ECN 201: Principle of Microeconomics Nusrat Jahan Lecture 6 Producer Theory

Production Function  Production Function The relationship between the input required and the amount of output that can be obtained is called the production function.  Total Product- the maximum output that a given quantity of input can produce.  Marginal Product- the extra product or output added by an extra unit of input.  Average Product- total product divided by quantity of input employed.  Law of Diminishing Returns The marginal product of each unit of intput will decline as the amount of that input increases holding all other inputs constant.

 Relationship Between Marginal Product and Average Product For the number of workers at which marginal product exceeds average product, average product is increasing. For the number of workers at which marginal product is less than average product, average product is decreasing.

 Isoquant Curve A graph of all possible combinations of inputs that result in the production of a given level of output.

Cost Function  Total Cost Lowest total dollar expense needed to produce each level of output. Total cost is the summation of fixed cost and variable cost.  Total Fixed Cost (TFC) - is the cost of the firm’s fixed factors.  Total Variable Cost (TVC) - is the cost of the firm’s variable factors.  Marginal Cost (MC) - is the increase in total cost that results from a one-unit increase in output.  Average Costs: Average Fixed Cost- Total Fixed Cost/ Total Output Average Variable Cost- Total Variable Cost/ Total Output Average Total Cost- Total Cost/ Total Output

 Relationship between Marginal Cost and Average Cost When marginal cost is less than average cost, average cost is decreasing, and when marginal cost exceeds average cost, average cost is increasing.

 Isocost Line An isocost line shows all combinations of inputs which cost the same total amount.

 Equilibrium in production

 Returns to Scale How total output changes when the inputs change.  Constant returns to scale- A change in all inputs lead to a proportional change in output.  Increasing returns to scale- A change in all inputs lead to a more than proportional change in output  Decreasing returns to scale- A change in all inputs lead to a less than proportional change in output.  Short-run Vs Long-run  Short-run is a time period in which the firms can adjust production by changing variable factors of production but cannot change the fixed factors.  Long-run is a sufficiently long time period in which the firms can adjust production by changing the fixed factors of production.

 Producer’s surplus The amount a seller is paid for a good minus the seller’s cost.