# ECONOMICS FOR MANAGERS

Topics: Costs, Economics, Marginal cost Pages: 18 (1413 words) Published: November 7, 2013
Economics for Managers
by Paul Farnham
y

Chapter 5:
Production and Cost Analysis
in the Short Run

5.1

Defining the
Production Function
P d ti
F
ti
The formula can be read as “quantity of
quantity
output is a function of the inputs
listed inside the parentheses”

Q = f (L, K, M…)
where
Q = quantity of output
L = quantity of labor input
K = quantity of capital input
y
M = quantity of materials input

5.2

Fixed Inputs Versus
Variable I
V i bl Inputs
t
Fixed input: quantity a manager
cannot change during a given
g
g g
time
Variable input: quantity a manager
can change during a given time
Amount of output would vary as
regarding amounts of input

5.3

Short-run Versus
Long-run P d ti
L
Production
Not expressed in terms of
calendar time, but in terms of
,
fixed and variable inputs
Short run
Short-run production function:
involves at least one fixed input
Long-run
Long run production function:
production process in which all
inputs are variable

5.4

Managerial Rule of Thumb:
Short run
Short-run Production and
Long-run Planning
Managers operate in the short
run, but must have long-run
vision
i i
They need to be aware that the
current amount of fixed inputs
t
t f fi d i
t
may not be appropriate as market
conditions change
Managers make more long run
economic decisions

5.5

Model of the Short-run
Production Function
P d ti
F
ti
Total product: total quantity of output
produced with a given quantity of
fixed and variable inputs

TP or Q = f (L, K)
where
TP or Q = total product or quantity
p
q
y
of output
L = quantity of labor input
K = quantity of capital input

5.6

Average Product
Average product: amount of
A
d t
t f
output per unit of variable input
AP = TP / L or Q / L
where
AP = The average product of labor

5.7

Marginal Product
M
i l
d t the dditi
l
output produced with an
MP = ΔTP / ΔL = ΔQ / ΔL
where
MP = The marginal product of labor

5.8

Total Product: Short-run
Production Function
Figure 5.1a

Law of diminishing
returns where marginal
product eventually
decreases

TP
0

L1

L2

L3

L
5.9

TP: Short-run
Production Function
P d ti
F
ti
TP increases rapidly up to level of
labor input L1 then increases at a
slower rate as labor input increases
TP curve becomes flatter and flatter
until it reaches maximum output
level at L3
Curve implies that marginal product
of labor first increases rapidly then
decreases, eventually becoming
zero or less

5.10

AP and MP: Short-run
Production Function
Figure 5.1b

MP
AP
0

L1

L2

L3

L
5.11

AP and MP: Short-run
Production Function
Between zero and L2, MP curve
lies above AP curve, causing AP
curve to increase
Below L2, MP curve is below AP
curve, causing AP curve to
decrease
Therefore, MP curve must
intersect AP curve at maximum
point of AP curve
i t f

5.12

Economic Explanation
Increasing marginal returns:
region where MP curve is positive
and increasing
di
i
Law of diminishing returns:
region where marginal product
i
h
i l
d t
curve is positive but decreasing
Negative marginal returns: region
N
ti
i l t
i
where product curve is negative
so that TP is decreasing

5.13

Law of Diminishing
Returns
R t
p
(MP) is decreasing
Occurs because capital input and
technologies are held constant

5.14...