The Production Function II 1. Costs - short run measures relationship - production & costs 2. Costs - long run scale expansion path long run costs 3. Returns to scale & economies of scale

1. Costs - short run Fixed & variable costs fixed = unavoidable variable = avoidable Costs rise as output increases e.g. As L, TPP   TC  given PK and PL inverse relationship MP & MC, AC & AP Measures of cost - Table 1

Measures of cost Total costs: TC = TFC + TVC Average costs: ATC = TC \ TPP or TC \ Q ATC = AFC + AVC Marginal costs: MC =TC \ TPP ‘…the extra cost of producing one more unit.’ Shape - Figures 1 to 3

Total costs for firm X Output (Q) 1 2 3 4 5 6 7 TFC (£) 12 TVC (£) 10 1 2 3 4 5 6 7 TFC (£) 12 TVC (£) 10 16 21 28 40 60 91 TC (£) 12 22 28 33 40 52 72 103 TC TVC TFC fig

Average and marginal physical product b c Output APP MPP Quantity of the variable factor fig

Average and marginal costs MC Costs (£) x fig Output (Q)

2. Costs - long run K & L are variable Profit maximisation requires cost minimisation Choice of technique: if MPK \ PK > MPL \ PL 20 \ 2 > 32 \ 8 10 > 4

Cost minimisation i.e. last pound spent on K adds 10 units Therefore spend 1 extra pound on K, TPP rises by 10 spend 2.50 less on L, TPP falls by 10 output is unchanged, but costs fall 1.50 Cost minimisation MPK \ PK = MPL \ PL tangency of isocost & isoquant

Scale expansion path & long run costs Vary K & L  TPP rises (no. of factories) See Figure - scale expansion path Long run average costs Returns to scale Scale economies

Deriving an LRAC curve from an isoquant map At an output of 100 LRAC = TC1 / 100 Units of capital (K) 100 O TC1 fig Units of labour (L)

Deriving an LRAC curve from an isoquant map Expansion path Units of capital (K) 700 600 500 400 300 200 100 O TC1 TC2 TC3 TC4 TC5 TC6 TC7 fig Units of labour (L)

A typical long-run average cost curve LRAC Costs O Output fig

Returns to scale (i) Increasing returns (ii) Constant returns LRAC a % increase in inputs leads to a larger % increase in output economies of scale (ii) Constant returns LRAC constant a given % increase in inputs leads to the same % increase in output

Returns to scale (iii) Decreasing returns Economies of scale LRAC a % increase in inputs leads to a smaller % increase in output diseconomies of scale Economies of scale plant level economies multi-plant economies Diseconomies of scale

Conclusion Cost minimisation - long run Profit = Revenue - Cost Profit maximisation - level? Market structure: Perfect competition Monopolistic competition Oligopoly Monopoly