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Cost, Revenue and Profit - Part 1

This document discusses key concepts in production and cost analysis, including: 1. The short-run production function distinguishes between fixed and variable factors of production. Total product, average product, and marginal product are defined. 2. The law of diminishing returns states that adding more of a variable factor will eventually yield lower per-unit returns as the most productive units are utilized first. 3. Short-run costs include total fixed costs (which are constant), total variable costs (which increase with output), and total costs. Marginal cost is the change in total cost from producing an additional unit of output.

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Yashjeet Gurung RCS KJ
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63 views28 pages

Cost, Revenue and Profit - Part 1

This document discusses key concepts in production and cost analysis, including: 1. The short-run production function distinguishes between fixed and variable factors of production. Total product, average product, and marginal product are defined. 2. The law of diminishing returns states that adding more of a variable factor will eventually yield lower per-unit returns as the most productive units are utilized first. 3. Short-run costs include total fixed costs (which are constant), total variable costs (which increase with output), and total costs. Marginal cost is the change in total cost from producing an additional unit of output.

Uploaded by

Yashjeet Gurung RCS KJ
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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COST, REVENUE AND

PROFIT
(A2 Economics) - Part 1
1. Production function
2. Law of diminishing returns
3. Cost function
Learning
Objectives
- identify the short-run production function: fixed
and variable
- factors of production, total product, average
product and marginal product
- explain the law of diminishing returns
- identify and describe marginal cost and average
cost
- identify the short-run cost function - fixed costs
versus variable costs
-
Short-run production function:
fixed and variable
•Variable factors are the inputs a manager can
adjust to alter production in the short run,
E.g, labour and materials

•Fixed factors are the inputs that a manager


cannot adjust to alter production in the short
run. e.g., capital or land.
Short run and Long
run
The short run is that period of time in which at
least one factor of production is fixed. All
production takes place in the short run

How long is the short run?

It is determined by the time it takes to increase


the quantity of the fixed factor
Short run and Long
run
Long run is that period of time in which all
factors of production are variable, but the state
of technology is fixed. All planning takes place in
the long run

If a firm plans ahead to change its fixed factors


then all factors of production are variable
Factor of production
Total product (TP)

is the total output that a firm produces, using its


fixed and variable factors in a given period
Factor of production
Average product (AP)

is the output that is produced, on average, by


each unit of variable factor (V)

AP = TP / V
Factor of production
Marginal product (MP)

is the extra output that is produced by using an


extra unit of the variable factor (V)

MP = change TP / change V
TP
Total product Average Marginal
Labour (V) (TP) product (AP) product (MP)
0 0
1 0.5
2 3
3 7
4 9
5 10
6 11
7 11
8 10.5
Total
TP
Output

Units of
labor per
day
TP,
Total AP Average
Labour product product
0 0
1 0.5 0.50
2 3 1.50
3 7 2.33
4 9 2.25
5 10 2.00
6 11 1.83
7 11 1.57
8 10.5 1.31
Total
TP and
Output
AP

Units of
labor per
day
TP, AP and
MP
Total Average Marginal
Labour product product product
0 0
1 0.5 0.50 0.5
2 3 1.50 2.5
3 7 2.33 4
4 9 2.25 2
5 10 2.00 1
6 11 1.83 1
7 11 1.57 0
8 10.5 1.31 -0.5
Total
TP, AP and
Output
MP

Units of
labor per
day
The Law of Diminishing
Returns
states that in all productive processes, adding
more of one factor of production (variable
factor) while holding all others constant (ceteris
paribus) will at some point yield lower per-unit
returns.
Total
The Law of Diminishing
Output
Returns
Marginal
Labour product
0
1 0.5
2 2.5
3 4
4 2
5 1
6 1
7 0
8 -0.5

Units of labor per day


Theory explained
Economic
cost
The economic cost of producing a good is the
opportunity cost of the firm's production
Explicit cost Implicit cost
The costs that have a money The cost of using the firm’s
value like raw materials, own resources. This is the
energy, rent, interest and earnings that a firm could
wages and have to be have had if it had employed its
purchased from outside the factors in another use
firm (Accounting costs) - Economist’s view
- Accountant’s view
Short run costs
Total Fixed Cost It is a constant amount
(TFC) Eg. rent, weekly payroll

Total Variable Cost TVC increases as more variable


(TVC) factors are used
Eg. delivery/shipping charges,
materials

Total Cost (TC) TC = TFC + TVC


Short run costs - Drawing
Exercise
Using data give, draw TC, TVC and TFC Curve
Output TFC TVC TC
0 400 0 400
1 400 200 600
2 400 400 800
3 400 600 1000
4 400 800 1200
5 400 1000 1400
6 400 1200 1600
7 400 1400 1800
Short run costs - Drawing
Exercise
Using data give, draw TC, TVC and TFC Curve

Costs

Output
Short run costs
Average Fixed Cost fixed cost per unit of output
(AFC) AFC = TFC / output

Average Variable variable cost per unit of output


Cost (AVC) AVC = TVC / output

Average Total Cost total cost per unit of output


(ATC) ATC = TC / output
ATC = AFC + AVC

Marginal Cost (MC) is the increase in the total cost of


producing an extra unit of output.
MC = change TC / change
output
Costs - fill in the
Output
blank
TVC TC AFC AVC ATC MC

0 50

1 10 10.00 60.00 10

2 30 80

3 16.67 20.00 36.67 30

4 100 150 12.50 37.50

5 150 30.00

6 210 260 8.33 35.00 43.33 60


Cost functions
Output TVC TC AFC AVC ATC MC

0 0 50

1 10 60 50.00 10.00 60.00 10

2 30 80 25.00 15.00 40.00 20

3 60 110 16.67 20.00 36.67 30

4 100 150 12.50 25.00 37.50 40

5 150 200 10.00 30.00 40.00 50

6 210 260 8.33 35.00 43.33 60


Cost curves
Relationship between ATC, AVC
and MC curves
MC curves cuts ATC
curves at their lowest
points

Vertical gap between ATC


and AVC gets smaller as
output grows

AFC falls as output


increases
Learning
Objectives
- identify the short-run production function: fixed
and variable
- factors of production, total product, average
product and marginal product
- explain the law of diminishing returns
- identify and describe marginal cost and average
cost
- identify the short-run cost function - fixed costs
versus variable costs
-
Daily
Reflection
At the end of each lesson, you will need to complete the
daily reflection.

1. What I have learnt?

2. What I need to improve?

3. Questions that I need to ask?

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