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Lecture Week 11, Cost of Production and Production Function

The document discusses the cost of production in economics. It defines economic cost as the opportunity cost of resources used in production, including both explicit costs like wages and implicit costs like foregone profits from a firm's self-owned resources. Economic profit is defined as total revenue minus both implicit and explicit costs, while accounting profit only deducts explicit costs. The short run is when a firm's plant capacity is fixed, while the long run allows for varying plant capacity. Diminishing marginal returns may occur as more of a variable input is added to a fixed input in production.

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25 views

Lecture Week 11, Cost of Production and Production Function

The document discusses the cost of production in economics. It defines economic cost as the opportunity cost of resources used in production, including both explicit costs like wages and implicit costs like foregone profits from a firm's self-owned resources. Economic profit is defined as total revenue minus both implicit and explicit costs, while accounting profit only deducts explicit costs. The short run is when a firm's plant capacity is fixed, while the long run allows for varying plant capacity. Diminishing marginal returns may occur as more of a variable input is added to a fixed input in production.

Uploaded by

kausar
Copyright
© © All Rights Reserved
Available Formats
Download as PPTX, PDF, TXT or read online on Scribd
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1

THE COST OF
PRODUCTION

Topic # Andleeb Azhar


References
2

 Chapter 8 (All contents including chapter quiz, questions for review,


Problems and Applications are included)
 McConnell, Brue and Flynn, 18th Edition,
 “ Economics:Principles, Problems and Policies (soft copy is
Uploaded on GCR)
Lecture Outline
3

 Economic Cost/Opportunity cost


 Implicit Cost
 Explicit cost
 Economic Profit vs. accounting profit
 Normal Profit vs. Economic Profits
 Short Run Vs. Long Run
 Short Run Production Relationship/Law of Diminishing Marginal Returns
 Total Product
 Average Product
 Marginal Product
Economic Cost
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 Economic cost, or opportunity cost, of any resource used to produce a good is the value or worth the
resource would have in its best alternative use.
 Explicit Cost: It is the cost of resources hired from market and used in production .
 E.g are the monetary payments (or cash expenditures) it makes to those who supply labor services, materials,
fuel, transportation services, and the like. Such money payments are for the use of resources owned by others
Implicit Cost: A firm’s implicit costs are the opportunity costs of using its self-owned, self-employed resources. To
the firm, implicit costs are the money payments that self-employed resources could have earned in their best
alternative use.

Economic Profit = Total Revenue-Implicit cost-explicit cost


Accounting Profit = Total Revenue – Explicit cost

Note economic profits<accounting profit


Why is it important to consider the implicit cost?
Short Run vs. Long Run
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 Short Run: Fixed Plant The short run is a period too brief for a firm to alter its plant
capacity, yet long enough to permit a change in the degree to which the fixed plant is used.
The firm’s plant capacity is fixed in the short run.
 However, the firm can vary its output by applying larger or smaller amounts of labor,
materials, and other resources to that plant. It can use its existing plant capacity more or
less intensively in the short run.

 Long Run: Variable Plant From the viewpoint of an existing firm, the long run is a period
long enough for it to adjust the quantities of all the resources that it employs, including
plant capacity.
 From the industry’s viewpoint, the long run also includes enough time for existing firms to
dissolve and leave the industry or for new firms to be created and enter the industry. While
the short run is a “fixed-plant” period, the long run is a “variable-plant” period.
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 production function…… Output = f (Land, labor, capital, enterprenure, ……..)


 Simple production fuction…..output = f( Labor, Capital)

 Short run production function = f(Labor (variable factor), Capital (fixed factor))
 Long Run production function = f(Labor (variable factor), Capital (variable
factor))
Law of Diminishing Marginal Returns
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 Law of diminishing returns: This law assumes that technology is


fixed and thus the techniques of production do not change. It
states that as successive units of a variable resource (say, labor)
are added to a fixed resource (say, capital or land), beyond some
point the extra, or marginal, product of the variable resource will
decline.
 For example, if additional workers are hired to work with a
constant amount of capital equipment, output will eventually rise
by smaller and smaller amounts as more workers are hired.
Law of Diminishing Marginal Returns
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Law of Diminishing Marginal Returns
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Short Run Production cost
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 Fixed cost: Fixed and does not change with level of output. E.g.
 Variable cost: Changes with level of out put. More output, more
variable cost e.g.
 Marginal cost: change in total cost due to change in output.

 Average cost: cost per unit of output.


Short Run Production cost
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Short Run Production cost
12
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