Chapter 8: Production and Cost in the Short Run
Chapter 8:
PRODUCTION AND COST IN THE SHORT RUN
Essential Concepts
1. A production function shows the maximum amount of output that can be produced from any specified
set of inputs, given the existing technology.
2. Technical efficiency is achieved when the maximum possible amount of output is being produced
3. Production inputs can be either variable or fixed:
(a) variable input: an input for which the level of usage may be readily varied in order to change the
level output. Payments for variable inputs are called variable costs. Examples of variable inputs
are labor, raw materials, and energy.
4. The short run refers to a time span during which the firm employs at least one fixed input, which, by
definition, must be paid even when output is zero in the short run. In the short run, quasi-fixed inputs
may or may not be employed.
5. The long run, also called the firm’s planning horizon, refers to the time period just far enough in the
6. A sunk cost of production is a payment for an input that, once made, cannot be recovered should the
7. In contrast to a sunk cost of production, an avoidable cost of production is a payment for an input that
TABLE 8.1
Inputs in Production
Input type
Payment
Relation to
output
Avoidable or
sunk?
Employed in short run
(SR) or long run (LR)?
Variable input
Variable cost
Direct
Avoidable
Both SR and LR
8. Average product (
/AP Q L=
) and marginal product (
) are related as follows:
9. The law of diminishing marginal product states that as the usage of a variable input increases, a point
is reached beyond which its marginal product decreases.
10. Panel A in the preceding figure shows the typical total product curve (TP) when production
occurs with only one variable input. The total product curve reflects the following relations:
a. No output can be produced with zero workers.
11. Panel B in the figure shows the AP and MP curves that correspond to TP in Panel A. Notice that
a. both curves first rise, reach a maximum, then decline.
12. Short-run total cost (TC) is the sum of total variable cost (TVC) and total fixed cost (TFC):
TC = TVC + TFC
13. Average fixed cost (AFC) is equal to total fixed cost divided by output:
15. Average total cost is equal to total cost divided by output or the sum of average variable and
average fixed cost:
TC
ATC AVC AFC
Q
= = +
16. Short-run marginal cost (SMC) measures the rate of change in TC as output varies:
17. The following figure shows the typical set of short-run average and marginal cost curves. Note
the following relations:
a. AFC decreases continuously as output increases (AFC is not shown in the figure above, but it
Chapter 8: Production and Cost in the Short Run
Answers to Applied Problems
1. a. Monthly fixed costs: The only fixed cost payment made each month is the $1,000 monthly lease
payment for camera and lighting equipment. This payment is a fixed cost because it does not
vary the number of portrait photos produced each month and the $1,000 payment (each month for
b. Sunk costs: If the studio shuts down at the end of August and the owner returns to work at the
bank for the remainder of the year, then the sunk costs include: (i) $200 for business cards, (ii)
$1,000 for the listing in Yellow Pages, (iii) $250 for the business license, and (iv) the $12,000 of
c. All sunk costs should be ignored, not only in August, but also in every time period after they are
paid because sunk costs can never be recovered no matter what decision the manager makes on
d. Entering into a new business involves making a risky decision because at the time you decide to
enter the new business you cannot know with certainty the amount of revenue you will earn, the
Chapter 8: Production and Cost in the Short Run
2. Diminishing returns begin when a new worker adds less to total product than the previous worker.
When diminishing returns set in, marginal product begins to decrease; total product is still increasing,
3. a. Energy efficiency in the context of this problem simply means producing a mile of transportation
with the least amount of a particular input, namely gasoline. Economic efficiency means
producing the mile of transportation at the lowest possible total cost. These are generally
4. a. All the sheet metal workers at CF&D could be working as “hard” as they can, and the firm could
still experience diminishing productivity as suggested by the law of diminishing marginal
productivity. If the production increases at CF&D were achieved without adding new machinery
5. Improvements in productivity, as measured by increases in MP and AP, directly result in reductions in
SMC and AVC, respectively. Lower costs make it possible to maintain, and possibly even increase,
profits in the face of falling prices.
6. The move was economically efficient if the same amount of furniture was produced at a lower total
7. The lease payments for the 2014 lease can only be considered sunk costs if the lease contract offers
no means of partial payment of the $144,000 lease amount should Digital Advantage wish to vacate
the retail space before making the last payment of $12,000 on December 1, 2014. If there is no
8. The tractor-trailer rig can be viewed as a lumpy and indivisible input, since Oversize Transport must
employ an entire 275-long rig in order to haul even one Caterpillar 740 dump truck and huge rigs
probably come only in 50-foot increments—200-, 250-, or 300-foot sizes. However, in the short run,
Answers to Mathematical Exercises
1. a. f(L,16) = g(L) = 20 4 L2 = 80L2.
2. a. From equation (9) in the Math Appendix, the slope of ATC = 1/Q(SMC – ATC). Similarly, it can
3. a. AVC = AVC(Q) = TVC/Q = 20L/Q. Solving for L in the production function, L = L(Q) = Q2/6400.
Substituting into AVC, AVC = [20(Q2/6400)]/Q = Q/320.
Chapter 8: Production and Cost in the Short Run