Production and Costs

• “The Economics of the Lemonade Stand”
• 4 main cost measures
  • Average fixed costs
  • Average variable costs
  • Average total costs
  • Marginal costs

The Production Process

• Input → Production Process → Output
• Production function = the relation between inputs and the Q of outputs
• Variable Input, usually labor
• Fixed Input, usually capital
• Possible: fixed input in the short-run, but variable input in the long-run.
• Short-run = all inputs are fixed
• Long-run = all inputs are variable

Introducing Costs

Definition Marginal Product of Labor = the additional quantity of

output obtained from using one more unit of labor, slope of Product of Labor curve

$$M{P}_L=\frac{\Delta Q}{\Delta L}$$

• Total Cost = Fixed Cost + Variable Cost
• Total Product Curve and Total Cost Curve are mirror to each other

Definition Marginal Cost = the change in total cost arising from

producing one more unit of output. slope of Total Cost Curve

$$MC=\frac{\Delta TC}{\Delta Q}$$

• Average Fixed Cost = Fixed Cost / Output
• ATC = AVC + AFC
• Marginal Cost curve crosses the lowest point of ATC curve.
  • If Marginal Cost < Average Total Cost, MC is pulling down the ATC, hence ATC is decreasing.
  • If MC > ATC, MC is pulling up the ATC, hence ATC is increasing

Conclusion to Production

• Natural Monopolies = lowering the Average Fixed Cost
• Higher marginal productivity per labor → higher wages