PRODUCTION

AND COST
ANALYSIS
Production
Production is the transformation of
inputs to outputs.
Production Function
The production function shows the
relation between input changes and
output changes. It is a mathematical
equation to find out the different variables
in computing or solving production
function.
The production function is
expressed as:

Q = f (K, L, M)
SHORT-RUN VS.
LONG-RUN
ANALYSIS OF
PRODUCTION
The Short-Run

The short-run analysis is using one factor

variable of production that cannot be changed.
The Long-Run

The long-run analysis connotes that all factors

can be changed.
Hypothetical data of production with with one variable
input
Points Land Labor TP AP MP

A 1 0 0 0 0

B 1 1 4 4 4

C 1 2 10 5 6

D 1 3 18 6 8

E 1 4 24 6 6

F 1 5 28 5.6 4

G 1 6 30 5 2

H 1 7 30 4.29 0

I 1 8 28 3.5 -2

J 1 9 24 2.67 -4
PRODUCTION WITH ONE VARIABLE INPUT

The quantity of only one input, keeping the

other input quantities unchanged, then the
quantity of its output obtained at any quantity
of the variable input .
PRODUCTION WITH TWO VARIABLE INPUTS
• ISOCOST- shows the different combinations of capital and
labor that producers can purchase or hire their total outlay and
the other factors.
K

ISOCOST CURVE

L
 SHIFTING OF ISOCOST
K
To the right- increase in total outlay
To the left- decease in total outlay

INITIAL ISOCOST

L
• ISOQUANT- shows the different combinations of capital and labor which yield the
same level of output. Isoquants have 3 characteristics; negatively slope, convex to
the origin and it do not intersect.

Shift to the right- increase in production

Shift to the left- decrease in production
 Isoquant 1 Isoquant 2 Isoquant 3
POINTS LABOR CAPITAL LABOR CAPITAL LABOR CAPITAL
A 2 22 4 26 6 30
B 1 16 3 20 5 24
C 2 10 4 14 6 18
D 3 6 5 10 7 14
E 4 4.6 6 8.4 8 12.4
F 5 3.6 7 7 9 11
G 6 3.2 8 6.4 10 10.6
H 7 3.6 9 7 11 11
MARGINAL RATE OF TECHNICAL SUBSTITUTION (MRTS)

It is the amount of capital that a producer is willing to give up in

exchange for labor.
 ISOQUANT 1 ISOQUANT 2 ISOQUANT 3
POINTS
LABOR CAPITAL MRTS LABOR CAPITAL MRTS LABOR CAPITAL MRTS

A 2 22 4 26 6 30
B 1 16 3 20 5 24
C 2 10 6 4 14 6 6 18 6
D 3 6 4 5 10 4 7 14 4
E 4 4.6 1.4 6 8.4 1.6 8 12.4 1.6
F 5 3.6 1 7 7 1.4 9 11 1.4
G 6 3.2 0.4 8 6.4 0.6 10 10.6 0.4
H 7 3.6 9 7 11 11
• TOTAL OUTPUT (or total product)
The total amount of output produced in physical units
such as bags of fertilizer, bottles of vinegar, or pairs of
shoes.
• AVERAGE PRODUCT
The total output divided by the quantity of the
variable
inputs under consideration.
• MARGINAL PRODUCT
The additional output attributed to the increase in the
quantity of the variable inputs under consideration.
The Law of Diminishing Marginal Return
States that in a production process, as one input variable is
increased, there will be a point at which the marginal per unit
output will start to decrease.
Type of Resource

•Fixed Resource – there’ s no change as you produce

more.

•Variable Resource – do change with the more that you

produce.
The Law Of Diminishing Marginal Returns is usually
represented in graphical form using three curves:

• Marginal Product Curve - shows the change in amount of

production per input.

• Total Product Curve - shows the change in production with

progressive increase in one production input.

• Average Product Curve - shows the change in average

production.
Labor Total Product Marginal Average
(No. Pizza) Product Product
0 0 - -
1 5 5 5
2 15 10 7.5
3 20 5 6.67
4 22 2 5.5
5 22 0 4.4
6 18 -4 3
 Making Pizza
25

20

Total Product
Total Product

15

10

5
STAGE II
STAGE I STAGE III
0
0 1 2 3 4 5 6
Labor
 Point of Maximum
Yield
20
MP Point of Diminishing
AP Returns
15

10
AP
MP
5

0
0 1 2 3 4 5 6

-5
STAGE I Labor
STAGE II STAGE III
Three Stage of production
Stage 1 : Most Productive
- Input leads to productive return. It pays to invest more
time and effort.
Stage 2 : Diminishing Returns
- Each added input leads to a decreasing rate of output. It’s
best to stop somewhere within this phase.
Three Stage of production
Stage 3 : Negative Returns
- Never get here. Not only do you not get a return for your
effort, you decrease your overall output.
COST ANALYSIS
Introduction of Cost
• Economic costs includes the payments such as rent, wages, interest and
profit, which are paid to factors of production – i.e. land, labor, capital,
entrepreneurship for their services.
Opportunity Cost
• Factors of production or resources, in an economy are limited and have alternative
uses. The cost of sacrifice or foregone for the next best use of resources is known
as opportunity cost.

Sunk Cost
• A cost that already has been incurred and thus cannot be
recovered.
Cost Functions
• Short Run Cost Function
• Long Run Cost Function
Short-Run Cost Function
• In short-run, some of the firm’s input are fixed and some are variable, and
this leads to fixed and variable costs.
• Fixed Cost
• Variable Cost
• Total Cost
• Average Fixed Cost
• Average Variable Cost
• Average Total Cost
• Marginal Cost
Short-Run Costs Function
• Fixed Cost
Fixed costs are those costs which do not change with the
change in level of output.
• Variable Cost
Variable costs are those costs which change with the change
in level of output when output is zero, the variable cost also zero. It will
increase with the increase in level of output. E.g electricity charges
Short-Run Cost Function
• Total Cost
Total cost is the cost of all the productive resources used by
the firm.
TC=TFC+TVC
• Average Fixed Cost
It can be calculated by dividing total fixed cost with the level
of output. As the level of output increases, the average fixed cost
decreases.
AFC=TFC/Q
Short-Run Cost Function
• Average Variable Cost
It is the per unit cost of the variable factors of production. It
can be calculated dividing total variable cost by output.
AVC=TVC/Q
• Average Total Cost
Average cost is the total cost per unit. It can be found out as
follows
ATC=TCP/Q
Short-Run Cost Function
• Marginal Cost
Marginal cost is an addition made to total cost by the production of
one more unit of output.
MC= TC/ Q
Calculation Table
Short-Run Curves
Long-Run Cost Curves
• In long-run all the factors of production are changeable. In long-run a firm can
increase its capacity, equipment, machinery, land, employee, etc. in order to
increase the output.
Long-Run Cost Curves
• Long-run total cost is the minimum total costs of producing various levels
of output when the firm can build any desired scale of plant.
LTC=f(Q)
Long-Run Cost Curves
• Long-Run Average Cost is the minimum per unit cost of producing any
level of output when the firm can build any desire scale of plant.
LAC=LTC/Q
• Long-Run Marginal Cost is the change in long-run total costs per unit
change in output.
LMC= LTC/ Q
Long-Run Cost Curves
Long-Run Cost Curves