Thomas12e Chapter8 12e

Chapter 8
Production & Cost in the

Short Run
© 2016 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in any
manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part. 7-1
Learning Objectives
 Explain general concepts of production and cost
analysis
 Examine the structure of short-run production based on
the relation among total, average, and marginal
products
 Examine the structure of short-run costs using graphs of
the total cost curves, average cost curves, and the
short-run marginal cost curve
 Relate short-run costs to the production function using
the relations between (i) average variable cost and
average product, and (ii) short-run marginal cost and
marginal product
manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.
8-2
Basic Concepts of
Production Theory
 Production function
~ A schedule showing the maximum amount of
output that can be produced from any specified
set of inputs, given existing technology
 Variable proportions production
~ Production in which a given level of output can be
produced with more than one combination of
inputs
 Fixed proportions production
~ Production in which one, and only one, ratio of
inputs can be used to produce a good
8-3
Basic Concepts of
Production Theory
 Technical efficiency
~ Achieved when maximum amount of output is
produced with a given combination of inputs
and technology
 Economic efficiency
~ Achieved when firm is producing a given
output at the lowest possible total cost
8-4
Basic Concepts of
Production Theory
 Inputs are considered variable or fixed depending
on how readily their usage can be changed
 Variable input
~ An input for which the level of usage may be varied to
increase or decrease output
 Fixed input
~ An input for which the level of usage cannot be changed
and which must be paid even if no output is produced
 Quasi-fixed input
~ A “lumpy” or indivisible input for which a fixed amount must
be used for any positive level of output
~ None is purchased when output is zero
8-5
Basic Concepts of
Production Theory
 Short run
~ Current time span during which at least one
input is a fixed input
 Long run
~ Time period far enough in the future to allow
all fixed inputs to become variable inputs
 Planning horizon
~ Set of all possible short-run situations the firm
can face in the future
8-6
Sunk Costs
 Sunk cost
~ Payment for an input that, once made, cannot
be recovered should the firm no longer wish
to employ that input
~ Irrelevant for all future time periods; not part
of the economic cost of production in future
time periods
~ Should be ignored for decision making
purposes
~ Fixed costs are sunk costs
8-7
Avoidable Costs
 Avoidable costs
~ Input costs the firm can recover or avoid
paying should it no longer wish to employ that
input
~ Matter in decision making and should not be
ignored
~ Variable costs and quasi-fixed costs are
avoidable costs
8-8
Inputs in Production (Table 8.1)
Input Type Payment Relation Avoidable Employed in

to Output or Sunk? SR or LR?
Variable Variable cost Direct Avoidable SR & LR
Fixed Fixed costs Constant Sunk SR only
Quasi-fixed Quasi-fixed costs Constant Avoidable If required:
SR & LR
8-9
Short Run Production
 In the short run, capital is fixed
~ Only changes in the variable labor input can
change the level of output
 Short run production function
Q = f (L, K) = f (L)
8-10
Average & Marginal Products
 Average product of labor
~ AP = Q/L
 Marginal product of labor
~ MP = Q/L
 When AP is rising, MP is greater than AP
 When AP is falling, MP is less than AP
 When AP reaches it maximum, AP = MP
 Law of diminishing marginal product
~ As usage of a variable input increases, a point is
reached beyond which its marginal product decreases
8-11
Total, Average, & Marginal Products
of Labor, K = 2 (Table 8.3)
Number of Total product (Q) Average product Marginal product
workers (L) (AP=Q/L) (MP=Q/L)
0 0 -- --
1 52 52 52
2 112 56 60
3 170 56.7 58
4 220 55 50
5 258 51.6 38
6 286 47.7 28
7 304 43.4 18
8 314 39.3 10
9 318 35.3 4
10 314 31.4 -4
8-12
Total, Average, & Marginal Products
K = 2 (Figure 8.1)
8-13
Short Run Production Costs
 Total fixed cost (TFC)
~ Total amount paid for fixed inputs
~ Does not vary with output
 Total variable cost (TVC)
~ Total amount paid for variable inputs
~ Increases as output increases
 Total cost (TC)
TC = TFC + TVC
8-14
Short-Run Total Cost Schedules
(Table 8.5)
Output (Q) Total fixed cost Total variable cost Total Cost
(TFC) (TVC) (TC=TFC+TVC)
0 $6,000 $ 0 $ 6,000
100 6,000 4,000 10,000
200 6,000 6,000 12,000
300 6,000 9,000 15,000
400 6,000 14,000 20,000
500 6,000 22,000 28,000
600 6,000 34,000 40,000
8-15
Total Cost Curves (Figure 8.3)
8-16
Average Costs
 Average fixed cost (AFC)
TFC
AVC 
Q
 Average variable cost (AVC)
TVC
AFC 
Q
 Average total cost (ATC)
TC
ATC   AFC  AVC
Q
8-17
Short Run Marginal Cost
 Short run marginal cost (SMC) measures
rate of change in total cost (TC) as output
varies
TVC TC
SMC  
Q Q
8-18
Average & Marginal Cost Schedules
(Table 8.6)
Output Average Average Average total Short-run

(Q) fixed cost variable cost cost marginal cost
(AFC=TFC/Q) (AVC=TVC/Q) (ATC=TC/Q= (SMC=TC/Q)
AFC+AVC)
0 -- -- -- --
100 $60 $40 $100 $40
200 30 30 60 20
300 20 30 50 30
400 15 35 50 50
500 12 44 56 80
600 10 56.7 66.7 120
8-19
Average & Marginal Cost Curves
(Figure 8.4)
8-20
Short Run Average & Marginal
Cost Curves (Figure 8.5)
8-21
Short Run Cost Curve Relations
 AFC decreases continuously as output
increases
~ Equal to vertical distance between ATC &
AVC
 AVC is U-shaped
~ Equals SMC at AVC’s minimum
 ATC is U-shaped
~ Equals SMC at ATC’s minimum
8-22
Short Run Cost Curve Relations
 SMC is U-shaped
~ Intersects AVC & ATC at their minimum
points
~ Lies below AVC & ATC when AVC & ATC
are falling
~ Lies above AVC & ATC when AVC & ATC
are rising
8-23
Relations Between Short-Run
Costs & Production
 In the case of a single variable input,
short-run costs are related to the
production function by two relations
w w
AVC  and SMC 
AP MP
Where w is the price of the variable input
TC = wL + rK
8-24
Short-Run Production & Cost
Relations (Figure 8.6)
8-25
Relations Between Short-Run
Costs & Production
 When marginal product (average
product) is increasing, marginal cost
(average cost) is decreasing
 When marginal product (average
product) is decreasing, marginal cost
(average variable cost) is increasing
 When marginal product = average
product at maximum AP, marginal cost =
average variable cost at minimum AVC
8-26
Summary
 Technical efficiency occurs when a firm produces
maximum output for a given input combination and
technology; economic efficiency is achieved when the
firm produces a given output at the lowest total cost
~ Production inputs can be variable, fixed, or quasi-fixed inputs
 Short run refers to the current time span during which
one or more inputs are fixed; Long run refers to the
period far enough in the future that all fixed inputs
become variable inputs
 Sunk costs are irrelevant for future decisions and are
not part of economic cost of production in future time
periods; avoidable costs are payments a firm can
recover or avoid, thus they do matter in decisions
8-27
Summary
 The total product curve gives the economically efficient
amount of labor for any output level when capital is
fixed in the short run
 Average product of labor is the total product divided by
the number of workers: AP = Q/L
 Marginal product of labor is the additional output
attributable to using one additional worker with the use
of capital fixed: MP = ∆Q/∆L
 The law of diminishing marginal product states that as
the number of units of the variable input increases,
other inputs held constant, a point will be reached
beyond which the marginal product of the variable input
declines
8-28
Summary
 Short-run total cost, TC, is the sum of total variable
cost, TVC, and total fixed cost, TFC: TC = TVC + TFC
 Average fixed cost, AFC, is TFC divided by output:
AFC = TFC/Q; average variable cost, AVC, is TVC
divided by output: AVC = TVC/Q; average total cost
(ATC) is TC divided by output: ATC = TC/Q
 Short-run marginal cost, SMC, is the change in either
TVC or TC per unit change in output Q
 The link between product curves and cost curves in the
short run when one input is variable is reflected in the
relations , AVC = w/AP and SMC = w/MP, where w is
the price of the variable input
8-29

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Chapter 8

Production & Cost in the

Input Type Payment Relation Avoidable Employed in

Output Average Average Average total Short-run

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