
How output responds when all inputs are increased in the same proportion.
Total cost
The sum of total fixed cost and total variable cost, \(TC=TFC+TVC\).
Marginal cost
The addition to total cost from producing one more unit, \(SMC=\dfrac{\Delta TC}{\Delta q}\).
Extra questions & answers
Try one from this chapter
A production function gives: