Chapter 6

Production and Cost: One

Variable Input

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Production Function
The

production function identifies

the maximum quantity of good y that
can be produced from any input
bundle (z1, z2).
A production function is stated as:
y=F(z1, z2).

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Production Functions
In

a fixed proportions production

function, the ratio in which the inputs
are used never varies.
In a variable proportion production
function, the ratio of inputs can vary.

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Figure 6.1 Finding a production function

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From Figure 6.1

The

production function is:

F(z1z2)=(1200z1z2)1/2
This is a Cobb-Douglas production
function. The general form is given
below where A, u and v are positive
constants.

y Az z

u v
1 2

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Costs
Opportunity

cost is the value of the

highest forsaken alternative.
Sunk costs are costs that, once
incurred, cannot be recovered.
Avoidable costs are costs that need
not be incurred (can be avoided).
Fixed costs do not vary with output.
Variable costs change with output.
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Long-Run Cost Minimization

1.
2.

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The goal is to choose quantities of

inputs z1 and z2 that minimize total
costs, subject to being able to
produce y units of output.
That is:
Minimize w1z1+w2z2 (w1,w2 are input
prices).
Choosing z1 and z2 subject to the
constraint y=F(z1, z2).
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Production: One Variable Input

Total

production function TP (z1)

(z2 fixed at 105) defined as:
TP (z1)=F(z1, 105)

Marginal

product MP(z1) is the rate

of output change when the variable
input changes (given fixed amounts
of all other inputs).
MP (z1)=slope of TP (z1)
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Figure 6.2 A total product function

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Figure 6.3 From total product to marginal product

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The Free-disposal Assumption

Because a production function gives the
maximum output from any input
combination, we assume that increased
amounts of inputs will not be used if they
negatively impact output.
This is sometimes called the freedisposal assumption and combined with
our definition of the production function,
implies that marginal product cannot be
negative.

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The Free-disposal Assumption

Given

the free-disposal assumption,

the marginal product of any input is
always greater than or equal to zero.
Furthermore, for any input bundle,
the marginal product of at least one
input is positive.

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Diminishing Marginal Productivity

Reflects the assumption that at some point the
rate of increase in total output (marginal
product) will begin to decline.
Suppose the quantities of all inputs except one
- say, input1- are fixed. There is a quantity of
input 1- say, z1 - such that whenever z1
exceeds z1, the marginal product of input 1
decreases as z1 increases.

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Figure 6.4 From total product to

marginal product: Another illustration

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Average Product
Average

product (AP) of the variable

input equals total output divided by the
quantity of the variable input.
AP(z1)=TP(z1)/z1

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Figure 6.5 From total product to

average product

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Figure 6.6 Comparing the average and

marginal product functions

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Marginal and Average Product

1.
2.
3.

When
When
When

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MP exceeds AP, AP is increasing.

MP is less than AP, AP declines.
MP=AP, AP is constant.

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Costs of Production: One Variable Input

The

cost-minimization problem is:

Minimize w1z1 by choice of z1.

Subject to constraint y=TP(z1).

The variable cost function, VC(y) is:
VC(y)=the minimum variable cost of
producing y units of output.

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Figure 6.7 Deriving the variable cost

function

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More Costs
Average

variable cost is variable

cost per unit of output. AV(y)=VC(y)/y
Short-run marginal cost is the rate
at which costs increase in the shortrun. SMC(y)=slope of VC(y)

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Figure 6.8 Deriving average variable

cost and short-run marginal cost

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Short-run Marginal Costs and

Average Variable Costs
1.

2.

3.

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When SMC is below AVC, AVC

decreases as y increases.
When SMC is equal to AVC, AVC is
constant (its slope is zero).
When SMC is above AVC, AVC
increases as y increases.

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Average Product and Average Cost

AVC (y)=w1/AP(z1)
The

average variable cost function

is the inverted image of the average
product function.

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Marginal Product and Marginal Cost

SMC (y)=(w1z1)/(MP(z))
The

short-run marginal cost

function is the inverted image of the
marginal product function.

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Figure 6.9 Comparing cost and product functions

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Figure 6.10 Seven cost functions

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Figure 6.11 The costs of commuting

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Figure 6.12 Total commuting costs

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Figure 6.13 The allocation of commuters to

routes

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Application: The Allocation of

Output Among Different Plants
Let

us reinterpret the lessons from traffic

congestion to solve a problem related to
multi-plant firms.
The firms problem is to allocate output
to its two plants so as to minimize its
total variable cost.

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Application: The Allocation of

Output Among Different Plants
Think

of Figure 6.13 as the variable and

marginal cost functions associated with
two plants (TCC1, TCC2 and MC1, MC2)
respectively.
The curve TCC in Figure 6.13a tells us
that the firm can minimize the variable
costs of producing 5000 units by
allocating 2000 units to the first plant
and 3000 units to the second plant.
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Application: The Allocation of

Output Among Different Plants
Using

the logic from Figure 6.13b:

Total costs can be reduced by allocating

output from the high-marginal cost plant to
the low-cost marginal plant.
To minimize the total variable cost of
producing a given output in two or more
plants, a firm allocates output to the plants
so that short-run marginal cost is the same
in all plants.
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