C.  Production and Cost Analysis in the Short Run

1.  Production analysis

• Production function - relationship between a flow of inputs and the resulting flow of outputs in a production process during a given period of time

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a.  Fixed vs. variable inputs

• Fixed inputs - can't change quantity in a given time period

Ex. -

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• Variable inputs - can change quantity in a given period

Ex. -

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b.  Short-run vs. long-run

• Short-run - at least one input is fixed

- Need to make decisions given the fixed input(s)

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• Long-run - all inputs are variable

- Planning horizion

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c.  Total product

• Total quantity produced with given quantities of fixed and variable inputs

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(1) Average product

• Output per unit of variable input

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(2)  Marginal product

• Additional output produced with an additional

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• Graphical representation:

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d.  Returns

(1) Increasing marginal returns

• Total product increases at an increasing rate

• Due to gains from division of labor and specialization

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(2)  Diminishing marginal returns

• Total product increases at a decreasing rate

• Due to gains from division of labor lessening, congestion of fixed input

• Law of Diminishing Marginal Returns - as more and more variable inputs are added to fixed inputs, the marginal product will eventually decline

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(3) Negative marginal returns

• Total product decreases as more of an input is used

• Extreme case of diminishing marginal returns

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e.  Examples of productivity issues

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2.  Cost analysis

• Opportunity cost - value of the best opportunity foregone when undertaking an activity

Ex. - Cost of attending USD

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• Historical cost - money paid for an input in the past

a.  Explicit vs. implicit costs

(1) Explicit costs - money actually spent

• Ex. - Rent paid, interest on loans, wages, cost of raw materials

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(2) Implicit costs - no direct payment, measured by opportunity cost

• Ex. - Foregone rent, foregone investment income, and foregone income

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b.  Profit

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(1)  Accounting profit - only consider explicit costs

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(2)  Economic profit - consider both explicit and implicit costs

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c.  Short-run costs

• Costs when at least one input is fixed

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(1) Total costs

(a)  Total fixed cost (TFC) - cost of fixed inputs, remain constant as output changes

• Ex. -

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(b) Total variable cost (TVC) - cost of variable inputs, changes as output changes

• Ex. -

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(c) Total cost (TC) - TFC + TVC

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• Graphical representation:

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(2) Per unit costs

(a) Average fixed cost (AFC)

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(b) Average variable cost (AVC)

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(c) Average total cost (ATC)

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(d) Marginal cost (MC)

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• Graphical representation:

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3.  Relationship between production and cost

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4.  Evidence and implications

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