PPA 723: Managerial
Economics
Study Guide:
Production, Cost, and Supply
Managerial Economics, Study Guide
Topics
 Short-run product curves
 Short-run cost curves
 Short-run firm supply
 Short-run market supply
 Input mix decision
 Long-run product curves
 Long-run cost curves
 Long-run firm supply
 Long-run market supply
Managerial Economics, Study Guide
Short-Run Product Curves
Question:
 If some inputs (usually capital) are fixed (i.e. in the short run), how much
output can a firm produce from different quantities of a variable input
(usually labor)?
Analytical Tools:
 Total product curve
 Average product curve
 Marginal product curve
Key Concepts/Results
 Law of diminishing marginal product (MPL eventually slopes downward)
 MPL = APL at minimum of APL curve
Managerial Economics, Study Guide
Short-Run Cost Curves
 Question:
 If some inputs (usually capital) are fixed (i.e. in the short run), how much does it
cost to produce various levels of output by varying a variable input (usually
labor)?
 Analytical Tools:




Average fixed cost curve
Average variable cost curve
Average total cost curve
Marginal cost curve
 Key Concepts/Results
 Law of diminishing marginal productivity leads to upward sloping MC curve after
some point
 U-shaped AVC (usually) and U-shaped ATC (always)
 MC = AVC at minimum of AVC
 MC = ATC at minimum of ATC
Managerial Economics, Study Guide
Short-Run Firm Supply
Question:
 If some inputs (usually capital) are fixed (i.e. in the short run),
what is the most profitable level of output for the firm to produce?
Analytical Tools:
 Average variable cost curve
 Marginal cost curve
 In a competitive market, marginal revenue = market price = P
Key Concepts/Results
 The firm shuts down (supply = 0) if P < minimum of AVC curve.
 If P > minimum of AVC curve, the firm sets P = MC, which
implies that the MC curve is the supply curve.
Managerial Economics, Study Guide
Short-Run Market Supply
Question:
 What does the market supply curve look like in the short run?
Analytical Tools:
 SR firm supply curve
 Number of firms
Key Concepts/Results
 The SR market supply curve is the horizontal summation of the
firm supply curves for the firms in the market.
 The more firms in the market, the more elastic the SR market
supply curve.
Managerial Economics, Study Guide
Long-Run Product Curves
Question:
 If all inputs are variable (i.e. in the long run), how much output can a
firm produce from combinations of inputs?
Analytical Tools:
 Isoquant
Key Concepts/Results
 Isoquants have the same properties as indifference curves, i.e. higher
isoquants indicate more product, isoquants cannot slope upward, and
isoquants cannot cross.
 The slope of an isoquant is MPL/MPK (with L on the horizontal axis).
 Constant returns to scale exist if product doubles when inputs double.
 Economies [diseconomies] of scale exist if product more than doubles
[less than doubles] when inputs double.
Managerial Economics, Study Guide
The Input-Mix Decision
Question:
 What is the least expensive input combination for producing a
given output?
Analytical Tools:
 Isoquants
 Isocost lines
Key Concepts/Results:
 The least expensive input combination is at the tangency
between an isocost line and the relevant isoquant.
 The slope of an isocost line is the wage rate over the capital
rental rate = w/r (with labor on the horizontal axis).
 The least cost combination is where MPL/w = MPK/r, that is,
where each input has the same MP per dollar of cost.
Managerial Economics, Study Guide
Long-Run Cost Curves
Question:
 If all inputs are variable (i.e. in the long run), how much does it cost to
produce various levels of output?
Analytical Tools:
 Expansion path
 Long-run average cost curve
 Long-run marginal cost curve
Key Concepts/Results
 Expansion path (from input-mix diagram) indicates the cost of every
output at the optimal input mix, i.e. the long-run cost curve.
 LR MC = LR AC at minimum of LR AC
 SR cost  LR cost
Managerial Economics, Study Guide
Long-Run Firm Supply
Question:
 If all inputs are variable (i.e. in the long run), what is the most
profitable level of output for the firm to produce?
Analytical Tools:
 LR AC curve
 LR MC curve
 In a competitive market, marginal revenue = market price = P
Key Concepts/Results
 The firm shuts down (supply = 0) if P < minimum of LR AC curve.
 If P > minimum of LR AC curve, the firm sets P = LR MC, which
implies that the LR MC curve is the supply curve.
Managerial Economics, Study Guide
Long-Run Market Supply
Question:
 What does the market supply curve look like in the long run?
Analytical Tools:
 LR firm supply curve
 Entry and exit
Key Concepts/Results
 Firms enter the market in response to economic profits and exit in
response to losses—thereby altering the market price.
 LR equilibrium exists when no firms have an incentive to enter or exit,
i.e. when economic profits equal zero.
 In LR equilibrium P = minimum LR AC
 With free entry and exist, the same costs for all firms, and constant input
prices, the LR supply curve is horizontal.