Production and Cost Analysis

Dr Ritesh Kumar Mishra, Department of Finance and Business Economics, University of Delhi
 Production

• Production: is defined as the transformation of inputs into outputs

• The production function: is a purely technical relation which connects factor inputs and
outputs. The production function includes all the technically efficient methods or production.

• A method of production (process, activity) is a combination of factor inputs required for

the production of one unit of output. Usually a commodity may be produced by various
methods of production. For example, a unit of commodity x may be produced by the
following processes:
 Production
• Production Activities may be presented graphically
by the length of lines from the origin to the point
determined by the labour and capital inputs.

• The three processes (as presented in previous

slide) are shown in figure.

• A method of production A is technically efficient

relative to any other method B, if A uses less of at
least one factor and no more from the other
factors as compared with B.

• Method B is technically inefficient as compared

with A.

• The basic theory of production concentrates only

on efficient methods. Inefficient methods will not
be used by rational entrepreneurs.
 Production
Technically inefficient:
The set of points in the
production set at which the firm is getting
• The figure depicts this possibility by showing the less output from its labor than it could.
production function for a single input, labor:

Q = f(L)

• Points on or below the production function make up

the firm’s production set.

• Production set: The set of technically feasible

combinations of inputs and outputs.

• If we invert the production function, we get a function:

L = g(Q)

• which tells us the minimum amount of labor L

Technically inefficient:
required to produce a given amount of output Q. This The set of points in the
function is the labor requirements function. production set at which the firm is getting
less output from its labor than it could.
 The Production Function
• Production function – Function showing the highest output that a firm can produce for every
specified combination of inputs.

• Although in practice firms use a wide variety of inputs, we will keep our analysis simple by focusing on
only two, labor L and capital K. We can then write the production function as:

• This equation relates the quantity of output to the quantities of the two inputs, capital and labor.

• For example, the production function might describe the number of personal computers that can be
produced each year with a 10,000-squarefoot plant and a specific amount of assembly-line labor.

• Or it might describe the crop that a farmer can obtain using specific amounts of machinery and
workers.
 Short Run versus & Long Run in Production

• It takes time for a firm to adjust its inputs to produce its product with differing amounts of labor and
capital.

• A new factory must be planned and built, and machinery and other capital equipment must be ordered
and delivered. Such activities can easily take a year or more to complete.

• As a result, if we are looking at production decisions over a short period of time, such as a month or
two, the firm is unlikely to be able to substitute very much capital for labor.

• Short run – It is the period of time in which quantities of one or more production factors cannot be changed.

• Long run – It a time period in which the firm has enough time to make all production inputs variable.
 Production with One Variable Input (Labor)
• When deciding how much of a particular input to buy, a firm has to compare the benefit that will result with
the cost of that input.

• Sometimes it is useful to look at the benefit and the cost on an incremental basis by focusing on the
additional output that results from an incremental addition to an input.

• In other situations, it is useful to make the comparison on an average basis by considering the result of
substantially increasing an input.

• When capital is fixed but labor is variable, the only way the firm can produce more output is by increasing
its labor input.

• Imagine, for example, that you are managing a clothing factory. Although you have a fixed amount of
equipment, you can hire more or less labor to sew and to run the machines.

• You must decide how much labor to hire and how much clothing to produce. To make the decision, you will
need to know how the amount of output q increases (if at all) as the input of labor L increases.
 Production with One Variable Input (Labor)
• Table 6.1 (next slide) gives this information. The first three columns show the amount of
output that can be produced in one month with different amounts of labor and capital fixed at
10 units.

• The first column shows the amount of labor, the second the fixed amount of capital, and the
third total output.

• In the table, when labor input is zero, output is also zero.

• Output then increases as labor is increased up to an input of 8 units. Beyond that point, total
output declines: Although initially each unit of labor can take greater and greater advantage
of the existing machinery and plant, after a certain point, additional labor is no longer useful
and indeed can be counterproductive.

• Five people can run an assembly line better than two, but ten people may get in one
another’s way.
Production with One Variable Input (Labor)

Increasing Marginal
Product of labour

Declining Marginal
Product of labour

Negative Marginal
Product of labour
 The Slopes of the Product Curve
• Figure (based on table 6.1, see previous slide)
shows the average and marginal product curves.
(The units on the vertical axis have changed from
output per month to output per worker per month.)
• Note that the marginal product is positive as long as
output is increasing, but becomes negative when
output is decreasing.
• The average product and marginal product curves
are closely related. When the marginal product is
greater than the average product, the average
product is increasing. This is the case for labor
inputs up to 4 in Figure.
• Similarly, when the marginal product is less than
the average product, the average product is
decreasing. This is the case when the labor input is
greater than 4 in Figure.
• We can see that the marginal product is above the
average product when the average product is
increasing and below the average product when the
average product is decreasing.
• It follows, therefore, that the marginal product must
equal the average product when the average
product reaches its maximum. This happens at
point E in Figure.
The Slopes of the Product Curve
 Average Product of Variable Input (Labor)
• We are now ready to characterize the productivity of the firm’s labor input.

• There are two related, but distinct, notions of productivity that we can derive from the
production function.

• The first is the average product of labor (𝑨𝑷𝑳 ). The average product of labor is the
average amount of output per unit of labor:
 Marginal Product of Variable Input (Labor)
• The other notion of productivity is the marginal product of labor (𝑀𝑃𝐿 ).

• The marginal product of labor is the rate at which total output changes as the firm changes
its quantity of labor:

• In most production processes, as the quantity of one input (e.g., labor) increases, with the
quantities of other inputs (e.g., capital and land) held constant, a point will be reached
beyond which the marginal product of that input decreases.

• This phenomenon, which reflects the experience of real-world firms, seems so pervasive
that economists call it the law of diminishing marginal returns.
 Relationship Between Marginal & Average Product

• There is a systematic relationship between average product and marginal product. Figure
6.3 (next slide) illustrates this relationship:

• When average product is increasing in labor, marginal product is greater than average
product. That is, if 𝐴𝑃𝐿 increases in L, then 𝑀𝑃𝐿 > 𝐴𝑃𝐿 .

• When average product is decreasing in labor, marginal product is less than average
product. That is, if 𝐴𝑃𝐿 decreases in L, then 𝑀𝑃𝐿 < 𝐴𝑃𝐿 .

• When average product neither increases nor decreases in labor because we are at a
point at which 𝐴𝑃𝐿 is at a maximum (point A in Figure 6.3), then marginal product is
equal to average product.
Relationship Between Marginal & Average Product
 The Law of Diminishing Marginal Returns
• Law of Diminishing Marginal Returns – the principle that as the use of an input (for
example Labour) increases with other fixed inputs (i.e. capital), the resulting additions to
output will eventually decrease.

• When the labor input is small (and capital is fixed), extra labor adds considerably to output,
often because workers are allowed to devote themselves to specialized tasks.

• Eventually, however, the law of diminishing marginal returns applies: When there are too
many workers, some workers become ineffective and the marginal product of labor falls.

• The law of diminishing marginal returns usually applies to the short run when at least one
input is fixed. However, it can also apply to the long run.

• So in the short-run when at least one factor input is fixed and we are changing the quantity
of other factor, the change in output is subject to Law of variable proportions.
The Law of Diminishing Marginal Returns
 The Three Stages of Production in the Short run
• In competitive markets, the short-run production function can be divided into three distinct
stages of production.

• To illustrate this phenomenon, let us focus on the data in Table 6.3. Assume – X (is units of
Labour) and Y (is units of capital).

• TP, MP, and AP resulting from increases in X, while holding Y constant at 2 units. The table
indicate that the total product is 7 when 1 unit of X (labour) is used, it increases to a
maximum of 54 when 7 units of X (labour) are used, and it decreases to 52 units when unit
8 of the X input is added.

• Also notice in Table 6.3 that MP begins at 7 units, increases to a maximum of 12, and falls
off to an ultimate value of -2. Average product also begins at 7, increases to a maximum of
10, and then drops to 6.5 units when 8 units of X (i.e. labour) are combined with the fixed
amount of Y (capital). The pattern of these changes can be seen in Figure 6.1.
The Three Stages of Production in the Short run
 The Three Stages of Production in the Short run
• As the figure indicates, Stage I runs from zero to four units of the variable input X (i.e., to the
point at which average product reaches its maximum).

• Stage II begins from this point and proceeds to seven units of input X (i.e., to the point at
which total product is maximized).

• Stage III continues on from that point.

• According to economic theory, in the short run, “rational” firms should only be operating in
Stage II.

• It is clear why Stage III is irrational: The firm would be using more of its variable input to
produce less output! However, it may not be as apparent why Stage I is also considered
irrational.

• The reason is that if a firm were operating in Stage I, it would be grossly underusing its fixed
capacity. That is, it would have so much fixed capacity relative to its usage of variable inputs
that it could increase the output per unit of variable input (i.e., average product) simply by
adding more variable inputs to this capacity.
The Three Stages of Production (the Short run)
 The Three Stages of Production (the Short run)

• If it is still not clear about the irrational nature of Stage I, there is an alternative
explanation.

• In Figure 6.3b (see previous slide), we have designated two levels of variable input
usage: 𝑋1and 𝑋2.

• Here we see that the average product is the same whether 𝑋1 or 𝑋2 units of the variable
input (labor in our case) are used.

• If output per variable input is the same regardless of which input level is used, the firm
should employ 𝑋2 units of labour because the total product will be higher.

• Because up to 𝑋2 units of labour, the Marginal product of labour is still positive (though
declining), hence, new worker is still adding positively in the total output.
 How much a rational firm will produce?
• Question – Where will a rational firm operate/produce? Answer: a rational firm with an
objective to maximize profit will operate in the second stage of production.

• Question – Then how do we identify the second stage of production? Answer: we can
identify with the following conditions:
 How much a rational firm will produce?

• The basic theory of production usually concentrates on

the range of output over which the marginal products of
factors, although positive, but decrease.

• That is, it focuses only over the range of diminishing (but

non-negative) productivity of the factors of production.

• The ranges of output considered by the traditional theory

are A'B' in figure 3.8 in figure 3.9.

• Alternatively we may say that the theory of production

concentrates on levels of employment of the factors over
which their marginal products are positive but decrease
(AB in figure 3.10).
 The Optimal use of Variable Input
• How much labour (the variable input) should the firm use in order to maximize profits?

• The answer is that the firm should employ an additional unit of labor as long as the extra revenue
generated from the sale of the output produced exceeds the extra cost of hiring the unit of labor. That
is until the extra revenue equals the extra cost.

• The extra revenue generate by the use of an additional unit of labour is called the Marginal Revenue
Product of labor (𝑀𝑅𝑃𝐿 ),which is equal to – the marginal product of labor times the marginal revenue
from the sale of the extra unit of output produced:

𝑴𝑹𝑷𝑳 =(𝑴𝑷𝑳 )(𝑴𝑹)

• The extra cost of hiring an additional unit of labor or Marginal Resource Cost (𝑀𝑅𝐶𝐿 ) is equal to the
increase in the total cost to the firm resulting from hiring the additional unit of labour:

∆𝑻𝑪
𝑴𝑹𝑪𝑳 =
∆𝑳
 The Optimal use of Variable Input
• Table 7-3 provides details of firm XYZ which is in stage of production. Column 3 of the table givens
the marginal revenue of Rs. 300 from the sale of each additional units of the commodity produced, on
the assumption that the firm is small and can sell the additional units of the product at the market price
P (of Rs. 100).

• From the table we see that the firm should hire 3.5 units of labour because that is where 𝑴𝑹𝑷𝑳=
𝑴𝑹𝑪𝑳= Rs. 200
The Optimal use of Variable Input
 Technology and Diminishing Marginal Returns
• The law of diminishing marginal returns applies to a
given production technology.
• Over time, however, inventions and other
improvements in technology may allow the entire
total product curve in Figure to shift upward, so that
more output can be produced with the same inputs.
• Figure illustrates this principle. Initially the output
curve is given by O1, but improvements in
technology may allow the curve to shift upward, first
to O2, and later to O3.
• Suppose, for example, that over time, as labor is
increased in agricultural production, technological
improvements are being made.
• These improvements might include genetically
engineered pest-resistant seeds, more powerful and
effective fertilizers, and better farm equipment.
• As a result, output changes from A (with an input of 6
on curve O1) to B (with an input of 7 on curve O2) to
C (with an input of 8 on curve O3).
Sources of New Production Technology
 The Long-run: Production with Two Variable Inputs
• We have so far discussed the
short-run production function
in which one input, labor, is
variable, and the other,
capital, is fixed.

• Now we turn to the long run,

for which both labor and
capital are variable.

• The firm can now produce its

output in a variety of ways by
combining different amounts
of labor and capital.

• Let’s begin by examining the

production technology of a
firm that uses two inputs and
can vary both of them.

• Suppose that the inputs are

labor and capital and that they
are used to produce food.

• The given Table tabulates the

output achievable for various
combinations of inputs.
 The Isoquants
• The information in previous table can also be
represented graphically using isoquants.

• An isoquant is a curve that shows all the

possible combinations of inputs that
yield the same output.

• Isoquant map Graph combining a number of

isoquants, used to describe a production
function.

• For example, isoquant 12Q shows all

combinations of labor and capital per year
that together yield 12 units of output per year.

• A higher isoquant (further away from the origin)

indicates higher level of output.
 Substitution Among Inputs: MRTS
• With two inputs that can be varied, a manager will want to
consider substituting one input for another.
• The slope of each isoquant indicates how the quantity of one
input can be traded off against the quantity of the other, while
output is held constant.
• When the negative sign is removed, we call the slope the
marginal rate of technical substitution (MRTS).
• The marginal rate of technical substitution of labor for capital is
the amount by which the input of capital can be reduced when
one extra unit of labor is used, so that output remains constant.

• In Figure the MRTS is equal to 2 when labor increases from 1

unit to 2 and output is fixed at 75. However, the MRTS falls to 1
when labor is increased from 2 units to 3, and then declines to
2/3 and to 1/3.
• Clearly, as more and more labor replaces capital, labor
becomes less productive and capital becomes relatively more
productive.
• Therefore, we need less capital to keep output constant, and
the isoquant becomes flatter.
 Slope of isoquant
• The MRTS (slope of isoquant) is closely related to the marginal
products of labor MPL and capital MPK.
• To see how, imagine adding some labor and reducing the amount of
capital sufficient to keep output constant.
• The additional output resulting from the increased labor input is equal
to the additional output per unit of additional labor (the marginal product
of labor) times the number of units of additional labor:

• Similarly, the decrease in output resulting from the reduction in capital

is the loss of output per unit reduction in capital (the marginal product
of capital) times the number of units of capital reduction:

• Because we are keeping output constant by moving along an isoquant,

the total change in output must be zero. Thus,
 Types of isoquant: Substitutability of Inputs

• Linear isoquant: This type assumes perfect

substitutability of factors of production: a
given commodity may be produced by using
only capital, or only labour, or by an infinite
combination of K and L

• Input-output isoquant: This assumes strict

complementarity (that is, zero substitutability)
of the factors of production. There is only one
method of production for any one commodity.
The isoquant takes the shape of a right angle.
This type of isoquant is also called 'Leontief
isoquant' after Leontief, who invented the
input output analysis. This also called fixed-
proportions isoquant.

• Smooth, convex isoquant : This form

assumes continuous substitutability of K and
L only over a certain range, beyond which
factors cannot substitute each other. The
isoquant appears as a smooth curve convex
to the origin
 Economic and Uneconomic Regions of Production
• Consider the Table 6.4 which contains the
details of Production Function for
Semiconductors using two inputs labour and
capital.
• From this table we see that two different
combinations of labor and capital—(L = 6, K
= 18) and (L = 18, K = 6)—result in an output
of Q = 25 units (where each “unit” of output
represents a thousand semiconductors).
• Thus, each of these input combinations is on
the Q = 25 isoquant.
• The fact that the isoquants (Figure 6.8, next
slide) are downward sloping illustrates an
important economic trade-off: A firm can
substitute capital for labor and keep its
output unchanged.
• If we apply this idea to a semiconductor firm,
it tells us that the firm could produce a given
quantity of semiconductors using lots of
workers and a small number of robots or
using fewer workers and more robots.
• Such substitution is always possible
whenever both labor and capital (e.g.,
robots) have positive marginal products.
Economic and Uneconomic Regions of Production
 Economic and Uneconomic Regions of Production

• The isoquants, as discussed in previous slide, are downward sloping: in the range of values
of labor and capital shown in the graph, as we increase the amount of labor we use, we can
hold output constant by reducing the amount of capital.

• But look at Figure 6.9, which shows the same isoquants when we expand the scale of
Figure 6.8 to include quantities of labor and capital greater than 24,000 man-hours and
machine-hours per day.

• The isoquants now have upward-sloping and backward-bending regions. What does this
mean?

• The upward-sloping and backward-bending regions correspond to a situation in which one

input has a negative marginal product, or what we earlier called diminishing total returns.
 Economic and Uneconomic Regions of Production

• For example, the upward-sloping region in Figure 6.9 occurs because there are diminishing
total returns to labor (MPL < 0), while the backward bending region arises because of
diminishing total returns to capital (MPK < 0).

• If we have diminishing total returns to labor, then as we increase the quantity of labor,
holding the quantity of capital fixed, total output goes down.

• Thus, to keep output constant (remember, this is what we do when we move along an
isoquant), we must also increase the amount of capital to compensate for the diminished
total returns to labor.

• A firm that wants to minimize its production costs should never operate in a region of
upward-sloping or backward-bending isoquants.
 Economic and Uneconomic Regions of Production
• For example, a semiconductor producer should not operate at a point such as A in Figure 6.9
where there are diminishing total returns to labor.

• The reason is that it could produce the same output but at a lower cost by producing at a
point such as E.

• By producing in the range where the marginal product of labor is negative, the firm would be
wasting money by spending it on unproductive labor.

• For this reason, we refer to the range in which isoquants slope upward or bend backward as
the uneconomic region of production.

• By contrast, the economic region of production is the region of downward-sloping

isoquants. From now on, we will show only the economic region of production in our graphs.
Economic and Uneconomic Regions of Production
 Returns to Scale
• In the long run, with all inputs variable, the firm • Given the two factor Production Function:
must also consider the best way to increase
output.
• One way to do so is to change the scale of the
operation by increasing all of the inputs to Q = F ( Labour , Capital )
production in proportion.
• If it takes one farmer working with one harvesting
machine on one acre of land to produce 100
bushels of wheat, what will happen to output if we • If we increase both the factor inputs by some amount,
put two farmers to work with two machines on two h, then the total output will increase by some amount,
acres of land? phi:
• Output will almost certainly increase, but will it

Q = F (hL, hK )
double, more than double, or less than double?
Returns to scale is the rate at which output
increases as inputs are increased proportionately.

• Increasing returns to scale – Situation in • Then, if:

which output more than doubles when all inputs
are doubled. If  = h, then F has constant returns to scale.
• Constant returns to scale – Situation in which
output doubles when all inputs are doubled. If  > h, then F has increasing returns to scale.
If  < h, then F has decreasing returns to scale.
• Decreasing returns to scale – Situation in
which output less than doubles when all inputs
are doubled.
 Returns to Scale

• From Left to Right (in the Figure)

• Figure 1: Constant Returns to scale

• Figure 2: Increasing Returns to Scale
• Figure 3: Decreasing Returns to scale
 Varying Returns to Scale

• Many production functions have increasing

returns to scale for small amounts of
output, constant returns for moderate
amounts of output, and decreasing returns
for large amounts of output.
• With a small firm, increasing labor and
capital may produce gains from
cooperation between workers and greater
specialization of workers and equipment—
returns to specialization—resulting in
increasing returns to scale.
• Firm growth eventually exhausts returns to
scale. With no more returns to
specialization, the production process
exhibits constant returns to scale.
• If the firm continues to grow, managing the
staff becomes more difficult, so the firm
suffers from decreasing returns to scale.
• Figure shows such a pattern
 The Empirical Production Function
• Cobb- Douglas Production Function: this form of production function was popularized by Charles W. Cobb
(a mathematician), and Paul H. Douglas (an economist and U.S. senator).

• Cobb- Douglas Production Function: A production function of the form:

Q = AL K 
• where Q is the quantity of output from L units of labor and K units of capital and where A, α, and β are
positive constants.

• Hsieh (1995) estimated a Cobb-Douglas production function for a U.S. firm producing electronics and other
electrical equipment as:

q=L 0.5
K 0.5

• With the Cobb–Douglas production function, capital and labor can be substituted for each other. The
elasticity of substitution for a Cobb–Douglas production function falls somewhere between 0 and ∞.

• In fact, it turns out that the elasticity of substitution along a Cobb–Douglas production function is always
equal to 1.
 Cobb- Douglas Production Function & Returns to Scale
• Does a Cobb–Douglas production function • From this, we can see that if:
exhibit increasing, decreasing, or constant
returns to scale?

• Let L1 and K1 and Q1 be the initial quantities

of labor and capital, and the initial output:

• Now let’s increase all input quantities by the

same proportional amount λ, where λ > 1, and • This shows that the sum of the exponents α + β in the
let Q2 denote the resulting volume of output: Cobb–Douglas production function determines
whether returns to scale are increasing, constant, or
decreasing.

• For this reason, economists have paid considerable

attention to estimating this sum when studying
production functions in specific industries.
 Cobb- Douglas Production Function: Estimates for INDIA
• In an empirical study, Chandan Sharma and Ritesh Kumar Mishra (Does export and productivity growth linkage
exist? Evidence from the Indian manufacturing industry, International Review of Applied Economics, Vol. 25, No.
6, November 2011, 633–652) estimated the Cobb-Douglas production for different industries in india.
Cobb- Douglas Production Function: Estimates for USA
Cobb- Douglas Production Function: Estimates for USA
 Cobb- Douglas Production Function: Estimates for USA

• Moroney (1967) estimated Cobb-Douglas production for many industries in the US economy as
presented in the below table:

• Though it is an old study and since then firms’ production technologies in USA have changed
considerably, but the estimates suggest that most of the firms are operating around Constant Returns
to Scale.
The Cost of Production
 Cost Minimizing Combinations of inputs

• Given a firm’s production technology, managers must decide how to produce. As we saw, inputs can
be combined in different ways to yield the same amount of output (the isoquants).

• For example, one can produce a certain output with a lot of labor and very little capital, with very little
labor and a lot of capital, or with some other combination of the two.

• Now we see how the optimal—i.e., cost-minimizing—combination of inputs is chosen.

• We will also see how a firm’s costs depend on its rate of output and show how these costs are likely to
change over time.

• We begin by explaining how cost is defined and measured, distinguishing between the concept of cost
used by economists, who are concerned about the firm’s future performance, and by accountants, who
focus on the firm’s financial statements.
 Measuring Cost

Economic Cost & Accounting Cost

Economic cost – Cost to a firm of utilizing economic Accounting cost – Actual expenses plus depreciation charges
resources in production. for capital equipment
Or Or
The sum of the firm’s explicit costs and implicit costs The total of explicit costs that have been incurred in the past.

Implicit Cost & Explicit Cost

Implicit Costs – Costs Explicit Costs – Costs

that do not involve outlays of cash that involve a direct monetary outlay
 Measuring Cost
• Opportunity Cost – The value of the next best alternative that is forgone when another alternative is
chosen.
• To illustrate, suppose that you own and manage your own business and that you are contemplating
whether you should continue to operate over the next year or go out of business.

To operate or
not

1- If you remain in business, you will need to spend 1- The opportunity cost of continuing in business over the
$100,000 (to hire workers) + $80,000 (to purchase raw next year is $255,000.
materials) + you spend 80 hours of your time every week
in your business. 2- Opportunity Cost = $180,000 (the required cash outlays
for labor and materials) + an implicit cost of $75,000
2- Your best alternative to managing your own business (the income that you forgo by continuing to manage
is to work the same number of hours in a corporation for your own firm).
an income of $75,000 per year.

The concept of opportunity cost is forward looking in that it

If you go out of business, you will not need to incur measures the value that the decision maker sacrifices at
these expenses the time the decision is made and beyond.
 Measuring Cost
• To analyze costs, we also need to distinguish between sunk and nonsunk costs. When assessing the
costs of a decision, the decision maker should consider only those costs that the decision actually
affects. Some costs have already been incurred and therefore cannot be avoided, no matter what
decision is made.

Sunk (Unavoidable) Versus Nonsunk (Avoidable) Costs

Costs that have already been Costs that are incurred only if a
incurred and cannot be recovered particular decision is made

Example: Consider a sporting goods firm that manufactures bowling balls. Let’s assume that a bowling ball factory costs $5 million to build and
that, once it is built, the factory is so highly specialized that it has no alternative uses. Thus, if the sporting goods firm shuts the factory down
and produces nothing, it will not “recover” any of the $5 million it spent to build the factory.

1 - In deciding whether to build the factory, the $5 million is a nonsunk cost. It is a cost the sporting goods firm incurs only if it builds the
factory.

2- After the factory is built, the $5 million is a sunk cost. It is a cost the sporting goods firm incurs no matter what it late r chooses to do with the
factory, so this cost is unavoidable.

When deciding whether to operate the factory or shut it down, the sporting goods firm therefore should ignore this cost.
 Measuring Cost
• Fixed cost (FC): Cost that does not vary with the level of output and that can be eliminated only by
shutting down.
• Depending on circumstances, fixed costs may include expenditures for plant maintenance, insurance, heat and
electricity, and perhaps a minimal number of employees. They remain the same no matter how much output the
firm produces.

• Variable cost (VC): Cost that varies as output varies.

• Variable costs, which include expenditures for wages, salaries, and raw materials used for production, increase as output
increases.

• Fixed cost does not vary with the level of output—it must be paid even if there is no output. The only way that a
firm can eliminate its fixed costs is by shutting down.

• Over a very short time horizon—say, a few months—most costs are fixed. Over such a short period, a firm is
usually obligated to pay for contracted shipments of materials and cannot easily lay off workers, no matter how
much or how little the firm produces.

• On the other hand, over a longer time period—say, two or three years—many costs become variable. Over this
time horizon, if the firm wants to reduce its output, it can reduce its workforce, purchase fewer raw materials, and
perhaps even sell off some of its machinery.
Fixed, Variable and Sunk Costs
Marginal and Average Cost
Figure
7.1
 The Shapes of the Cost Curves
• Figure 7.1 (previous slide) illustrates how various cost measures change as output changes.

• The top part of the figure shows total cost and its two components, variable cost and fixed cost; the
bottom part shows marginal cost and average costs.

• These cost curves, which are based on the information in Table 7.1 (see previous slide), provide
different kinds of information.

• Observe in Figure (a) that fixed cost FC does not vary with output—it is shown as a horizontal line at
$50. Variable cost VC is zero when output is zero and then increases continuously as output
increases.

• The total cost curve TC is determined by vertically adding the fixed cost curve to the variable cost
curve. Because fixed cost is constant, the vertical distance between the two curves is always $50.
Figure (b) shows the corresponding set of marginal and average variable cost curves.

• Whenever marginal cost lies below average cost, the average cost curve falls.
• Whenever marginal cost lies above average cost, the average cost curve rises.
• When average cost is at a minimum, marginal cost equals average cost.
 The User Cost of Capital
• The User Cost of Capital: Annual cost of owning and using a capital asset, equal to economic
depreciation plus forgone interest.

• Let’s suppose that Delta Airlines is thinking about purchasing a new Boeing 777 airplane for $150 million.
We will assume that the life of the airplane is 30 years; the amortized cost is therefore $5 million per year.
The $5 million can be viewed as the annual economic depreciation for the airplane.

• So far, we have ignored the fact that had the firm not purchased the airplane, it could have earned interest
on its $150 million. This forgone interest is an opportunity cost that must be accounted for.

• Therefore, the user cost of capital— the annual cost of owning and using the airplane instead of selling it
or never buying it in the first place—is given by the sum of the economic depreciation and the interest (i.e.,
the financial return) that could have been earned had the money been invested elsewhere.

• Formally: or
 Equilibrium of Firm: The Cost-Minimizing Input Choice
• We now turn to a fundamental problem that all firms face:
how to select inputs to produce a given output at minimum
cost.
• For simplicity, we will work with two variable inputs: labor
(measured in hours of work per year) and capital
(measured in hours of use of machinery per year).
• The amount of labor and capital that the firm uses will
depend, of course, on the prices of these inputs.
• The Isocost Line – The set of combinations of labor and
capital that yield the same total cost for the firm.
• To see what an isocost line looks like, recall that the total
cost C of producing any particular output is given by the
sum of the firm’s labor cost wL and its capital cost rK:

• If we rewrite the total cost equation as an equation for a

straight line, we get:

• It follows that the isocost line has a slope of K L = -(w/r),

which is the ratio of the wage rate to the rental cost of
capital.
 Equilibrium of Firm: The Cost-Minimizing Input Choice
• Suppose we wish to produce at an output level q1. How can we
do so at minimum cost?
• Look at the firm’s production isoquant, labeled q1, in Figure.
The problem is to choose the point on this isoquant that
minimizes total cost.
• Figure illustrates the solution to this problem. Suppose the firm
were to spend C0 on inputs. Unfortunately, no combination of Slope of Isoquant = Slope
inputs can be purchased for expenditure C0 that will allow the of isocost
firm to achieve output q1.
• However, output q1 can be achieved with the expenditure of
C2, either by using K2 units of capital and L2 units of labor, or
by using K3 units of capital and L3 units of labor. But C2 is not
the minimum cost.
• The same output q1 can be produced more cheaply, at a cost of
C1, by using K1 units of capital and L1 units of labor. In fact,
isocost line C1 is the lowest isocost line that allows output q1 to
be produced.
• The point of tangency of the isoquant q1 and the isocost line C1
at point A gives us the cost-minimizing choice of inputs, L1 and
K1, which can be read directly from the diagram.
• At this point, the slopes of the isoquant and the isocost line are
just equal.
• That is cost minimizing level of output or also equilibrium
of firm.
 Long-run Cost-minimization Problem
• Figure 7.2 (see next slide) shows two isocost lines and the isoquant corresponding to Q0 units
of output.

• The solution to the firm’s cost-minimization problem occurs at point A, where the isoquant is just tangent to an
isocost line. That is, of all the input combinations along the isoquant, point A provides the firm with the lowest
level of cost.

• To verify this, consider other points in Figure 7.2, such as E, F, and G:

• Point G is off the 𝑄0 isoquant altogether. Although this input combination could produce 𝑄0 units of output, in
using it the firm would be wasting inputs (i.e., point G is technically inefficient). This point cannot be optimal
because input combination A also produces 𝑄0 units of output but uses fewer units of labor
and capital.

• Points E and F are technically efficient, but they are not cost-minimizing because they are on an isocost line
that corresponds to a higher level of cost than the isocost line passing through the cost-minimizing point A.
By moving from point E to A or from F to A, the firm can produce the same amount of output,
but at a lower total cost.
Long-run Cost-minimization Problem
 Long-run Cost-minimization Problem
• Note that the slope of the isoquant at the cost-minimizing point A is equal to the slope of the
isocost line.

• We know that the negative of the slope of the isoquant is equal to the marginal rate of
𝑀𝑃
technical substitution of labor for capital, 𝑀𝑅𝑇𝑆𝐿,𝐾 and that 𝑀𝑅𝑇𝑆𝐿,𝐾 = 𝐿 . Thus, the cost-
𝑀𝑃𝐾
minimizing condition occurs when:
 Long-run Cost-minimization Problem
• To see why the condition must hold, consider a non–cost-minimizing point in Figure 7.2 (see
previous slide), such as E.

• At point E, the slope of the isoquant is more negative than the slope of the isocost line.

𝑀𝑃𝐿 𝑊 𝑀𝑃𝐿 𝑀𝑃𝐾

• Therefore, -( ) < -( ), or 𝑀𝑃𝐿 /𝑀𝑃𝐾 > w/r, or > .
𝑀𝑃𝐾 𝐿 𝑤 𝑟

• This condition implies that a firm operating at E could spend an additional dollar
on labor and save more than one dollar by reducing its employment of capital services in
a manner that keeps output constant.

• Since this would reduce total costs, it follows that an input combination, such as E, at which
equilibrium condition does not hold cannot be cost-minimizing.
 Equilibrium of Firm: Change in Price of One Input
• When the expenditure on all inputs increases, the slope of
the isocost line does not change because the prices of the
inputs have not changed. The intercept, however, increases.
• Suppose that the price of one of the inputs, such as labor,
were to increase. In that case, the slope of the isocost line -
(w/r) would increase in magnitude and the isocost line would
become steeper.
• Figure shows this. Initially, the isocost line is C1, and the firm
minimizes its costs of producing output q1 at A by using L1
units of labor and K1 units of capital.
• When the price of labor increases, the isocost line becomes
steeper. The isocost line C2 reflects the higher price of labor.
• Facing this higher price of labor, the firm minimizes its cost
of producing output q1 by producing at B, using L2 units of
labor and K2 units of capital.
• The firm has responded to the higher price of labor by
substituting capital for labor in the production process.
• It follows that when a firm minimizes the cost of producing a
particular output, the following condition holds:

• or
 The Expansion Path of the Firm
• Now we extend this analysis to see how the firm’s costs depend on its output level. To do this, we determine
the firm’s cost-minimizing input quantities for each output level and then calculate the resulting cost.
• The cost-minimization exercise yields the result illustrated by Figure. We have assumed that the firm can
hire labor L at w = $10/hour and rent a unit of capital K for r = $20/hour.
• Given these input costs, we have drawn three of the firm’s isocost lines. Each isocost line is given by the
following equation:

C = ($10/hour)(L) + ($20/hour)(K)

• In Figure, the lowest (unlabeled) line represents a cost of $1000, the middle line $2000, and the highest line
$3000.
• You can see that each of the points A, B, and C in Figure is a point of tangency between an isocost curve
and an isoquant. Point B, for example, shows us that the lowest-cost way to produce 200 units of output is
to use 100 units of labor and 50 units of capital; this combination lies on the $2000 isocost line.
• The curve passing through the points of tangency between the firm’s isocost lines and its isoquants is its
expansion path. The expansion path describes the combinations of labor and capital that the firm will
choose to minimize costs at each output level.
 Application: Self Reading
• Going “beyond the curves”: current production issues and challenges for
today’s managers
 Long-Run Average Cost
• Long-run average cost curve (LAC) Curve relating average
cost of production to output when all inputs, including capital,
are variable.
• Long-run marginal cost curve (LMC) Curve showing the
change in long-run total cost as output is increased
incrementally by 1 unit.

• Figure shows a typical long-run average cost curve (LAC)

consistent with this description of the production process.
Like the short-run average cost curve (SAC), the long-run
average cost curve is U-shaped, but the source of the U-
shape is increasing and decreasing returns to scale, rather
than diminishing returns to a factor of production.

• The long-run marginal cost curve (LMC) can be

determined from the long-run average cost curve; it
measures the change in long-run total costs as output is
increased incrementally. LMC lies below the long-run average
cost curve when LAC is falling and above it when LAC is
rising.

• The two curves intersect at A, where the long-run average

cost curve achieves its minimum. In the special case in which
LAC is constant, LAC and LMC are equal.
 Possible Shapes of the Long-Run Average Cost
• Depending on the production technology used and skill of managers in organizing the production
process so as delay the onset of diseconomies of scale, different firms can witness different shapes
of LAC:
 Economies and Diseconomies of Scale
• Economies of Scale – As output increases, the firm’s average cost of producing that output is likely to
decline, at least to a point. This can happen for the following reasons:

• If the firm operates on a larger scale, workers can specialize in the activities at which they are most productive.
• Scale can provide flexibility. By varying the combination of inputs utilized to produce the firm’s output, managers
can organize the production process more effectively.
• The firm may be able to acquire some production inputs at lower cost because it is buying them in large quantities
and can therefore negotiate better prices. The mix of inputs might change with the scale of the firm’s operation if
managers take advantage of lower-cost inputs.

• Diseconomies of Scale – At some point, however, it is likely that the average cost of production will
begin to increase with output. There are three reasons for this shift:

• At least in the short run, factory space and machinery may make it more difficult for workers to do their jobs
effectively
• Managing a larger firm may become more complex and inefficient as the number of tasks increases.
• The advantages of buying in bulk may have disappeared once certain quantities are reached. At some point,
available supplies of key inputs may be limited, pushing their costs up.
Economies and Diseconomies of Scale
 Economies of Scope
• Many firms produce more than one product. Sometimes a firm’s products are closely linked to one
another:
• A chicken farm, for instance, produces poultry and eggs,
• An automobile company produces automobiles and trucks,
• An university produces teaching and research.

• At other times, firms produce physically unrelated products.

• In both cases, however, a firm is likely to enjoy production or cost advantages when it produces two
or more products.

• These advantages could result from the:

• Joint use of inputs
• Or joint use of production facilities,
• Joint marketing programs,
• Or possibly the cost savings of a common administration.

• In some cases, the production of one product yields an automatic and unavoidable byproduct that is
valuable to the firm. For example, sheet metal manufacturers produce scrap metal and shavings that
they can sell.
 Economies of Scope

Economies & Diseconomies of Scope

Situation in which joint output Situation in which joint output of

of a single firm is greater than a single firm is less than could
output that could be achieved be achieved by separate firms
by two different firms when each when each produces a single
produces a single product. product.

• This possibility could occur if the production of one product somehow conflicted with the production of the second.

• There is no direct relationship between economies of scale and economies of scope. A two-output firm can enjoy
economies of scope even if its production process involves diseconomies of scale.

• Suppose, for example, that manufacturing flutes and piccolos jointly is cheaper than producing both separately. Yet the
production process involves highly skilled labor and is most effective if undertaken on a small scale.

• Likewise, a joint-product firm can have economies of scale for each individual product yet not enjoy economies of
scope. Imagine, for example, a large conglomerate that owns several firms that produce efficiently on a large scale but
that do not take advantage of economies of scope because they are administered separately.
 The Degree of Economies of Scope
• In reality many firms produce more than one product. For example, ITC and Godrej, Bajaj.

• For a firm that produces two products, total costs would depend on the quantity Q1 of the first product the firm
makes and the quantity Q2 of the second product it makes. We will use the expression TC(Q1, Q2) to denote
how the firm’s costs vary with Q1 and Q2.

• Economies of Scope – a production characteristic in which the total cost of producing given quantities of two
goods in the same firm is less than the total cost of producing those quantities in two single-product firms.

• Mathematically, economies of scope are present when:

• The zeros in the expressions on the right-hand side of above equation indicate that the single-product firms
produce positive amounts of one good but none of the other.

• These expressions are sometimes called the stand-alone cost of producing goods 1 and 2.

• Intuitively, the existence of economies of scope tells us that “variety” is more efficient than “specialization.
 The Degree of Economies of Scope

• Degree of economies of scope (SC) =

• C(q1) represents the cost of producing only output q1, C(q2) represents the cost of producing only output q2,
and C(q1, q2) the joint cost of producing both outputs.

• With economies of scope, the joint cost is less than the sum of the individual costs. Thus, SC is greater than
0.

• With diseconomies of scope, SC is negative.

 The Degree of Economies of Scope

• The extent to which there are economies of scope can also be determined by studying a firm’s costs. If a
combination of inputs used by one firm generates more output than two independent firms would produce, then it
costs less for a single firm to produce both products than it would cost the independent firms.
• To measure the degree to which there are economies of scope, we should ask what percentage of the cost of
production is saved when two (or more) products are produced jointly rather than individually.

Degree of economies of scope (SC) =

• C(q1) represents the cost of producing only output q1, C(q2) represents the cost of producing only output q2,
and C(q1, q2) the joint cost of producing both outputs.

• With economies of scope, the joint cost is less than the sum of the individual costs. Thus, SC is greater than 0.

• With diseconomies of scope, SC is negative.

• In general, the larger the value of SC, the greater the economies of scope.
Case_FedEx Ground
 Economies of Experience: The Learning Curve
• The Learning Curve: As a firm gains experience in the production of a commodity or
service, its average cost of production usually declines.

• In other words, for a given level of output per time period, the increasing cumulative total
output over many time periods often provides the manufacturing experience that enables
the firm to significantly lower its cost of production.

• The learning curve shows the decline in the average input cost of production with rising
cumulative total output of the firm over time.

• For example, it might take 1,000 hours for an aircraft manufacturer to assemble the 100 th
aircraft, but only 700 hours to assemble the 200 th aircraft because as managers and
workers gain experience they usually become more efficient, especially when the production
process is relatively new.

• See figure 8-7 (next slide) for learning curve.

 Economies of Experience: The Learning Curve
• The figure shows a learning
curve that indicates that the
average cost declines from
about Rs. 250 for producing
the 100th unit of the product
(point F) to about Rs. 200 for
producing the 200 th unit
(point G) and to about Rs.
165 for the 400 th unit (point
H).

• Note that the average cost

declines at a decreasing rate
so that the learning curve is
convex to the origin.

• This is the usual shape of the

learning curve – firms usually
achieve the largest decline in
average cost when the
production process is
relatively new and less
decline as the firm matures.
 The Learning Curve
• The learning curve can be expressed algebraically as follows:

𝑪 = 𝒂𝑸𝒃

• Where C is the average input cost of the Qth unit of output, a is the average cost of the first
unit of output, and b will negative because the average input cost declines with increases in
cumulative total output. The greater the value of b, the faster the average input cost
declines.

• Taking the logarithm of both sides of the above equation, we can write:

𝐥𝐨𝐠 𝑪 = 𝐥𝐨𝐠 𝒂 + 𝒃 𝐥𝐨𝐠 𝑸

• In the above logarithmic form, b is the slope of learning curve.

 The Learning Curve: Practice Problem
• The parameters of the learning curve (as expressed in log form, see previous slide) can estimated by
regression analysis with a given data on average cost and cumulative output.

• Suppose that we have following estimated learning curve equation:

𝐥𝐨𝐠 𝑪 = 𝟑 − 𝟎. 𝟑 𝐥𝐨𝐠 𝑸

• The estimated value of log a = 3, and b = -0.3. thus the average cost of 100th unit is:

𝐥𝐨𝐠 𝑪 = 𝟑 − 𝟎. 𝟑 𝐥𝐨𝐠 𝟏𝟎𝟎

• Since the log of 100 is 2 (one can obtain using a calculator), we have

𝐥𝐨𝐠 𝑪 = 𝟑 − 𝟎. 𝟑(𝟐)
= 𝟑 − 𝟎. 𝟔
= 𝟐. 𝟒

• Since the antilog of 2.4 is 251.19, the average input cost (c) of the 100 th unit of output is Rs. 251.19
 Economies of Experience vs Economies of Scale
• Contract this with economies of scale, which refers to declining long-run average cost as the firm’s
output per time period increases.

• The left panel of figure 8.13 (see next slide) shows a learning curve that indicates that the average
cost declines from $10 for producing the 10th unit of the product (point H), to $7 for producing the 20th
unit (point T) to $5 for producing 40th unit if the product (point W). So as cumulative grows (along the
horizontal axis) the average cost decline (on the vertical axis).

• The difference between the reduction in cost due to LEARNING and due to INCREASING RETURNS
TO SCALE is clarified in the right panel of the figure.

• Reduction in LAC due to increasing returns to scale – movement from point D to point F along
the same LAC curve as output per time period increases.

• Reduction in LAC due to Learning – downward shift in the LAC curve, say from point D to D*, for a
given level of output per time period, but as the firm learns from a larger total cumulative output over
many periods.
The Learning Curve
 Reasons for the Learning Effect on cost in production

• Learning-by-Doing and the Experience Curve: Economies of scale refer to the cost advantages that flow
from producing a larger output at a given point in time.

• Economies of experience (or learning effect) refer to cost advantages that result from accumulated
experience over an extended period of time, or from learning-by-doing, as it is sometimes called.

• Economies of experience arise for several reasons:

• Workers often take longer to accomplish a given task the first few times they do it. As they become more adept,
their speed increases.
• Managers learn to schedule the production process more effectively, from the flow of materials to the organization
of the manufacturing itself.
• Engineers who are initially cautious in their product designs may gain enough experience to be able to allow for
tolerances in design that save costs without increasing defects.
• Better and more specialized tools, as made and used overtime, and plant organization may also lower cost.
• Suppliers may learn how to process required materials more effectively and pass on some of this advantage in the
form of lower costs
 Practice Question – 1
• Question – Explain (a) why to the right of ridge line OB in Fig. 6-16 we have
stage III for labor and (b) why above ridge line OA in this figure we have stage III
for capital.
• Answer – (a): Ridge line OB joins points C, D, E, and F at which isoquants I, II,
III, and IV have zero slope (and thus zero MRTSLK). To the left of OB, the
isoquants are negatively sloped. To the right of OB, the isoquants are positively
sloped. This means that starting from point C on isoquant I, if the firm used more
labor, it would also have to use more capital in order to remain on isoquant I. If it
used more labor with the same amount of capital, the level of output would fall.
The same is true at points D, E, and F. Therefore, the MPL must be negative to
the right of ridge line OB. This corresponds to stage III for labor. (Note that the
quantities of capital indicated by points C, D, E, and F are the minimum amounts
of capital to produce the output indicated by isoquants I, II, III, and IV. Also, at
points C, D, E, and F, the MRTSLK = MPL/MPK = 0/MPK = 0.)
• Answer – (b): Ridge line OA joins G, H, J, and M at which isoquants I, II, III, and
IV have infinite slope (and thus infinite MRTSLK). Above ridge line OA, the
isoquants are positively sloped. Thus, starting at point G on isoquant I, if
the firm used more capital, it would also have to use more labor in order to
remain on isoquant I. If it used more capital with the same amount of labor, the
level of output would fall. The same is true at points H, J, and M. Therefore, the
MPK must be negative above ridge line OA. This corresponds to stage III for
capital. (Note that the quantities of labor indicated by points G, H, J, and M are
the minimum amounts of labor to produce the output indicated by isoquants I, II,
III, and IV. Also, at points G, H, J, and M, the MRTSLK = MPL/
MPK = MPL/0 = infinity.)
 Practice Question – 2
• Explain what is meant by (a) constant returns to scale, (b) increasing returns to scale, and (c) decreasing returns to scale.
Explain briefly how each of these might arise.
• Answer:
 Practice Question – 3
• Question – Which set of isoquants in Fig. 6-24 shows (a) constant returns to scale, (b) increasing returns to scale, and (c)
decreasing returns to scale?
 Practice Question – 3

• Answer:

• (a) Panel B shows constant returns to scale. It shows that when we double both inputs, we double output; if we
triple all inputs, we triple the level of output. Thus, OG = GH = HJ (and similarly for any other ray from the origin).
Note that output expands along ray OE (and the K/L ratio remains unchanged), as long as relative factor prices
remain unchanged.

• (b) The case of increasing returns to scale is shown in panel A, where an increase in both inputs in a given
proportion causes a more than proportionate increase in output. Thus, OM > MN > NR. Once again, if relative
factor prices remain unchanged, output expands along ray OD.

• (c) Panel C shows decreasing returns to scale. Here, to double output per unit of time, the firm must more than
double the quantity of both inputs used per unit of time. Thus, OS < ST < TZ.
 Practice Question – 4
• Question – (a) What are some of the implicit costs incurred by an entrepreneur in running a firm? How are these implicit costs
estimated? Why must they be included as part of costs of production? (b) What price does the firm pay to purchase or hire the
factors it does not own?

• Answer:
• (a) An entrepreneur must include as part of the costs of production not only what this person actually pays out to hire labor,
purchase raw and semi-finished materials, borrow money, and rent land and buildings (the explicit costs) but also the maximum
salary that the entrepreneur could have earned working in a similar capacity for someone else (say, as the manager of another
firm). Similarly, the entrepreneur must include as part of the costs of production the return in the best alternative use from the
capital, land, and on any other factor of production that this person owns and uses in the enterprise. These resources owned
and used by the firm itself are not “free” resources. The (implicit) cost to the firm involved in using them is equal to the (best)
alternatives foregone (i.e., what these same resources would have earned in their best alternative use). Whenever we speak of
costs in economics or draw cost curves, we always include both explicit and implicit costs.

• (b) For the inputs which the firm purchases or hires, the firm must pay a price at least equal to what these same inputs could
earn in their best alternative use. Otherwise, the firm could not purchase them or retain them for its use. Thus the cost to the firm
involved in the use of any input, whether owned by the firm (implicit cost) or purchased (explicit cost), is equal to what the same
input could earn in its best alternative use. This is the alternative or opportunity cost doctrine.
 Practice Question – 5
• Question: (a) On the same set of axes, plot the TFC, TVC,
and TC schedules in below Table (b) Explain the reason for
the shape of the curves.

• Answer – (b): Since TFC remain constant at $120 per time

period regardless of the level of output, the TFC curve is
parallel to the horizontal axis and $120 above it, TVC are zero
when output is zero and rise as output rises. Before the
law of diminishing returns begins to operate, TVC increase at
a decreasing rate. After the law of diminishing returns begins
to operate, TVC increases at an increasing rate. Thus the
TVC curve begins at the origin and is positively sloped. It is
concave downward up to the point of inflection and concave
upward thereafter. Since TC equal TFC plus TVC, the TC
curve has exactly the same shape as the TVC curve but is
everywhere $120 above it. In drawing the TFC, TVC, and TC
curves, all resources are valued according to their opportunity
cost, which includes explicit and implicit costs. Also, the TFC,
TVC, and TC curves indicate respectively the minimum TFC,
TVC, and TC of producing various output levels per time
period.
 Further Readings

• Robert Pindyck and Daniel Rubinfeld, Microeconomics, 8th Eds, Ch. 6 & 7.

• Christopher R. Thomas and S. Charles Maurice, Managerial Economics, 12th Eds, ch. 8 & 9.

• David Besanko and Ronald Braeutigam, Microeconomics, 6th eds, ch.8 for learning curve