An Introduction to Cost and Production Functions by David F. Heathfield

By David F. Heathfield

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The inverted 'U'shaped average and marginal product curves). This is not an unnatural property from a technical point of view. Most processes have large scale economies, meaning that average cost of production declines initially. However, it seems reasonable to assume that average cost must start to increase somewhere. Transportation costs, costs of managing a very large organisation, lack of flexibility for very large firms, etc. are some of the factors which are put forward to explain why increasing economics of scale eventually will come to an end and why average production costs eventually increase.

Of course the possession of capital still involves costs, but the cost difference between using and not using the equipment is zero, so the use of existing capital stock may be regarded as free. The cost structure facing the firm in the short run is therefore quite different from that of the LR case. 7) but P2V2 is fixed) where FC represents thefixed cost of production. 7) can be interpreted as the short-run isocost line. 4. In this case the minimum cost is not zero but equal to the fixed cost.

The fundamental decision unit here is the firm, and we will assume that the firm's sole aim is to maximise profit. Profit is defined as the difference between total revenue (TR) and total cost (TC). e. prices offactors and output) and partly by the technological choice set represented by the production function . e. e. a point on the isoquant) such as to maximise profits. We shall analyse these two aspects in the context of a simple two-factor model. 2 The Isocost Line Let us assume that the prices of our two inputs, v 1 and PI and P2 respectively.

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