1. Chapter 6 Production, Cost, and Profit © 2001 South-Western College Publishing

2. 2 Production Function The physical relationship between resource inputs and product output

3. 3 Principle of Diminishing Marginal Returns 4 As more units of a variable resource are added to a set of fixed resources, the resulting additions to output eventually become smaller 4 Marginal Product (MP): change in total output resulting from an additional unit of input 4 Average Product (AP): total output divided by the number of units of an input used.

4. 4 Relationship of MP to AP Labor 16 14 12 10 8 6 4 2 0 1 2 3 4 5 6 7 8 9 10 11 12 Output AP MP

5. 5 Returns to Scale 4 Constant returns to scale: output changes in a fixed proportion to the change in total inputs 4 Decreasing returns to scale: output changes disproportionately little compared to a change in the scale of inputs 4 Increasing returns to scale: output changes disproportionately much in comparison to a change in the scale of inputs

6. 6 Costs of Production 4 Alternative Uses and Opportunity Costs 4 Explicit and Implicit Costs 4 Classifications of Costs 4 Relationship between Product and Cost Curves

7. 7 Opportunity Cost of Productive Resources Amount of payment needed to attract productive resources away from their next best opportunities for employment

8. 8 Explicit and Implicit Costs 4 Explicit costs –expenditures for production that result from agreements or contracts 4 Implicit costs –a firm’s opportunity cost of using its own resources or those provided by its owners without a corresponding cash payment

9. 9 Classifications of Production Costs 4 Fixed Costs –costs that remain constant as output varies 4 Average Fixed Costs (AFC) = 4 Variable Costs –costs that vary as output changes 4 Average Variable Costs (AVC) =

10. 10 4 Total Cost (TC) –the sum of total fixed cost and total variable cost at a particular level of output 4 Average Total Cost (ATC) = and also, AFC+AVC 4 Marginal Cost (MC) –the change in total cost resulting from production of one more unit of output Classifications of Production Costs

11. 11 Relationship of AFC, AVC, ATC, and MC Output $7 6 5 4 3 2 1 0 10 20 30 40 50 60 70 80 90 100 Cost AFC ATC AVC MC

12. 12 Relationship Between Product Curves and Cost Curves Output Input Cost 0 0 A A B B MC MP AP AVC (a) (b)

13. 13 Revenue 4 Average revenue (AR) –revenue per unit of output sold 4 Total revenue (TR) –amount of revenue or income received from the sale of a given quantity of goods or services 4 Marginal revenue (MR) –change in TR that results from the sale of one more unit of output

14. 14 Profit 4 Total Profit is the difference between total revenue and total cost total revenue – total cost = profit

15. 15 Total Revenue v. Total Cost Break-Even Point –the output level at which total revenue equals total cost =

16. 16 Break-Even Chart Output 200 150 100 50 0 10 20 30 40 50 60 70 80 90 Cost and Revenue TFC TC TR Break-Even Point Maximum Profit

17. 17 Short Run v. Long Run 4 Short Run –period of time in which some productive resources are fixed 4 Long Run –period of time in which all productive resources (including machinery, buildings, other capital items) are variable

18. 18 Economic Profit 4 Normal Profit –amount of profit necessary to induce an entrepreneur to stay in business 4 Economic Profit –revenue in excess of all costs, including normal profit