Microeconomics Summary
Module 1-X
Timo Verkade
,M1: Production and cost
functions
- Key concepts of production function
- Key concepts of cost function
Introduction
A firm’s success and ability to grow partly depends on its pricing and production decisions.
Production function
A firm transforms inputs into output. In the long run all inputs can be adjusted.
2 types of inputs:
- Fixed input = cannot be changed in a short run/fixed for a period of time (e.g. land)
- Variable input = can be changed at any time (e.g. labor, intermediary good)
Production function = relationship between quantity of input and quantity of output (for given
amount of a fixed input).
Marginal product input = change in output generated by adding one unit of input, given an amount
of other input (= marginal analysis). Can become negative (if firm hires too many employees who
distract each other).
Increasing returns to scale = inputs increase by a given proportion, production increases more than
proportionally
Constant returns to scale = inputs increase by a given proportion, production increases by the same
proportion
Decreasing returns to scale = inputs increase by a given proportion, production increases less than
proportionally
Economies of scale includes cost advantage (more favorable terms/bargaining power) and demand
advantages (network effects, e.g. value rises with number of users).
, - Can also suffer from diseconomies of scale (= additional layers of bureaucracy as example)
Cost function
Total cost (TC) = Variable cost (VC) + Fixed cost (FC)
2 types of costs
- Fixed cost (FC) = cost of fixed input (e.g. rent). Does not depend on quantity of output.
- Variable cost (VC) = increases with the quantity of output (e.g. salary, electricity, COGS).
Cost function = shows how total production costs vary with quantity produced.
Average total cost (ATC) = TC/Q. This is the average cost per unit produced.
Marginal cost (MC) = The effect on total cost of producing one additional unit of output (slope).
- If AC > MC: AC is decreasing
- If AC < MC: AC is increasing
- MC intersects the AC curve at its lowest point
Module 1-X
Timo Verkade
,M1: Production and cost
functions
- Key concepts of production function
- Key concepts of cost function
Introduction
A firm’s success and ability to grow partly depends on its pricing and production decisions.
Production function
A firm transforms inputs into output. In the long run all inputs can be adjusted.
2 types of inputs:
- Fixed input = cannot be changed in a short run/fixed for a period of time (e.g. land)
- Variable input = can be changed at any time (e.g. labor, intermediary good)
Production function = relationship between quantity of input and quantity of output (for given
amount of a fixed input).
Marginal product input = change in output generated by adding one unit of input, given an amount
of other input (= marginal analysis). Can become negative (if firm hires too many employees who
distract each other).
Increasing returns to scale = inputs increase by a given proportion, production increases more than
proportionally
Constant returns to scale = inputs increase by a given proportion, production increases by the same
proportion
Decreasing returns to scale = inputs increase by a given proportion, production increases less than
proportionally
Economies of scale includes cost advantage (more favorable terms/bargaining power) and demand
advantages (network effects, e.g. value rises with number of users).
, - Can also suffer from diseconomies of scale (= additional layers of bureaucracy as example)
Cost function
Total cost (TC) = Variable cost (VC) + Fixed cost (FC)
2 types of costs
- Fixed cost (FC) = cost of fixed input (e.g. rent). Does not depend on quantity of output.
- Variable cost (VC) = increases with the quantity of output (e.g. salary, electricity, COGS).
Cost function = shows how total production costs vary with quantity produced.
Average total cost (ATC) = TC/Q. This is the average cost per unit produced.
Marginal cost (MC) = The effect on total cost of producing one additional unit of output (slope).
- If AC > MC: AC is decreasing
- If AC < MC: AC is increasing
- MC intersects the AC curve at its lowest point
