Econ 24 MICROECONOMICS

By: M. Consignado
 The firm is a price taker in the input/factor
market which means that at the existing
market price, it can buy any level of input it
wants without influencing the market price.

 The firm wants to maximize the output that

can be produced given the quantity of inputs
it uses or it wants to minimize the cost of
inputs required to produce a given quantity of
output.
 Inputs are substitutable to some degree.

 Output refers to “identical goods” whose

productive processes could be embodied in
similar production functions.
 Transformation of inputs into desired outputs
of goods and services

 The production process usually involves

Manufacturing, Assembly and Processing to
produce tangible products known as goods.
 Equation, table or graph showing the
maximum output of a commodity that firm
can produce per period of time with each set
inputs.
 Q = f (K,L)
Quantity output (Q) is a function of capital (K)
and labor (L)

TP = f(I)

Y = f(X)
 The production function is:
F(z1z2)=(1200z1z2)1/2
 This is a Cobb-Douglas production function.
The general form is given below where A, u
and v are positive constants.

y  Az z u

1 2
v
 In a fixed proportions production function,
the ratio in which the inputs are used never
varies.
 In a variable proportion production function,
the ratio of inputs can vary.
 Refers to the additional output that can be
produced by using an additional unit of input.

 The incremental change in the level of output

resulting from an additional unit of variable
input
 Refers to the total output divided by total
amount of a particular input used

 Efficiency of the variable input to be

transformed into output
Marginal Product (MP)
Change in Total Product
Marginal Product =
Change in Labor Input

Average Product (AP)

Total Product
Average Product =
Units of Labor
Postulates that as we use more and more
units of variable input with a given amount of
fixed input, after a point we get diminishing
returns (MP) from variable input.
 Total production function TP (z1) (Z2 fixed at
105) defined as:
TP (z1)=F(z1, 105)
 Marginal product MP(z1)the rate of output
change when the variable input changes
(given fixed amounts of all other inputs).
 MP (z1)=slope of TP (z1)
 SHORT-RUN PRODUCTION
RELATIONSHIPS
Law of Diminishing Returns
Total Product, TP
Total Product

Increasing
Marginal
Average Product, AP, and

Quantity of Labor
Marginal Product, MP

Returns

Average
Product
Marginal
Quantity of Labor Product
 SHORT-RUN PRODUCTION
RELATIONSHIPS
Law of Diminishing Returns
Total Product, TP
Total Product

Diminishing
Marginal
Average Product, AP, and

Quantity of Labor Returns

Marginal Product, MP

Average
Product
Marginal
Quantity of Labor Product
 SHORT-RUN PRODUCTION
RELATIONSHIPS
Law of Diminishing Returns
Total Product, TP
Total Product

Negative
Marginal
Average Product, AP, and

Quantity of Labor
Marginal Product, MP

Returns

Average
Product
Marginal
Quantity of Labor Product
1. When MP exceeds AP, AP is increasing.
2. When MP is less than AP, AP declines.
3. When MP=AP, AP is constant.
Units of Labor Total Product Marginal Average Product
inputs Product

0 0

1 2000

2 3000

3 3500

4 3800

5 3900
 Opportunity cost is the value of the highest
forsaken alternative.
 Sunk costs are costs that, once incurred,
cannot be recovered.
 Avoidable costs are costs that need not be
incurred (can be avoided).
 Fixed costs do not vary with output.
 Variable costs change with output.
 ECONOMIC COSTS
Economic Costs or
Opportunity Costs
Forgoing the
opportunity to produce
alternative goods and
services
Explicit Costs
 ECONOMIC COSTS
Normal Profits
•Treated as a cost
•Required to attract &
retain resources
Economic or Pure Profits
Economic Total
Economic Cost
Profit Revenue
 ECONOMIC COSTS
Profits to an Profits to an
Economist Accountant
T
Economic (opportunity) Costs

Economic O
Profit T
A Accounting
L Profit
Implicit costs
(including a
normal profit) R
E
V
Explicit Accounting
E
Costs
N costs (explicit
U costs only)
E
SHORT RUN AND LONG RUN
Accounting:
Short and long run is based
upon annual chronology.
Economics:
Short run has fixed plant
capacity size.
Long run has variable plant
capacity size.
 SHORT-RUN PRODUCTION COSTS
Fixed Costs
Total Fixed Costs
Total Fixed Costs
Average Fixed Costs = Quantity

Variable Costs
Total Variable Costs
Total Variable Costs
Average Variable Costs = Quantity
 SHORT-RUN PRODUCTION COSTS
Total Cost
Total Fixed and Variable Costs
Total Costs
Average Total Cost = Quantity

Marginal Cost
Total Variable Costs
Change in Total Costs
Marginal Cost = Change in Quantity
 SHORT-RUN PRODUCTION COSTS
Summary of Definitions
Total Fixed Costs = TFC
Total Variable Costs = TVC
Total Costs = TC
Average Fixed Costs = AFC
Average Variable Costs = AVC
Average Total Costs = ATC
Marginal Cost = MC
Number of FC VC TC MC / U AC / U AFC / U AVC / U
Units (PhP) (PhP) (PhP) (PhP) (PhP) (PhP) (PhP)

0 55.00 .0.00

1 55.00 30.00

2 55.00 55.00

3 55.00 75.00

4 55.00 105.00

5 55.00 155.00

6 55.00 225.00

7 55.00 315.00

8 55.00 425.00
 SHORT-RUN COSTS GRAPHICALLY
TC
Combining TVC
With TFC to get TVC
Total Cost Fixed Cost
Costs (dollars)

Total Variable Cost

Cost
TFC
Quantity
 Average variable cost is variable cost per unit
of output. AV(y)=VC(y)/y
 Short-run marginal cost is the rate at which
costs increase in the short-run. SMC(y)=slope
of VC(y)
1. When SMC is below AVC, AVC decreases as y
increases.
2. When SMC is equal to AVC, AVC is constant
(its slope is zero).
3. When SMC is above AVC, AVC increases as y
increases.
 AVC (y’)=w1/AP(z1’)

 The average variable cost function is the

inverted image of the average product
function.
 SMC (y’)=(w1Δz1)/(MP(z’))

 The short-run marginal cost function is the

inverted image of the marginal product
function.
 SHORT-RUN COSTS GRAPHICALLY

MC
Plotting Average and
Marginal Costs ATC
Costs (dollars)

AVC

AFC
Quantity
PRODUCTIVITY AND COST CURVES

Average Product and

Marginal Product
AP
MP
Quantity of labor
MC
Costs (dollars)

AVC

Quantity of output
LONG-RUN PRODUCTION COSTS

For every plant capacity

size...
there is a short-run ATC
curve.
All such plant capacities
can be plotted.
 LONG-RUN PRODUCTION COSTS

Unit Costs

Output
 LONG-RUN PRODUCTION COSTS

Unit Costs

Output
 LONG-RUN PRODUCTION COSTS

The long-run ATC just “envelopes”

all of the short-run ATC curves.
Unit Costs

Output
 LONG-RUN PRODUCTION COSTS

Unit Costs

long-run ATC

Output
 ECONOMIES AND
DISECONOMIES OF SCALE
• Labor Specialization
• Managerial
Specialization
• Efficient Capital
• Other Factors
Diseconomies of Scale
Constant Returns to Scale
graphically presented...
 ECONOMIES AND
DISECONOMIES OF SCALE

Economies
of scale
Unit Costs

long-run ATC

Output
 ECONOMIES AND
DISECONOMIES OF SCALE

Economies Constant returns

of scale to scale
Unit Costs

long-run ATC

Output
 ECONOMIES AND
DISECONOMIES OF SCALE

Economies Constant returns Diseconomies

of scale to scale of scale
Unit Costs

long-run ATC

Output
 ECONOMIES AND
DISECONOMIES OF SCALE

Where extensive
economies of
Unit Costs

scale exist

long-run ATC

Output
 ECONOMIES AND
DISECONOMIES OF SCALE

Where economies
Unit Costs

of scale are
quickly exhausted

long-run ATC

Output
Isoquants
Isocost line
 Various combinations of two inputs that the
firm can use to produce a specific level of
output
 Various combinations of labor and capital that
the firm can hire or rent at given total cost

COST Equation – relates the levels of possible

input usage for any given cost outlay
Co = rK + wL
Where: Co = cost outlay
K,L = inputs
r =market price of capital (rent)
w= market price of labor (wage)
 Isoquant is tangent to isocost line

MRTS LK = w/r
MPL/MPK = w/r
MPL/w = MPK/r
 Refers to the maximum amount of K that a
producer can technically “give up” in order to
use an additional unit of L, while maintaining
the same output level.
 It is the rate by which “ labor can be
substituted for capital while holding output
constant along an isoquant”.
 It is also the negative of the slope of an IQ.
Given:
W=50/hr
R= 100/hr
Q=1000 units
Q=AK∞LВ
A=10
∞=0.4
В=0.6
 Refers to the locus connecting all points of
tangencies of isoquants to isocost lines or all
cost-minimizing input combinations which
the firm will choose in producing different
output levels, holding the prices of inputs
constant.
 A line joining all points of equilibrium (least
cost input combination) for each possible
output level.
economic (opportunity) variable costs
cost total cost
explicit costs average fixed cost (AFC)
implicit costs average variable cost
normal profit (AVC)
economic profit average total cost (ATC)
short run marginal cost (MC)
long run economies of scale
total product (TP) diseconomies of scale
marginal product (MP) constant returns to scale
average product (AP) minimum efficient scale
law of diminishing returns natural monopoly
fixed costs

Copyright McGraw-Hill/Irwin, 2005 BACK END

NEXT:
Pure Competition

Chapter 10