1. Introduction to Economics
Egor Sidorov

2. Production function and output Costs within the short run
Costs within the long run

3. Inputs and outputs
Economics assumes that firms do their best to achieve maximum efficiency: i.e. producing maximum output with the available inputs and at minimum costs.
Production is the result of co-operation of all factors of production.
Output level depends on:
technology (T),
capital stock (K),
land stock (R)
and amount of labour input (L).

4. Production function
function that specifies the maximum output of a firm, given the available combinations of inputs. Production function reflects the technology level.
Q = f(R, L, K, T,…)
1 800
L, thous. hrs.
K, mil. USD
Q, thous. pieces 1 2
1 000 4
1 800
1 000 L
Ploskost - plane 4 2 1
Q=f(L, K), other factors remain equal 2 K

5. Total and marginal physical product
Assuming that land and capital remain unchanged within the short run and the only variable factor is labor, one can observe the following:
TPP (Total physical product)
MPP (Marginal physical product) 2 1 3 5 4
2000
1000 6
3000
Labor 2 1 3 5 4
1000
500 6
Labor
Law of diminishing returns
Mathematically marginal product is the first derivation of production function
1500

6. Relationship between total product (TP) and marginal product (MP)PF TP TP TP TP PF MP AP
Increasing (marginal) returns
Diminishing (marginal) returns
Who wants to produce like this? MP MP MP MP + + -

7. Law of diminishing returns
MP = TP / F
Marginal product is the extra output produced by one more unit of an input.
In a production system where one input is variable and the rest are fixed, at some point, additional unit of variable input yields smaller and smaller increases in output (i.e. marginal product decreases).

8. Returns to scale
Law of diminishing returns concerns the changes of only one input while the rest remain fixed.
Returns to scale refers to changes in output subsequent to a proportional change in all inputs:
Constant returns to scale,
Increasing returns to scale (Economies of scale),
Decreasing returns to scale (Diseconomies of scale).
E.g. one can refer to economies of scale if quantity of all input factors are increased by some amount (e.g. by 10 percent) and costs subsequently increase by a lesser amount (e.g. by 8 percent).

9. Short vs long run
Short run is a time frame when the firm can change only part of its production factors (the so-called variable production factors), while at least one production factor remain unchanged (the so-called fixed production factors).
E.g. the faculty building is a fixed production factor, while professors represent variable production factors within the short run ►
Long-run assumes no fixed factors of production, so all factors are variable.

10. Technological change TP Quantity of transistors (mil) Core 2 Duo 2050
Pentium I, II, III, IV
Intel 386 TP 2 1 3 5 4
2000
1000 6
3000
Labor
2009

11. Optimal (least costly) input combination
Isoquant curve refers to all combinations of inputs producing the same output (TP1).
Capital and labor cost money. Economists try to figure out which one of possible technological combinations is the cheapest for the necessary level of output.
TP1
Capital A
Technical Rate of Substitution – rate, at which the quantity of one input has to be reduced when one extra unit of another input is used, so that output remains constant
Labor

12. Isocost curve (equal cost curve)
Isocost is a budget line of a firm, showing all combinations of inputs which the firm can “afford”. 10 20 2 1 30
E.g. the cost of maintaining excavator is equal to employing 15 workers. Our budget allows us either lease 2 excavators or to hire 30 workers.

13. Optimal production point
Optimal production point is established by putting together our technological possibilities (isoquant) and our budget (isocost).
The tangent point shows the optimal combination of inputs given the current technological conditions. 10 20 2 1 30

14. Production function and output Costs within the short run
Costs within the long run 15

15. Costs within the short run
Firms buy labor, capital and land on the production factor markets in order to maintain production.
Total costs of a firm consist of:
Fixed costs (FC) are not dependent on the level of output (e.g., rent payments).
Variable costs (VC) change in proportion to level of output.

16. Fixed and variable costs
C (USD) 2 1 3 5 4
2000
1000 6
3000 Q VC
Progressive
The growth of variable costs is usually non-linear. In many cases it is connected with the different level of variable factors’ exploitation.
Degressive
Proportional (linear) FC

17. Total (TC) and Marginal Costs (MC)
MC = TC / Q
Marginal cost is the change in total cost that arises when the quantity produced changes by one unit.
What are marginal costs of transporting additional passenger on the plane?
TC (Total costs)
MC (Marginal costs) 2 1 3 5 4
2000
1000 6
3000 Q TC 2 1 3 5 4
1000
500 6 Q
Mathematically marginal product is the first derivation of the cost function
1500 MC

18. Unit costs
AC = TC / Q
Average costs (AC, AVC a AFC) are derived as TC, VC or FC divided by volume of output.
Average fixed costs (AFC) – the downward slope of the curve shows that it is sensible to distribute fixed costs among the greater amount of products.
AC = AVC + AFC TC
1000 AC 2 1 3 5 4 6 Q AC
1000
AVC
500
AFC

19. Technological optimum
Minimum production costs refer to the point where marginal cost curve crosses average cost curve.
When MC is below AC, AC is decreasing
MC crosses AC in the lowest point, after it AC begin to increase
AC, MC 2 1 3 5 4 6 Q AC MC
AVC

20. Production function and output Costs within the short run
Costs within the long run 21

21. Total costs within the long run
The total costs curve within the long run has the same shape as within the short run.
Within the short run the shape of TC curve is determined by returns to production factor.
Within the long run the shape of the curve is determined by the returns to scale.

22. Average costs within the long run
The long-run AC curve reflects the technological changes.
LRAC shows the lowest AC of production for different periods and for different technologies.
AC1
AC3
AC2

23. Understanding costs: accounting vs. economic definitions
Accountant’s viewpoint:
Explicit costs are costs that the firm actually pays e.g. for hiring employees or buying raw materials.
Manager’s and economist’s viewpoint :
Implicit costs (opportunity costs) occur when one foregoes an alternative action but does not make an actual payment. Managers and economists should consider them before making decisions.

24. Thank you for attention!
Refernces:
SAMUELSON, P. A., NORDHAUS, W. D. Ekonomie 18. vydání. Praha: Svoboda, 2005.
KRAFT, J., RITSCHELOVÁ, I. Ekonomie pro environmentální management. Ústí n. L.: UJEP, 2003.
MCDOUGAL LITTELL. Economics: Concept and Choices. Canada: McDougal Littell, 2008.