Advance Theory of Supply

Short Run Production Cost

Wendell Long
Important concepts:

short-run: the period of time when
the firm still has at least one fixed
factor of production
long-run: the period of time when all
the firms factors of production are
variable
Production function: The
relationship between inputs (factors of
production) and output, so that output
= f(inputs)

enterprise capital labour land
Output
Inputs
Output
oductivity
, , ,
Pr
The law of diminishing
returns/variable proportions
Provided that at least one factor is
held fixed, and additional units of a
variable factors are added to it,
eventually the extra output resulting
from an additional unit of the varying
factor will become successively
smaller.

Assumptions of the law:
1. Factor proportions are changeable. It
is possible to change the ratio of the
variable factor the fixed factors of
production.

2. The law holds good in the short-run.

3. Variable factors are assumed to be
identical.

Assumptions (contd)
4. Prices of variable factors do not
change.

5. Technique of production remains
unchanged,

Limitations:
(1) The art of agriculture should not
change. The law of diminishing return
will not hold good if the cultivator
continues to use improved seeds,
fertilizers, and modern agricultural
implements.
Limitations (contd):
(2) The law may not operate in case of
land which is cultivated for the first
time. If a new land is taken to
cultivation, it will yield increasing
return for the first few years.
Newspaper article on Improve
farming methods

New project aims to increase crop yield
By Jensen LaVende jensen.lavende@trinidadexpress.com

Story Created: Oct 13, 2012 at 9:52 PM ECT

THE Ministry of Food Production is embarking on a project it hopes will
see the level of crop production increase by four times its current rate,
thereby reducing the country's food import bill.
Speaking at the Centre of Excellence, Macoya last Friday at the
"Breakthrough in Agriculture: Increase in Productivity" forum, crop
agronomist Marcus Mycoo told farmers gathered that using crop-specific
treatments would increase their yields.
Mycoo demonstrated how he was able to produce 50-pound cassava
crops within 11 months and edible cassava within four months by
"convincing" the plant to continuously feed even after it had germinated.
APPLY Diminishing returns to:
Planting cassava

Studying



Bake & Shark
APPLY Diminishing returns to:
Cleaning a room



Manufacturing shirts
Relationship among Total Physical Product (TPP),
Average Physical Product (APP) & Marginal Physical
Product (MPP) curves.
Also showing stages of production



APP,
MPP &
TPP





Units of a variable factor (labour)


horizontal intercept
maximum line
TPP
maximum line
maximum line
APP
MPP
W. Long 11
Stage
1
Stage
2
Stage
3
Relationship between Total Physical Product (TPP),
Average Physical Product (APP) & Marginal Physical
Product (MPP) curves (contd):
TPP continues to increase even after MPP
declines, but the amount by which TPP
increases diminishes until it is maximise at
the point where MPP = 0 (as seen in diagram
above).
MPP & APP:- The MPP curve cuts the
maximum point or the top of the APP curve.
So long as the MPP is greater than the APP it
will pull the APP curve towards it, but as soon
as the MPP is less than the APP, then it will
draw the APP down towards it.
MPP & APP:- Both curve eventually fall due
to the law of diminishing marginal
(average) returns.

W. Long 12
The Costs of a Firm Re: Total
Cost
Total Cost: is the cost of all resources
necessary to produce any particular level of
output. It is comprised of fixed costs and
variable costs.
Fixed costs those costs that do not vary
with output in the short-run. They may also
be termed indirect costs.
Variable costs are those costs which vary
with output. Variable costs are zero when
output is zero and use directly with output.
They may also be termed direct costs.
Total cost = fixed cost + variable cost i.e.
TC=FC + VC
W. Long 13
The Costs of a Firm Re: Total Cost an
illustration

TC
VC
FC
Cost
s
Output
0
50
0
W. Long 14
The Costs of a Firm Re: Average
Costs
Average Total cost (Average cost) is the
total cost divided by the number of units of
the commodity produced.
It comprises average fixed cost and average
variable cost.
Average fixed cost (AFC) =
Average Variable cost (AVC) =
ATC = AFC + AVC
Marginal cost this is the additional cost
incurred in producing an additional unit of
output. This is the difference between
preceding total cost minus the presently
considered total cost.
Q
TC
Output
t Total
AC
cos
Q
FC
or
Output
t fixed cos
Q
VC
or
Output
t Variablecos
W. Long 15
The Costs of a Firm Re: Average
Costs & Marginal Cost an illustration
M
C
AC
AFC
AVC
Output
Costs
minimum line
minimum line
Increasing returns
to scale
decreasing returns
to scale
W. Long 16
The relationship between Average Cost (AC), Average
Variable Cost (AVC) and Marginal Costs (MC) curves:

MC declines sharply, reaches a minimum and then rises rather
sharply. This occurs because variable costs increases first by
decreasing amounts, and then by increasing amounts.

MC & AC & AVC: the AC falls as MC falls, but as the MC rises AC
falls at a decreasing rate until the MC intercepts the AC at its lowest
point (optimum point). After this point the MC is above AC and thus
forces AC to rise. The same relationship occurs between MC & AVC

The shape of the Average Cost Curve (AC): As can be seen in the
previous diagram, the shape of the firm's short run AC curve is due
to the firm experiencing a reduced costs with increasing output
(increasing returns to scale), when the MC is below the AC. When
MC is above AC the firm is experiencing increasing costs as output
increases (decreasing returns to scale) thus the AC rises and a
"U"shape occurs.

The U sharp of the short-run AC can also be explain by the law of
diminishing returns/variable proportions , this law states provided
that at least one factor is held fixed, and additional units of a variable
factors are added to it, eventually the extra output resulting from an
additional unit of the varying factor will become successively smaller.




W. Long 17
Costs in the Long-Run
revisited
Economies of scale: cost in the long
run
(all factors of production are now
variable)
Averag
e costs
Output/time
SRAC1
SRAC3
SRAC2
LRAC
Negative slope of the curve
due to increasing returns to
scale
Diseconomies
of scale
W. Long 18
Cost & Revenue part 1
Lecture 8

Wendell Long
Various Revenue Concepts
Total revenue refers to the total amount of
money that the firm receives from the sale of its
output. Total revenue is equal to the quantity
sold multiplied by the selling price. TR = P x Q

Average revenue this is the total revenue
divided by the number of units sold. Average
revenue is always the same as the price of the
commodity.

Marginal revenue this is the additional revenue
obtained from the sale of one more unit of output.
MR is the difference between the preceeding
total revenue and the now being considered total
revenue.
q
pq
q
TR
AR
1

n n n
TR TR MR
W. Long 20
Application of Revenue: perfect
competition
A firms revenue schedule

(1)
Price ($)
(2)
Quantity
1 x 2 = (3)
Total rev.
3/2= (4)
Ave. Rev.
3/2=(5)
Mar. Rev.
6 0 0 6 6
6 1 6 6 6
6 2 12 6 6
6 3 18 6 6
6 4 24 6 6
6 5 30 6 6
6 6 36 6 6
6 7 42 6 6
6 8 48 6 6
6 9 54 6 6
W. Long 21
Revenue curves under Perfect
Competition

MR =
AR
TR
Revenu
e
Output
0
6
W. Long 22
Profit Maximisation: The total approach -
perfect competition (schedule)
Price(P) Quantity
(Q)
Total Rev.
PxQ
Total cost
FC+VC
Profit ()
6 0 0 3 -3
6 1 6 5 1
6 2 12 8 4
6 3 18 12 6
6 4 24 17 7
6 5 30 23 7
6 6 36 10 6
6 7 42 38 4
6 8 48 47 1
6 9 54 58 -4
W. Long 23
Profit Maximisation: The total approach -
perfect competition (graph)

4
TC
TR
TR
,
TC
Quantity
Profit
Breakeven point
Los
s
W. Long 24
Profit Maximisation: The marginal
approach - perfect competition
(schedule)
(1)
P
(2)
Q
1x2=(3)
TR
(4)
TC
3-4=(5)

3/2=(6)
AR
3/2=
(7)
MR
4/2=
(8)
MC
6 0 0 3 -3 - - -
6 1 6 5 1 6 6 2
6 2 12 8 4 6 6 3
6 3 18 12 6 6 6 4
6 4 24 17 7 6 6 5
6 5 30 23 7 6 6 6
6 6 36 10 6 6 6 7
6 7 42 38 4 6 6 8
6 8 48 47 1 6 6 9
6 9 54 58 -4 6 6 10
W. Long 25
Profit Maximisation: The marginal
approach - perfect competition (graph)

Price
Quantity
6 P = MR = AR
MC
5
W. Long 26