Production and Cost

1. Production and Cost • How do companies know what to charge for their products?

2. The Theory of Production • The relationship between factors of production & output of goods and services • Short run production allows producers to change ONLY labor amount • Long run production allows producers to adjust all FOP including capital • Law of variable production states output will change in short run as one FOP is varied while others are same

3. Production in the Short Run • Fixed Resources: resources that cannot be altered easily • Factories, trucks, equipment, where houses • Variable Resources: resources that can be altered quickly to change output

4. Production Function • Describes the relationship between changes in output to different amounts of a single input • Can be illustrated with a schedule or graph • Allows businesses to maximize resources

5. Production Function Con’t. • Total Product: total output of a firm • Marginal Product: the change in output with each additional resource • After the 3rd unit, the firm experiences the law of diminishing returns

6. Law of Diminishing Returns • as one input variable is increased, there will be a point at which the marginal per unit output will start to decrease, holding all other factors constant

7. Costs in the Short Run • Fixed cost: one that doesn’t change in the short run • Variable cost: varies with the amount produced • Total Cost: fixed plus variable costs • Marginal Cost: how much it costs to produce one extra unit of something

9. Revenue & Costs • Marginal Revenue: extra money a firm receives from selling another unit of something • Businesses will continue to sell as long as marginal revenue exceeds or equals marginal costs • Firms that cannot cover variable cost will shut down

10. Production and Costs in the Long Run • Economies of scale: when average costs of production decrease as the size of the firm increases • Diseconomies of scale- firms see an increase in marginal cost when output is increased.