Producer Behaviour & Costs

NODE 01

The Firm

• Production unit organizing resources.
• Combines L, K, Land, Entrep.
• Uses Technology + Organization.
• Produces Goods / Services.

NODE 02

Firm Objectives

• Standard assumption: Profit Maximisation.
• Profit = Total Revenue − Total Cost.
• Other goals: Market share, survival, growth.
• Innovation & social objectives.

NODE 03

Production Function

L, K →

ƒ

→ Q

• Relationship between Inputs → Output.
• Q = f(L, K).
• Technology is assumed given.

NODE 04

Fixed vs Variable

VS

• Fixed: Cannot change immediately (e.g. factory).
• Variable: Can change in short run (e.g. labor).
• Short Run = At least one input fixed.
• Long Run = All inputs variable.

NODE 05

Total Product (TP)

• Total quantity of output produced.
• E.g., 10 workers → 1,200 units.
• TP = total output.

NODE 06

Average Product (AP)

=

• Output per unit of variable input.
• AP = TP ÷ units of variable input.
• E.g., 1000 units ÷ 10 workers = 100/worker.

NODE 07

Marginal Product (MP)

+

• Additional output from one more unit of input.
• MP = ΔTP ÷ ΔVariable Input.
• The increment of production.

NODE 08

TP, AP, MP Relation

• MP > 0 → TP rises.
• MP = 0 → TP is maximum.
• When MP > AP → AP rises.
• When MP = AP → AP is max.

NODE 09

Law of Variable Proportions

• Variable factor added to fixed factor.
• Increasing → Diminishing → Negative returns.
• Additional units eventually become less productive.

NODE 10

Returns to Scale

↗

• When ALL inputs change proportionately.
• Increasing: Output grows > proportion.
• Constant: Output grows = proportion.
• Decreasing: Output grows < proportion.

NODE 11

Cost of Production

• Explicit cost: Actual monetary expenditure (wages, rent).
• Implicit cost: Opportunity cost of owned resources.
• E.g., Foregone rent from own building.

NODE 12

Fixed Cost

• Do not change with output in short run.
• E.g., rent, insurance, fixed salaries.
• Exists even if output is zero.

NODE 13

Variable Cost

• Changes with the level of output.
• E.g., raw materials, piece-rate labour, fuel.
• Output ↑ → Variable Cost ↑.

NODE 14

Total Cost (TC)

TC

• TC = Total Fixed Cost + Total Variable Cost.
• TC = TFC + TVC.
• Fundamental cost formula.

NODE 15

Average Fixed Cost (AFC)

• AFC = TFC ÷ Q.
• Continuously falls as output increases.
• Spreads fixed cost across more units.

NODE 16

Average Variable Cost (AVC)

• AVC = TVC ÷ Q.
• May initially fall, then rise.
• Driven by diminishing marginal returns.

NODE 17

Average Total Cost (ATC)

• ATC = TC ÷ Q, or ATC = AFC + AVC.
• Commonly has a U-shape in short-run theory.

NODE 18

Marginal Cost (MC)

• Additional cost of producing one more unit.
• MC = ΔTC ÷ ΔQ.
• Also: MC = ΔTVC ÷ ΔQ (since TFC is constant).

NODE 19

MC & AVC/ATC Rel.

• MC < ATC → ATC falls.
• MC = ATC → ATC is at minimum.
• MC > ATC → ATC rises.
• MC cuts AVC and ATC at their minimums.

NODE 20

Revenue

• Income earned from selling output.
• TR = Price × Quantity sold.
• AR = TR ÷ Q (Usually AR = P).
• MR = ΔTR ÷ ΔQ.

NODE 21

Profit

π

• Profit (π) = Total Revenue − Total Cost.
• Economic Profit: Deducts explicit AND implicit costs.
• Accounting Profit: Deducts only explicit costs.

NODE 22

Break-Even

• Total Revenue = Total Cost.
• Profit = 0.
• Covers costs but earns no economic profit.

NODE 23

Profit-Maximising Output

• Firm maximises profit where MR = MC.
• Compares additional revenue vs additional cost.
• Provided second-order conditions are met.

NODE 24

Shutdown Logic

• May produce at a loss if revenue covers AVC.
• Shutdown if Price < Minimum AVC in short run.
• Fixed costs must be paid regardless.

NODE 25

Economies of Scale

↓AC

• Average cost declines as firm expands.
• Reasons: Specialisation, bulk purchasing.
• Spreading fixed costs, better machinery.

NODE 26

Diseconomies of Scale

• Average cost rises for very large firms.
• Reasons: Coordination problems, bureaucracy.
• Management complexity, congestion.

NODE 27

Internal & External

VS

• Internal: Benefits from firm's OWN expansion.
• External: Benefits from wider industry growth.
• E.g., Tech clusters developing shared suppliers.

NODE 28

Supply of the Firm

• Willingness to produce depends on:
• Price, costs, technology, expectations.
• Production conditions + Price = Supply decision.

NODE 29

Elasticity of Supply

• Responsiveness of Qty supplied to Price change.
• %Δ Qty Supplied ÷ %Δ Price.
• Elastic = Strong response, Inelastic = Weak.

NODE 30

Factors of Elasticity

• More responsive: spare capacity, easy inputs, storability, longer time.
• Less responsive: long production time, fixed capacity, perishability.

NODE 31

Short vs Long Run Supply

FIXED CAPACITY

EXPAND FACTORIES

• Short run: Capacity limits adjustment.
• Long run: Can expand factories, enter/exit markets.
• Supply is more responsive over longer periods.

NODE 32

Technology & Cost

→ ↓ COST

• Reduces input required per unit of output.
• Tech ↑ → Productivity ↑ → Unit cost ↓.
• Increases supply capacity.

NODE 33

Taxes & Subsidies

vs

• Tax: Raises cost → Supply ↓.
• Subsidy: Reduces effective cost → Supply ↑.
• Govt policy interacts directly with decisions.

NODE 34

Producer Surplus

• Difference between price received and minimum acceptable.
• Measure of producer benefit from market exchange.

NODE 35

Complete Producer Logic

• Inputs → Tech → Output.
• Costs + Price/Revenue → Profit/Loss.
• Production Decision → Firm Supply → Market Supply.

NODE 36

Master Formula Bank

∑ ƒ(x)

• AP = TP/L ; MP = ΔTP/ΔL
• TC = TFC + TVC
• ATC = AFC + AVC
• MC = ΔTC/ΔQ
• TR = P×Q ; MR = ΔTR/ΔQ
• Profit max: MR = MC