Lecture 6

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Production with Two Variable Inputs


isoquant: Curve showing all possible combinations of inputs that yield the same output.

isoquant map: Graph combining a number of isoquants, used to describe a production function.

Diminishing Marginal Returns

Substitution Among Inputs

marginal rate of technical substitution (MRTS)
Amount by which the quantity of one input can be reduced when one extra unit of another input is used, so that output remains constant.

\text{MRTS}=\dfrac{-\Delta K}{\Delta L}=\dfrac{MP_L}{MP_K}

Production Functions—Two Special Cases

  • Perfect Substitutes (straight line)
  • Fixed-Proportions Production Function (L-shaped)

Returns to Scale

  • returns to scale: Rate at which output increases as inputs are increased proportionately.
  • increasing returns to scale: Situation in which output more than doubles when all inputs are doubled.
  • constant returns to scale: Situation in which output doubles when all inputs are doubled.
  • decreasing returns to scale: Situation in which output less than doubles when all inputs are doubled.

The Cost of Production

Measuring Cost

Economic Cost vs. Accounting Cost

The important difference here is economic includes implicit cost (opportunity cost).

Opportunity Cost

Cost associated with opportunities that are
forgone when a firm’s resources are not put to their best
alternative use.

Sunk Cost

Expenditure that has been made and cannot be recovered.

Because a sunk cost cannot be recovered, it should not influence the firm’s decisions.
One example is that the sunk cost of producing facial masks are too much due to the equipment is not that cheap.

  • total cost (TC or C): Total economic cost of production, consisting of fixed and variable costs.
  • fixed cost (FC): Cost that does not vary with the level of output and that can be eliminated only by shutting down.
  • variable cost (VC): Cost that varies as output varies. \text{TC} = \text{FC} + \text{VC}

Cost in the Short Run

Fixed cost, Variable Cost.

Cost in the Long Run

No fixed cost.

Long-Run versus Short-Run Cost Curves

In the long tun, the total cost is equal or smaller than the short time. That is \text{LRTC}\leqslant\text{SRTC}

Production with Two Outputs – Economies of Scope

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