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Slide 1

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Production and Cost Theory
UNIT 3…read more

Slide 2

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Key terms
· Production
­ A process or set of processes that convert factor
inputs into outputs
· Short run
­ A time period where at least one factor is fixed
and no firms can enter or leave the market
· Long-run
­ A time period where the scale of all FOP are
variable…read more

Slide 3

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The law of diminishing marginal returns
­ Short-term law stating that as a variable factor of
production is added to fixed factors, eventually
marginal returns of the variable factor will begin to
· Fixed costs (e.g. rent)
­ The costs of employing the fixed factors of production
in the short-run
· Variable costs (e.g. labour)
­ The costs of employing variable factors in the short-
run…read more

Slide 4

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Returns to scale
­ How output changes when the scale of all the FOP
change in the long-run (increasing, constant or
· Economies of scale
­ Falling long-run average costs as the size/scale of a
firm's output increases
· Diseconomies of scale
­ Increasing long-run average costs as the size/scale of
the firm increases…read more

Slide 5

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Optimum plant size
­ A scale of production where economies of scale
can be gained but before diseconomies of scale
set in
· Minimum efficient scale
­ The smallest size of the plant that can benefit
from minimum long-run average costs…read more

Slide 6

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SRPT ­ Law of Diminishing Returns
· In the short-run, a firm can only increase output by
increasing the scale of any variable factors of
production and adding this to the fixed capital
· If a firm decides to add more units of labour to it's
production line, this is likely to increase marginal
productivity in the workplace at first due to
specialisation and the division of labour
· However, eventually diminishing marginal productivity
is likely to occur if units of the variable FOP are being
added to a fixed capacity as the benefits of
specialisation become exhausted…read more

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