Unit #2 Production and Cost (Theory of the Firm)
q = f(k, L)
where k = capital and L = Labour (some books use N for labour)
k and L are positive inputs – if you use more k, you can produce more. Same thing for L.
q of q of Marginal Average Fixed Variable Total Marginal
labour labour Price of Price of Costs Costs Costs Costs
Labour Labour (F.C.) (V.C.) (T.C.) (M.C.)
(MP L (AP L
In the short run -the period of time in which one variable is fixed while the other can vary.
Capital is fixed therefore in the short run, to change output, must change Labour
Total Product of Labour Curve
Here Product means output.
TPLstands for Total Product of Labour.
1) Slope of any total is its marginal. Therefore, LP = marginal product of Labour.
MP iL the additional output you receive when you add one more unit of
MP = Change in quantity / Change in Labour
2) Slope of any line from the origin to a curve is average (for whatever point on
the line you shoes. Eg. MP average at L=3)
L When average product of labour equals marginal product of labour that
is your maximum
If MP L AP L then AP iLcreases
If marginal is about average it pulls the average up and vice versa!
If MP Lecreases, what happens to AP ? It Lepends!
What causes the MP to tLke this shape?
- in the short run, capital is fixed, therefore you have the Law of Diminishing Returns
given a fixed level of capital (or anything), as we add labour eventually the additional
output you receiver from one more unit of labour will fall
because you have a fixed amount of capital
Production in the Long Run
- change both capital and labour (nothing is fixed)
1) Increasing Returns to Scale
a. Double inputs means more than double outputs
2) Constant Returns to Scale
a. Double input, means double output
3) Decreasing Returns to Scale
a. Double input means less than double output
- A firm doesn’t get to choose and will likely experience all three at different stages. No law of
Cost in the Short Run (capital is fixed)
- Cost based on production
Total Cost = Fixed Costs + Variable Cost **Divide by q to g