MICROECONOMICS ECONONE :theory of Production

ECONONE
Transformation of inputs into finished

products
LAND
LABOR
CAPITAL/EQUIPMENT
ENTREPRENEURSHIP
Transformation of inputs into finished

products
CAPITAL/
EQUIPMENT
LAND
L
A
B
O
R
&
E
N
T
R
E
P
Total Product: sum of quantity produced

LABOR
TOTAL PRODUCT
1
3
5
10
10
Marginal Product of Labor (MPL): additional unit of

output produced per additional unit of labor input
Labor
(# of Workers)
Total
Product
Marginal Product of
Labor
(3-1) / (2-1) = 2
(5-3) / 3-2) = 2
10
(10-5) / (4-3) = 5
10
(10-10) / (5-4) = 0
THEORY
Marginal Product of Labor (MPL): additional unit of

output produced per additional unit of labor input
Labor
(# of Workers)
Total
Product
Marginal Product of
Labor
(2-1) / (2-1) = 1
(5-2) / 3-2) = 3
(7-5) / (4-3) = 2
11
(11-7) / (5-4) = 4
REALITY
Law of Diminishing Marginal Products

Productivity declines as variable input (labor) is
increased given fixed input (capital)
+
2
diminishing
Total Revenue
Amount a firm receives for the sale of its
products.
Price of Product x Quantity of Products Sold
Total Cost
Firms expenses in producing goods.
Price of Input x Quantity of Inputs Used
Profit is the firms total revenue minus its

total cost.
Profit = Total revenue - Total

cost
Measuring Costs
FIXED COSTS
Land Capital
VARIABLE COSTS
Labor Capital Capital
# of
# of
Quantit
Bond
y
# of
# of
# of
Papers # of Tape Produce Deductio
Round Desks Scissors Workers Ordered
Used
d
ns
R1
2
2
1
3
1
1
0
R2
2
2
2
3
3
3
0
R3
2
2
3
4
5
5
0
R4
2
2
4
10
10
10
0
R5
2
2
5
14
10
10
0
Php DO
5 NOT VARY
5
5
30
3
VARY
with 8
production8of
with production
output
of output
R1
R2
R3
R4
R5
Measuring Costs
Total
Scissor Bond
Desk
Product
s
Paper
1
10
10
24
3
10
10
24
5
10
10
32
10
10
10
80
10
10
10
112
Tape
8
24
40
80
80
Work
er
5
10
15
20
25
Measuring Costs According to Type
R1
R2
R3
R4
R5
Total
Total
Total Fixed Variable
Total
Produ
Costs (TFC) Costs Costs (TC)
ct
(TVC)
1
20
37
57
3
20
58
78
5
20
87
107
10
20
180
200
10
20
217
237
Measuring Average Costs: cost of each typical unit

of product.
AVERAGE COSTS
FORMULA
Average Total Cost (ATC)
TC/Q
Average Fixed Cost (AFC)
TFC/Q
Average Variable Cost (AVC)
TVC/Q
Total
Product
R1
R2
R3
R4
R5
1
3
5
10
10
Average
Average
Average Total
Fixed Costs Variable Cost
Cost
(AFC)
(AVC)
20
37
57
7
19
26
4
17
21
2
18
20
2
22
24
Measuring Revenues: Selling Price x Quantity Sold
R1
R2
R3
R4
R5
Total
Total Product
Total
(TP)
Revenue (TR)
1
30
3
90
5
150
10
300
10
300
29
870
*Each paper chain is Php 30
Measuring Profit: TR - TC
Total
Total
Revenu
product
e (TR)
R1
1
30
R2
3
90
R3
5
150
R4
10
300
R5
10
300
Total
29
870
Total
Cost
(TC)
57
78
107
200
237
679
Deduction
Profit ()
s
0
0
0
0
0
0
-27
12
43
100
63
191
PROFIT-MAXIMIZING CONDITION
Analyze Marginal Revenue (MR) and Marginal
Costs (MC)
MR is the additional revenue earned for an
additional unit produced
MC is the additional cost incurred for an additional
unit produced
Costs (MC)
For the 21st unit produced
EXISTING
QTY. OF
UNITS
PRODUCED
= 20
I want to
produce an
additional
one (1) unit
I will earn an
additional
(marginal) revenue.
I will incur an
additional
(marginal) cost.
Costs (MC)
For the 21st unit produced
EXISTING
QTY. OF
UNITS
PRODUCED
= 20
I want to
produce an
additional
one (1) unit
MR = TR/Output
MC = TC/Output
Costs (MC)
Output
Price
TR
TC
200
100
200
250
180
350
160
420
140
500
120
600
100
720
Profit
MR
MC
Costs (MC)
Output
Price
TR
TC
200
100
200
200
250
180
360
350
160
480
420
140
560
500
120
600
600
100
600
720
Profit
MR
MC
Costs (MC)
Output
Price
TR
TC
Profit
MR
MC
200
100
-100
200
200
250
-50
200
150
180
360
350
10
160
100
160
480
420
60
120
70
140
560
500
60
80
80
120
600
600
40
100
100
600
720
-120
120
Costs (MC)
Output
Price
TR
TC
Profit
MR
MC
200
100
-100
200
200
250
-50
200
150
180
360
350
10
160
100
160
480
420
60
140
560
120
600
-120
70
If MR > MC
Addtl Earnings
> Addtl
500
60
80 Expenses
80
(UNDERproduction inefficient)
600 Produce
0 MORE to
40earn more
100
100
600
720
-120
120
Costs (MC)
Output
Price
TR
TC
Profit
MR
MC
200
100
-100
200
200
250
-50
200
150
180
360
350
10
160
100
160
480
420
140
560
120
600
60 If MC-120
70
> MR
Addtl Expenses > Addtl Earnings
500
60
80
80
(OVERproduction inefficient)
Produce
LESS40
to earn more
600
0
100
100
600
720
-120
120
Costs (MC)
Output
Price
TR
TC
Profit
MR
MC
200
100
-100
200
200
250
180
360
160
480
-50
150
If MC = 200
MR
Addtl Expenses
= Addtl
350
10
160 Earnings
100
Efficient production (Optimum)
Earned the60Maximum
Profit (PEAK)
420
-120
70
140
560
500
60
80
80
120
600
600
40
100
100
600
720
-120
120
Earn the HIGHEST PROFIT at MR = MC
MC
Value
MR = MC
MR > MC
MR < MC
Underproduction
Overproduction
MR
Q
BUT if MR MC, what will you choose?
MR > MC
OR
MR < MC
BUT if MR MC, what will you choose?
MR > MC
OR
WHY?
MR < MC
The relationship between the quantity a

firm can produce and its costs determines
pricing decisions.
Copyright2004 South-Western
Costs
$3.50
ATC is high at low levels of output
3.25
3.00
ses
a
e
r
inc
t
u
p
out
s
a
ines
l
c
e
d
MC MC rises as output increases
ATC
2.75
2.50
2.25
2.00
1.75
1.50
ATC
1.25
AVC
1.00
ATC is U-shaped
ATC rises because AVC

rises
0.75
0.50
AFC
0.25
0
Quantity
of Output
(glasses of lemonade per hour)
9
10
Copyright 2004 South-Western
Costs
$3.50
3.25
3.00
2.75
Efficient Scale: MC = minimum ATC
2.50
2.25
MC
2.00
If MC > ATC, ATC is rising
1.75
ATC
1.50
If MC
1.25 < ATC,
ATC
is falling
1.00
0.75
0.50
0.25
0
Quantity
of Output
(glasses of lemonade per hour)
9
10
Because many costs are fixed in the short

run but variable in the long run, a firms
long-run cost curves differ from its short-run
cost curves.
Average
Total
Cost
ATC in short
run with
small factory
ATC in short ATC in short

run with
run with
medium factory large factory
ATC in long run
$12,000
10,000
Economies
of
scale
Constant
returns to
scale
1,000 1,200
Diseconomies
of
scale
Quantity of
Cars per Day
A. Complete the table.

Q
0
TVC
TFC
60
TC
60
100
136
148
200
235
276
322
372
429
10
490
B. Graph AFC, AVC, ATC and MC
AFC
AVC
ATC
MC
A. Complete the table.

Q
TVC
TFC
TC
AFC
AVC
ATC
MC
60
60
40
60
100
60
40
100
40
76
60
136
30
38
68
36
88
60
148
20
29.33
56
12
140
60
200
15
35
50
52
175
60
235
12
35
47
35
216
60
276
10
36
46
41
262
60
322
8.57
37.43
46
46
312
60
372
7.50
39
46.50
50
369
60
429
6.67
41
47.67
57
10
430
60
490
6.0
43
49
61
B. Graph AFC, AVC, ATC and MC

MICROECONOMICS ECONONE :theory of Production

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ECONONE

Transformation of inputs into finished

Transformation of inputs into finished

Total Product: sum of quantity produced

Marginal Product of Labor (MPL): additional unit of

Marginal Product of Labor (MPL): additional unit of

Law of Diminishing Marginal Products

Profit is the firms total revenue minus its

Profit = Total revenue - Total

Measuring Costs According to Type

Measuring Average Costs: cost of each typical unit

Average Total Cost (ATC)

Average Fixed Cost (AFC)

Average Variable Cost (AVC)

Measuring Revenues: Selling Price x Quantity Sold

The relationship between the quantity a

ATC is high at low levels of output

ATC rises because AVC

Copyright 2004 South-Western

Efficient Scale: MC = minimum ATC

If MC > ATC, ATC is rising

Copyright 2004 South-Western

Because many costs are fixed in the short

ATC in short ATC in short

ATC in long run

A. Complete the table.

B. Graph AFC, AVC, ATC and MC

A. Complete the table.

B. Graph AFC, AVC, ATC and MC

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