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Inputs and Costs
Inputs and Costs
September 21, 2006
Reading: Chapter 8
Begin examination of how firms make decisions using the
principles of individual decision making (marginal costs and
benefits)
First we examine relation between inputs and outputs
Second we examine costs and marginal (and other) costs
Next topic: Marginal benefits for the firm and how they decide
how much to produce 2
Inputs and Costs
a.Production function
How inputs and outputs are related
Diminishing returns
b.Cost function and cost curve
Total cost
How cost function is related to production
function
c. Marginal and average cost
d.Short-run and long-run costs and returns to scale
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Production Function
Definitions
Production function: relationship between the quantity
of inputs a firm uses and the quantity of output it
produces.
Inputs are of two types:
Fixed input: an input whose quantity is fixed and cannot
be varied in the relevant time preriod.
Variable input: an input whose quantity the firm can vary
in the relevant time period.
Time periods:
Short run: time period in which at least one input is fixed.
Long run: time period in which all inputs can be varied.
Why? Some things take longer to change than others
Why? Some things take longer to change than others
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Production Function
Total product curve
The total product curve shows how the quantity of output
depends on the quantity of one variable input, for a given
quantity of other inputs.
Assume:
firm produces one product
with two inputs, labor and land
amount of land held constant
So labor is variable input and land is fixed input
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Production Function
Total product curve, cont.
Diminishing returns
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The marginal product of an input is the additional quantity of
output that is produced by using one more unit of that input.
The marginal product of labor is the additional quantity of
output produced by using one more unit of labor.
Production Function
Marginal Product
We have diminishing returns to an input when an increase
in the quantity of that input, holding the levels of all other
inputs fixed, leads to a decline in the marginal product of that
input.
Marginal product can be negative – total product falls as input
increased.
