PRODUCTION and COSTS

1. Econ 11-UPLB PRODUCTION and COSTS Economics 11 University of the Philippines Los Banos

3. Theory of Production and Costs Focus- mainly on the the firm. We will examine Its production capacity given available resources the related costs involved

4. What is a firm? A firm is an entity concerned with the purchase and employment of resources in the production of various goods and services. Assumptions: the firm aims to maximize its profit with the use of resources that are substitutable to a certain degree the firm is" a price taker in terms of the resources it uses.

5. The Production Function The production function refers to the physical relationship between the inputs or resources of a firm and their output of goods and services at a given period of time, ceteris paribus. The production function is dependent on different time frames. Firms can produce for a brief or lengthy period of time.

6. Firm�s Inputs Inputs - are resources that contribute in the production of a commodity.  Most resources are lumped into three categories: Land, Labor, Capital.

7. Fixed vs. Variable Inputs Fixed inputs -resources used at a constant amount in the production of a commodity. Variable inputs - resources that can change in quantity depending on the level of output being produced. The longer planning the period, the distinction between fixed and variable inputs disappears, i.e., all inputs are variable in the long run.

8. Production Analysis with One Variable Input Total product (Q) refers to the total amount of output produced in physical units (may refer to, kilograms of sugar, sacks of rice produced, etc) The marginal product (MP) refers to the rate of change in output as an input is changed by one unit, holding all other inputs constant.

9. Total vs. Marginal Product Total Product (TPx) = total amount of output produced at different levels of inputs Marginal Product (MPx) = rate of change in output as input X is increased by one unit, ceteris paribus.

10. Production Function of a Rice Farmer

12. Marginal Product The marginal product refers to the rate of change in output as an input is changed by one unit, holding all other inputs constant. Formula:

13. Marginal Product Observe that the marginal product initially increases, reaches a maximum level, and beyond this point, the marginal product declines, reaches zero, and subsequently becomes negative. The law of diminishing returns states that "as the use of an input increases (with other inputs fixed), a point will eventually be reached at which the resulting additions to output decrease"

14. Total and Marginal Product

15. Law of Diminishing Marginal Returns As more and more of an input is added (given a fixed amount of other inputs), total output may increase; however, as the additions to total output will tend to diminish. Counter-intuitive proof: if the law of diminishing returns does not hold, the world�s supply of food can be produced in a hectare of land.

16. Average Product (AP) Average product is a concept commonly associated with efficiency. The average product measures the total output per unit of input used. The "productivity" of an input is usually expressed in terms of its average product. The greater the value of average product, the higher the efficiency in physical terms. Formula:

21. Relationship between Average and Marginal Curves: Rule of Thumb When the marginal is less than the average, the average decreases. When the marginal is equal to the average, the average does not change (it is either at maximum or minimum) When the marginal is greater than the average, the average increases

22. Relationship between Average and Marginal Curves: Example of Econ 11 Scores When the marginal score (new exam) is less than your average score, the average decreases. When the marginal score (new exam) is equal to the average score, the average does not change. When the marginal score (new exam) is greater than your average score, the average increases.

25. Three Stages of Production In Stage I APL is increasing so MP>AP. All the product curves are increasing Stage I stops where APL reaches its maximum at point A. MP peaks and then declines at point C and beyond, so the law of diminishing returns begins to manifest at this stage

26. Three Stages of Production Stage II starts where the APL of the input begins to decline. QL still continues to increase, although at a decreasing rate, and in fact reaches a maximum Marginal product is continuously declining and reaches zero at point D, as additional labor inputs are employed.

27. Three Stages of Production Stage III starts where the MPL has turned negative. all product curves are decreasing. total output starts falling even as the input is increased

28. COSTS OF PRODUCTION Opportunity Cost Principle - the economic cost of an input used in a production process is the value of output sacrificed elsewhere. The opportunity cost of an input is the value of foregone income in best alternative employment. Implicit vs. Explicit Costs Explicit costs � costs paid in cash Implicit cost � imputed cost of self-owned or self employed resources based on their opportunity costs.

29. 7 Cost Concepts (Short-run) Total Fixed Cost (TFC) Total Variable Cost (TVC) Total Cost (TC=TVC+TFC) Average Fixed Cost (AFC=TFC/Q) Average Variable Cost (AVC=TVC/Q) Average Total Cost (AC=AFC+AVC) Marginal Cost (MC= ?AVC/?Q

30. Short Run Analysis Total fixed cost (TFC) is more commonly referred to as "sunk cost" or "overhead cost." Examples: include the payment or rent for land, buildings and machinery. The fixed cost is independent of the level of output produced. Graphically, depicted as a horizontal line

31. Short Run Analysis Total variable cost (TVC) refers to the cost that changes as the amount of output produced is changed. Examples - purchases of raw materials, payments to workers, electricity bills, fuel and power costs. Total variable cost increases as the amount of output increases. If no output is produced, then total variable cost is zero; the larger the output, the greater the total variable cost.

32. Short Run Analysis Total cost (TC) is the sum of total fixed cost and total variable cost TC=TFC+TVC As the level of output increases, total cost of the firm also increases.

33. Total Costs of Production

41. Table 5.4 Average Cost of Production

44. The LAC The LAC curve is an envelop curve of all possible plant sizes. Also known as �planning curve� It traces the lowest average cost of producing each level of output. It is U-shaped because of Economies of Scale Diseconomies of Scale

49. Economies and Diseconomies of Scale Economies of Scale- long run average cost decreases as output increases. Technological factors Specialization Diseconomies of Scale: - long run average cost increases as output increases. Problems with management � becomes costly, unwieldy

52. LAC and LMC Long-run Average Cost (LAC) curve is U-shaped. the envelope of all the short-run average cost curves; driven by economies and diseconomies of size. Long-run Marginal Cost (LMC) curve Also U-shaped; intersects LAC at LAC�s minimum point.