Managerial Economics
ninth edition
Thoma
Mauric
Chapter 8
Production & Cost in
the Short Run
McGraw-Hill/Irwin
McGraw-Hill/Irwin
Managerial Economics,
Managerial Economics,
Copyright 2008 by the McGraw-Hill Companies, Inc. All
Managerial Economics
Basic Concepts of Production
Theory
Production function
Maximum amount of output that can be
produced from any specified set of inputs,
given existing technology
Technical efficiency
Achieved when maximum amount of output is
produced with a given combination of inputs
Economic efficiency
Achieved when firm is producing a given
output at the lowest possible total cost
8-2
Managerial Economics
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 changed
quite readily
Fixed input
An input for which the level of usage cannot readily be
changed and which must be paid even if no output is
produced
Quasi-fixed input
An input employed in a fixed amount for any positive
level of output that need not be paid if output is zero
8-3
Managerial Economics
Basic Concepts of Production
Theory
Short run
At least one input is fixed
All changes in output achieved by
changing usage of variable inputs
Long run
All inputs are variable
Output changed by varying usage of all
inputs
8-4
Managerial Economics
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 )
8-5
Managerial Economics
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
8-6
Managerial Economics
Total, Average, & Marginal Products
of Labor, K = 2 (Table 8.2)
Number of
workers (L)
8-7
Total product (Q) Average product
(AP=Q/L)
Marginal product
(MP=Q/L)
--
--
52
52
52
112
56
60
170
56.7
58
220
55
50
258
51.6
38
286
47.7
28
304
43.4
18
314
39.3
10
318
35.3
10
314
31.4
-4
Managerial Economics
Total, Average & Marginal
Products, K = 2 (Figure 8.1)
8-8
Managerial Economics
Total, Average & Marginal Product
Curves
Q2
Q1
Total
product
Panel A
Q0
L0
L1
L2
Panel B
Average
product
L0
8-9
L1
L2
Marginal
product
Managerial Economics
Short Run Production Costs
Total variable cost (TVC)
Total amount paid for variable inputs
Increases as output increases
Total fixed cost (TFC)
Total amount paid for fixed inputs
Does not vary with output
Total cost (TC)
TC = TVC + TFC
8-
Managerial Economics
Short-Run Total Cost Schedules
(Table 8.4)
Output (Q)
0
8-
Total fixed cost
(TFC)
$6,000
Total variable cost
(TVC)
$
Total Cost
(TC=TFC+TVC)
$ 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
Managerial Economics
Total Cost Curves (Figure 8.3)
8-
Managerial Economics
Average Costs
Average variable cost ( AVC )
TVC
AVC
Q
Average fixed cost ( AFC )
TFC
AFC
Q
Average total cost ( ATC )
TC
ATC
AVC AFC
Q
8-
Managerial Economics
Short Run Marginal Cost
Short run marginal cost (SMC)
measures rate of change in total
cost (TC) as output varies
TC TVC
SMC
Q
Q
8-
Managerial Economics
Average & Marginal Cost Schedules
(Table 8.5)
Output
(Q)
8-
Average
Average
fixed cost
variable cost
(AFC=TFC/Q) (AVC=TVC/Q)
--
Average total
cost
(ATC=TC/Q=
AFC+AVC)
Short-run
marginal cost
(SMC=TC/Q)
--
--
--
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
Managerial Economics
Average & Marginal Cost Curves
(Figure 8.3)
8-
Managerial Economics
Short Run Average & Marginal
Cost Curves (Figure 8.5)
8-
Managerial Economics
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 AVCs minimum
ATC is U-shaped
Equals SMC at ATCs minimum
8-
Managerial Economics
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-
Managerial Economics
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
AVC
MP
A
w
and SMC
MP
Where w is the price of the variable input
8-
Managerial Economics
Short-Run Production & Cost
Relations (Figure 8.6)
8-
Managerial Economics
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-
