FOUNDATIONS OF

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FOUNDATIONS OF PRODUCERS DECISIONMAKING
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Production Functions linkage between inputs
outputs OUTPUT f ( inputs) f is the summary of
how technology makes various combinations of
input into specific amounts of
outputs. Commonly written q f (K,L) K
capital L labor (land entrepreneurship is
ignored)
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Firms can vary labor more than any
other resource. Production in the Short Run
specialization and divisions of labor allows for
more output up to a point.
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Marginal Average Physical Products of
Labor APPL total output/labor (q/L) MPPL
additional output produced by an
additional unit of labor 1. Hiring decisions
hinge on MPPL. 2. Extra workers must produce at
least as much revenue as they cost 3. Must also
assume all workers were clones from a robot
factory (every worker is thus the LAST or
marginal worker)
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Production of labor will rise only as
other resources employed rise. Total Production
Curve pg. 512 MPPL APPL bottom
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Short Run Law of Diminishing Marginal Return 1.
Every worker is a robot so each is the last unit
of labor 2. As you increase your use of labor,
you automatically reduce use of other
resources a.successful eq. Increases of various
resources (labor) are added to some fixed factors
influencing production (capital land) b.
productivity may rise initially/marginal
physical products must eventually decline
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c. At least 1 resource is fixed d. Specialization
allows each worker to add more than the
previous Short Run Production Costs TC(TFC)
(TVC) Fixed Costs ( historical or sunken) sum of
short run costs that are not related to the
level of production.
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Short Run costs are fixed Implicit costs are
fixed a. have no bearing on rational decisions
about how much to produce. b. only good because
we learn from them Variable Costs costs incurred
when a firm produces vary with level of
production in proportion to output TC curve
sum of FC curve VC curve
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Labor only variable resource in SR supply of
workers perfectly elastic Variable Costs reflect
wages labor inputs labor inputs determines
amount of output
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Average Costs Equal TC / output (q) ATC
(average total costs) Also called Unit Cost
total cost incurred per unit of output AVC (
average variable costs) TC/q TFC/q TVC/q
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Average Fixed Costs these costs are constant
fixed costs per unit decrease as managers
spread overhead through volume Figure 3 pg.
517 (MUST KNOW) 1. As output increases, the
difference between AVC and ATC curves shrink 2.
AFC continuously decline
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Marginal Costs change in TC associated with
producing an additional unit of output. this is
a U shaped curve diminishing returns cause
marginal costs to rise SHORT RUN COSTS OF
PRODUCTION GRAPH MUST KNOW PG. 518 figure 5
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• Point a is profit maximization
• b diminishing returns
• Relating Costs of Production
• 1. Total cost and total product are
• closely related
• 2. Ultimately AFC AVC ATC
• Workers make a constant, so we can c
• calculate labor costs when AVC is lowest
• Hire labor when AVC is lowest

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• Summary of Short Run decisions
• Only labor is allowed to vary
• Technology can change in SR/not LR
• Technology had to determine because it
• comes in spurts

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• Long Run can constantly adjust all resources
• Can sell previously fixed resources to
• other firms and rid yourself of obligations
• to meet fixed payments.
• 2. May obligate your firm to buy more
• machinery
• 3. May enter or leave the market
• 4. Expand or contract the scope of operations

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Least Cost Production adjusting resources until
equal marginal production per dollar. 1.
Follows the law of equal advantage 2. Higher
labor prices will induce a firm to substitute
capital for labor EX auto industry 3. Increase
in interests substitute labor Resources may be
compliments to each other EX Labor positive to
capital and land 4. Increases in other resources
cause a rise in labor total average production
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LRAC curve pg. 522 figure 7 MUST KNOW THIS
GRAPH LRAC plants of different size can be
built a collection of SRAC curves
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Economies and Diseconomies of Scale Economies
of Scale LRAC decrease as output increases.
may vary of change of each resource because
of Law of Diminishing Return
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• Reasons for diseconomies of scale
• Giant firms become diseconomies because
• they have layers layers of management
• 2. Mass of information to digest
• 3. Decisions on different levels
• Measuring LRAC
• a. larger firms are more efficient
• b. firms too large because diseconomies
• because it uses up all feasible scales

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c. This too large varies within
industries Economies of Scope Can get economies
of production even if you are too small to be
economies of scale. one firm produces or
distributes several products that share the same
production facility or inputs EX gas stations
become convenience stores
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• Major problems
• 1. managerial control
• The diversity of products can make these
• problems worse
• Measuring LRAC
• MUST KNOW FIGURE 8 PG. 524
• Ex 1930s largest car factory,
• never efficiently used, torn down.
• Every industry has to face economies
• diseconomies of scale

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Survival Principle theory that clustering
within an industry of firms helps efficiency
Determined by 1. Luck 2. Monopoly power 3.
Business Acumen (quick insight) Maximum
Efficiency Scale plants are the smallest that
will produce output at minimum average total
costs.
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• Summary of Economies of Scale
• Encourage size
• Tend to reward compact firms
• Perception of profit opportunities
• Firms can perfectly adjust its size by
• purchasing more or fewer resources
• 5. Fails to consider the concept of research
• development
• 6. laws that consider market power need to
• understand economies of scale

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Technology Changes 1. Increases output 2. Allows
distribution of unknown goods ( 2forms) a.
improvement to non-human resources b. new
knowledge to combine resources 3. Tends to come
in waves EX computers 4. Profit can induce new
technologies 5. Uncertain if SR and LR
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6. Enhance scale bigger is better 7. Second
only to labor in growth (20 of LR growth) 8.
Can reduce the cost of communication
transportation