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
FOP + variable input, short run increasing/decreaing labor, long run- building a new factory

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
Stage I= Most Productive, Stage II= Dimishing returns, Stage III= negative returns

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

8. Tons Moved per day Fixed Cost Workers per day Variable Cost Total Cost
(truck, boxes, etc.)
Workers per day
Variable Cost
(workers)
Total Cost
Marginal Cost
Change in cost/change in quantity
$200 - 2 1
$100
$300
$50 5
$400
$33.33 9 3
$500
$25.00 12 4
$600 14
$700
$50.00 15 6
$800
$100.00

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.