Module 3: Production and Cost Analysis in the Short Run - Chapter 5 Notes

1. What is Production function?

 Production function is the relationship between a flow of inputs and the resulting flow of outputs in a
production process during a given period of time.
 The production function describes the physical relationship between the inputs or factors of production
and the resulting outputs of the production process. It is essentially an engineering concept, as it
incorporates all of the technology or knowledge involved with the production process.
 The production function illustrates how inputs are combined to produce different levels of output and
how different combinations of inputs may be used to produce any given level of output.
 It shows the maximum amount of output that can be produced with different combinations of inputs.
This concept rules out any situations where inputs are redundant or wasted in production.
 The production function forms the basis for the economic decisions facing a firm regarding the choice of
inputs and the level of outputs to produce.

2. What is the formula for the Production Function?

Q ∙ f(L, K, Mc)
where
Q = quantity of output
L = quantity of labor input
K = quantity of capital input
M = quantity of materials input

 The above indicates that more inputs may be involved with a given production function. There may also
be different types of labor and capital inputs, which we could denote by LA, LB, LC and KA, KB, and KC,
respectively.
 Note that in a production function, capital (K) refers to physical capital, such as machines and buildings,
not financial capital. The monetary or cost side of the production process (i.e., the financial capital
needed to pay for workers and machines) is reflected in the functions that show how costs of production
vary with different levels of output, which we’ll derive later in the chapter.

3. What is a Fixed Input?

 An input whose quantity a manager cannot change during a given period of time.

4. What is a Variable Input?

 An input whose quantity a manager can change during a given period of time.

5. Give an example of a Fixed and a Variable?

 A factory, a given amount of office space, and a plot of land are fixed inputs in a production function.
Automobiles or CD players can be produced in the factory, accounting services can be undertaken in the
office, and crops can be grown on the land.
 However, once a manager decides on the size of the factory, the amount of office space, or the acreage
of land, it is difficult, if not impossible, to change these inputs in a relatively short time period. The
amount of automobiles, CD players, accounting services, or crops produced is a function of the
manager’s use of the variable inputs in combination with these fixed inputs. Automobile workers, steel
and plastic, accountants, farm workers, seed, and fertilizer are all variable inputs in these production
processes. The amount of output produced varies as managers make decisions regarding the quantities
of these variable inputs to use, while holding constant the underlying size of the factory, office space, or
plot of land.

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6. What is a Short-run production function?
 A production process that uses at least one fixed input.

7. What is a Long-run production function?

 A production process in which all inputs are variable.

8. Explain short-run production function?

 A short-run production function involves the use of at least one fixed input. At any given point in time,
managers operate in the short run because there is always at least one fixed input in the production
process.
 Managers and administrators decide to produce beer in a brewery of a given size or educate students in
a school with a certain number of square feet. The size of the factory or school is fixed in the short run
either because the managers have entered into a contractual obligation, such as a rental agreement, or
because it would be extremely costly to change the amount of that input during the time period.

9. Explain Long-run production function?

 In a long-run production function, all inputs are variable. There are no fixed inputs because the quantity
of all inputs can be changed. In the long run, managers can choose to produce cars in larger automobile
plants, and administrators can construct new schools and abandon existing buildings.
 Farmers can increase or decrease their acreage in another planting season, depending on this year’s crop
conditions and forecasts for the future. Thus, the calendar lengths of the short run and the long run
depend on the particular production process, contractual agreements, and the time needed for input
adjustment.

10. What is the Managerial Rule of thumb Short-Run Production and Long-Run Planning?
 Managers always operate in the short run, but they must also have a long-run planning horizon.
Managers need to be aware that the current amount of fixed inputs, such as the size of a factory or
amount of office space, may not be appropriate as market conditions change. Thus, there are more
economic decisions for managers in the long run because all inputs can be changed in that time frame
and inputs can be substituted for each other.

11. What is Total product?

 The total quantity of output produced with given quantities of fixed and variable inputs.

12. What is the Formula for Total product?

TP or Q ∙ f(L, K )
where
TP or Q = total product or total quantity of output produced
L = quantity of labor input (variable)
K = quantity of capital input (fixed)

Equation 5.2 presents the simplest type of short-run production function. It has only two inputs: one fixed (K
)and one variable (L). The bar over the K denotes the fixed input. In this production function, the amount of
output (Q) or total product (TP) is directly related to the amount of the variable input (L), while holding
constant the level of the fixed input (K ) and the technology embodied in the production function.

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13. What are the two productivity measures used to analyze the production process?
 To analyze the production process, we need to define two other productivity measures: average product
and marginal product. The average product is the amount of output per unit of variable input, and the
marginal product is the additional output produced with an additional unit of variable input.

14. What is Average Product?

 The amount of output per unit of variable input.

15. What is Marginal Product?

 The additional output produced with an additional unit of variable input.

16. What are the Formulas for Average Product and Marginal Product?
5.3 AP ∙ TP/L or Q/L
where
AP = average product of labor
5.4 MP ∙ ΔTP/ΔL ∙ ΔQ/ΔL
where
MP = marginal product of labor

17. What are the Relationships Among Total, Average, and Marginal Product?
 Let’s examine how the total, average, and marginal product change as we increase the amount of the
variable input, labor, in this short-run production function, holding constant the amount of capital and
the level of technology. We can see in Table 5.1 that the total product or total amount of output (Column
3) increases rapidly up to 4.5 units of labor. This result means that the marginal product, or the
additional output produced with an additional unit of labor (Column 6), is increasing over this range of
production. Between 4.5 and 10 units of labor, the total product (Column 3) is increasing, but the rate of
increase, or the marginal product, is becoming smaller (Columns 5 and 6). Total product reaches its
maximum amount of 217 units when 10 units of labor are used, but total product decreases if 11 units of
labor are employed. The marginal product of labor is 5 as labor is increased from 9 to 10 units and –6 as
labor is increased from 10 to 11 units (Column 5). Therefore, the marginal product is zero when the total
product is precisely at its maximum value of 217 units (Column 6).

18. Draw a Graph for The short-run production function illustrates the law of diminishing returns:

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 The Short-Run Production Function
The short-run production function illustrates the law of diminishing returns where the marginal product, or
the additional output produced with an additional unit of variable input, eventually decreases.

19. What is Increasing marginal returns?

 The results in that region of the marginal product curve where the curve is positive and increasing, so
that total product increases at an increasing rate.

20. What is Law of diminishing marginal returns or law of the diminishing marginal product?
 The phenomenon illustrated by that region of the marginal product curve where the curve is positive,
but decreasing, so that total product is increasing at a decreasing rate.

21. What is Negative marginal returns?

 The results in that region of the marginal product curve where the curve is negative and decreasing, so
that total product is decreasing.

Watch Elasticity of Demand- Micro Topic 2.3 by Jacob Clifford (2014).

WATCH : https://www.youtube.com/watch?v=xLSRMt-wWAM&ab_channel=JacobClifford

22. Remember the relationships among Total Product and Average Product and Marginal Product.

23. What is a Cost function?

A mathematical or graphic expression that shows the relationship between the cost of production and the
level of output, all other factors held constant.

24. What is Opportunity cost?

The economic measure of cost that reflects the use of resources in one activity, such as a production process
by one firm, in terms of the opportunities forgone in undertaking the next best alternative activity.

25. What is Explicit cost?

 A cost that is reflected in a payment to another individual, such as a wage paid to a worker, that is
recorded in a firm’s bookkeeping or accounting system.

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26. What is Implicit cost?
A cost that represents the value of using a resource that is not explicitly paid out and is often difficult to
measure because it is typically not recorded in a firm’s accounting system.

27. What is Historical cost?

 The amount of money a firm paid for an input when it was purchased, which for machines and capital
equipment could have occurred many years in the past.

28. What is Profit?

 The difference between the total revenue a firm receives from the sale of its output and the total cost

29. What is Accounting profit?

 The difference between total revenue and total cost where cost includes only the explicit costs of
production.

30. What is Economic profit?

 The difference between total revenue and total cost where cost includes both the explicit and any
implicit costs of production.

31. What is Short-run cost function

 A cost function for a short-run production process in which there is at least one fixed input of
production.

32. What is Total fixed cost?

The total cost of using the fixed input, which remains constant regardless of the amount of output produced.

33. What is Total variable cost?

The total cost of using the variable input, which increases as more output is produced.

34. What is Total cost?

 The sum of the total fixed cost plus the total variable cost.

35. What is Average fixed cost?

 The total fixed cost per unit of output.

36. What is Average variable cost?

 The total variable cost per unit of output.

37. What is Average total cost?

 The total cost per unit of output, which also equals average fixed cost plus average variable cost.

38. What is Marginal cost?

 The additional cost of producing an additional unit of output, which equals the change in total cost or the
change in total variable cost as output changes

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39. What are the formulas for Short-Run Cost Functions?

40. Draw the Short-Run Cost Functions?

41. What are the Formulas for Short-Run Production and Cost Functions?

42. What is the Relationship Between Short-Run Production and Cost?

 The shape of the short-run production function in Figure 5.3a determines the shape of the short-run cost
function in Figure 5.3b.

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43. Draw a graph of the Short-run production and Short-run Cost?

44. What is Alternative Short-Run Production and Cost Functions?

 The underlying production function influences the costs of production.

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