Intermediate Microeconomic Theory 3550
Fall 2008
Chapter 6: Production and Cost
I
II
III
IV
V
Definitions
A.
Goods and Services
B.
Time
Production Function
Short-Run Model
A.
APL
B.
MPL
C.
Mathematical Example
D.
First and Second Stages
Cost
Long-Run Model
A.
Isoquants
1.
MRTS
2.
Marginal Product and MRTS
B.
Isocost Curves
C.
Equimarginal Principle
D.
Output Maximization
Firm: Any organization that sells goods and/or services in a market.
How do firms behave?
Keep doing activity X as long as MB(X) > MC(X) or until MB(X) = MC(X).
Definitions
Short Run: decision making time frame where some inputs are variable but some are fixed.
Long Run: planning time frame where all inputs are variable.
Production Function: the technological relationship between inputs and outputs if production is efficient.
To keep it simple, we will assume that production only requires two inputs, capital, K, and labor, L.
Output = Q = Total Product (TP) = f(L, K; Technology)
L and K are variables, but technology determines how combining different amounts of K and L results in
Q.
Technology determines which of the following is the relationship between K, L and output.
Lecture_Chapter6_Fall’08
First Stage: MPL > APL:
Second Stage: MPL<APL:
2nd stage
E
st
TP, Q
1 stage
F
DMR
D
IMR
C
B
A
0
La
Lb
Lc
1st stage
Ld
Le
Lf
Le
Lf
L
2nd stage
MPL, APL
IMR
Begin at same
point b/c
MPL =APL
when L and L
are both 1
DMR
0
La
Lb
Lc
Ld
L
Lecture_Chapter6_Fall’08
Production in the Long Run
An isoquant demonstrates all the combinations of inputs that produce the same level of output if
production is technically efficient.
The MRTS is the slope of the isoquant if L is on the horizontal axis.
An isocost curve is like a budget constraint; it reflects all the combinations of inputs that cost the same
amount. PL *L + PK * K = TC
K
TC/PK
Slope = PL/PK
TC/PL
L
LRAC: What is the average cost of producing any level of Q if inputs can be adjusted so that the firm is
operating on its expansion path.
LRMC: If the firm is on its expansion path and increases output by one unit, what is the MC if the firm
can adjust inputs to remain on the expansion path.
Lecture_Chapter6_Fall’08