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Production Function
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The relationship that describes how inputs (like capital and labor) are transformed into output
Think of a recipe and the requirements
There are specific production functions as well (this is the basic definition)
Think of a recipe and the requirements
There are specific production functions as well (this is the basic definition)
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Long Run
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All factors of production are variable
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Short Run
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Some factors of production are fixed and constrain decisions
Properties:
Passes through the origin
Initially the addition of variable inputs augments output at an increasing rate
Beyond some point additional units of the variable input give rise to smaller and smaller increments of output
Properties:
Passes through the origin
Initially the addition of variable inputs augments output at an increasing rate
Beyond some point additional units of the variable input give rise to smaller and smaller increments of output
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Law of Diminishing Returns
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The principle that, at some point, adding more of a variable input, such as labor, to the same amount of a fixed input, such as capital, will cause the marginal product of the variable input to decline
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Fixed Costs (FC)
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cost that does not vary with the level of output in the short run (the cost of all fixed factors of production)
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Variable Cost (VC)
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cost that varies with the level of output in the short run (the cost of all variable factors of production)
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Total Cost (TC)
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all costs of production: the sum of variable and fixed costs
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Short Run Costs
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TC(Q) = FC + VC(Q)
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Long Run Costs
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All costs variable, no fixed costs
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Marginal Cost
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The incremental cost of producing an additional unit of output
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Isocost
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Combination of inputs that yield the same cost
- wL + rK = C
Or re-arranging to the intercept-slope formulation
- K = (C/r) - (w/r)L
- wL + rK = C
Or re-arranging to the intercept-slope formulation
- K = (C/r) - (w/r)L
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Cost-Minimizing Input Combination Rule
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Employ inputs so that the marginal rate of technical substitution equals the ratio of input prices:
(MPl)/(MPk) = (w/r)
Equivalently, produce at a given level of output where the marginal product per dollar spent is equal for all inputs:
MPl/w = MPk/r
(MPl)/(MPk) = (w/r)
Equivalently, produce at a given level of output where the marginal product per dollar spent is equal for all inputs:
MPl/w = MPk/r
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Output Expansion Path
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the locus of tangencies (minimum-cost input combinations) traced out by an isocost line of given slope as it shifts outward into the isoquant map for a production process
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Long-Run Average Cost Curve
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Defines the minimum average cost of producing alternative levels of output allowing for optimal selection of both fixed and variable inputs
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Minimum efficient Scale
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the level of production required for LAC to reach its minimum level
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Economies of Scale
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Declining portion of the long-run average cost curve as output increases
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Diseconomies of Scale
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Rising portion of the long-run average cost curve as output increases
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Constant Returns to Scale
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Portion of the long-run average cost curve that remains constant as output increases
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Natural Monopoly
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An industry whose market output is produced at the lowest cost when production is concentrated in the hands of a single firm
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