# ch 5 unit5

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• 1. Managerial Economics & Business Strategy Chapter 5 goes with unit 5 The Production Process and Costs (pp. 168-187 but place most emphasis on costs which start at the bottom of page 177)
• 2. Overview
• Cost Analysis
• Total Cost, Variable Cost, Fixed Costs
• Cubic Cost Function
• Cost Relations
• 3. Production Analysis
• Production Function
• Q = F(K,L)
• The maximum amount of output that can be produced with K units of capital and L units of labor.
• Short-Run vs. Long-Run Decisions
• Fixed vs. Variable Inputs
• 4. Marginal Productivity Measures
• Marginal Product of Labor: MP L = Q/ L
• Measures the output produced by the last worker.
• Marginal Product of Capital: MP K = Q/ K
• Measures the output produced by the last unit of capital.
• 5. Average Productivity Measures
• Average Product of Labor
• AP L = Q/L.
• Measures the output of an average worker.
• Average Product of Capital
• AP K = Q/K.
• Measures the output of an average unit of capital.
• 6. Isoquant
• The combinations of inputs (K, L) that yield the producer the same level of output.
• The shape of an isoquant reflects the ease with which a producer can substitute among inputs while maintaining the same level of output.
• 7. Marginal Rate of Technical Substitution (MRTS)
• The rate at which two inputs are substituted while maintaining the same output level.
• 8. Linear Isoquants
• Capital and labor are perfect substitutes
• Q = aK + bL
• Linear isoquants imply that inputs are substituted at a constant rate, independent of the input levels employed.
Q 3 Q 2 Q 1 Increasing Output L K
• 9. Leontief Isoquants
• Capital and labor are perfect complements.
• Capital and labor are used in fixed-proportions.
• Since capital and labor are consumed in fixed proportions there is no input substitution along isoquants
L Q 3 Q 2 Q 1 K Increasing Output
• 10. Cobb-Douglas Isoquants
• Inputs are not perfectly substitutable.
• Diminishing marginal rate of technical substitution.
• As less of one input is used in the production process, increasingly more of the other input must be employed to produce the same output level.
Q 1 Q 2 Q 3 K L Increasing Output
• 11. Isocost
• The combinations of inputs that produce a given level of output at the same cost:
• wL + rK = C
• Rearranging,
• K= (1/r)C - (w/r)L
• For given input prices, isocosts farther from the origin are associated with higher costs.
• Changes in input prices change the slope of the isocost line.
K L C 1 L K C 1 / r C 1 / w C / w 0 C / r New Isocost Line for a decrease in the wage (price of labor: w 0 > w 1 ). C 0 C 0 / w C 0 / r C / w 1 New Isocost Line associated with higher costs (C 0 < C 1 ).
• 12. Cost Minimization Q L K Point of Cost Minimization Slope of Isocost = Slope of Isoquant
• 13. Cost Analysis
• Types of Costs
• Fixed costs (FC)
• Variable costs (VC)
• Total costs (TC)
• Sunk costs
• 14. Total and Variable Costs
• C(Q): Minimum total cost of producing alternative levels of output:
• C(Q) = VC(Q) + FC
• VC(Q): Costs that vary with output.
• FC: Costs that do not vary with output.
0 \$ Q C(Q) = VC + FC VC(Q) FC
• 15. Fixed and Sunk Costs FC: Costs that do not change as output changes. Sunk Cost: A cost that is forever lost after it has been paid. \$ Q FC C(Q) = VC + FC VC(Q)
• 16. Some Definitions
• Average Total Cost
• ATC = AVC + AFC
• ATC = C(Q)/Q
• Average Variable Cost
• AVC = VC(Q)/Q
• Average Fixed Cost
• AFC = FC/Q
• Marginal Cost
• MC = C/ Q
MR \$ Q ATC AVC AFC MC
• 17. Fixed Cost ATC AVC Q 0 AFC Fixed Cost Q 0 (ATC-AVC) = Q 0 AFC = Q 0 (FC/ Q 0 ) = FC \$ Q ATC AVC MC
• 18. Variable Cost AVC Variable Cost Q 0 Q 0 AVC = Q 0 [VC(Q 0 )/ Q 0 ] = VC(Q 0 ) \$ Q ATC AVC MC
• 19. ATC Total Cost Q 0 Q 0 ATC = Q 0 [C(Q 0 )/ Q 0 ] = C(Q 0 ) Total Cost \$ Q ATC AVC MC
• 20. Conclusion
• Cost functions are the foundation for helping to determine profit-maximizing behavior in future chapters.

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