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# Chapter Six

Cost of Production
Factors

 Fixed Factor
 Variable Factor
 Time Factor
Fixed Factors

##  Factors which do not increase or decrease

with amount of output of good that firm is
producing.
 Example: Factory building, plant, equipment,
permanent staff etc
 Whether output is zero or increasing some of
the fixed factors are used
Variable Factor

##  Factors which increase or decrease with the

output level of good produced.
 Example: Raw material, Labor
 It increases with the level of output
increases. When there is no good produced
there is no usage of variable factor.
Time factor

 Short-run
 Long-run
Short-Run Production Relationship

Labor-Output relationship
Given fixed plant capacity

## Total Product (TP): Total Quantity or output of a

particular product.

## Marginal Product (MP): Additional Output associated

MP = Changes in TP / Changes in Labor input
Short-Run Production Relationship

## Marginal Product (MP): Additional Output

MP = Changes in TP / Changes in Labor input

## Average Product (AP): labor productivity, output

per unit of labor input
AP = TP / Units of Labor
Short-Run Production Relationship
(1) (2) MP, Changes in AP,
Units of TP (2) / Changes in (2)/(1)
(1)
labor
0 0 -- --
1 10 10 10
Increasing
2 25 15 12.5
Marginal
3 45 20 Returns 15
4 60 15 15
5 70 10 Diminishing 14
Marginal
6 75 5 Returns 12.5
7 75 0 10.71
Law of Diminishing Returns

 Assume
• Technology is fixed.
• Techniques of production do not change.
• All units of labor are of equal quality.
 It refers to how the marginal contribution of a factor
of production usually decreases as more of the factor
is used
 Each additional unit of the variable input (Labor)
yields smaller and smaller increases in output.
 First labor employed gives more productivity as
compared to next last.
Law of Diminishing Returns

##  When workers cause more congestions then

marginal productivity would become
negative.
TP

Total
Products

Quantity of Labor
TP
Relationship between MP and AP:
Total
Products When MP exceeds AP, AP rises, when
MP is less than AP, then AP declines.

Quantity of Labor

## Increasing Diminishing Negative

Marginal Marginal Marginal
Returns Return Return
Marginal
product

AP
Quantity of Labor / marginal and
average products
MP
Short-Run Production Cost:

 Fixed cost
 Variable Cost
 Total Cost (FC+VC)
 Variable cost can be controlled or altered in
short run but not Fixed cost.
Short-Run Production Cost:

## Per Unit or Average cost;

Average Fixed Cost
AFC = Total Fixed Cost (TFC) / Q

## Average Variable Cost

AVC = Total Variable Cost (TVC) / Q
AFC

ATC

AVC

AFC
Short-Run Production Cost:

##  At low level of output, production is

relatively inefficient

## Marginal Cost (MC):

MC = change in TC / change in Q
MC

ATC

AVC

AFC
Minimum Efficient Scale (MES)

##  Which is lowest level of output at which a

firm can minimize its long-term average
cost.
 Given demand curve efficient production will
be achieved with large scale producer. Small
scale firms can not realize minimum efficient
scale.
 Natural monopoly: average total cost is
minimized when only one firm produces
particular goods and services
Applications
Rising cost of Insurance companies

##  9/11 terrorist attack

 Increase cost of security and cameras
Successful Start-Up Firms

##  These firms reduce their cost by moving high

to low point on their short-run cost
 Their ability to spread huge product
development and advertising cost over large
number of goods.
Daily Newspaper

##  Resources to produce newspaper: reporters,

delivery people, photographers, editors,
management, printing press, ink makers,
loggers, loggers truck delivery, and so on.
 Yet sell for \$0.50 per newspapers.
 They are achieving economies of scale.
The End