1. BAEB602
MICROECONOMICS
CHAPTER 5
COST PRODUCTION
PREPARED BY:
Nur Suhaili Ramli
School of Marketing and
Entrepreneurship (SoME)
FACULTY OF BUSINESS AND MANAGEMENT

2. CHAPTER 5: COST PRODUCTION
The Meaning of Costs
TOPIC
 Opportunity costs
 meaning of opportunity cost
 examples
 Measuring a firm’s opportunity costs
 factors not owned by the firm: explicit costs
 factors already owned by the firm: implicit costs
 irrelevance of:
historic costs
replacement costs
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3. CHAPTER 5: COST PRODUCTION
Production in the Short run
TOPIC
 Production functions
 factors of production
labour
land and raw materials
capital
entrepreneurship
 the relationship between inputs and output
TPP = ƒ(F1, F2, F3, … Fn)
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4. CHAPTER 5: COST PRODUCTION
Production in the Short run
TOPIC
 Long-run and short-run production
 fixed and variable factors
 distinction between short run and long run
 The law of diminishing returns
 The short-run production function:
 total physical product (TPP)
 average physical product (APP)
 marginal physical product (MPP)
 the graphical relationship between TPP, APP and MPP
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5. CHAPTER 5: COST PRODUCTION
Costs in the Short run
TOPIC
 Costs and inputs
 costs and the productivity of factors
 costs and the price of factors
 Fixed costs and variable costs
 Total costs
 total fixed cost (TFC)
 total variable cost (TVC)
TVC and the law of diminishing returns
 total cost (TC = TFC + TVC)
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6. CHAPTER 5: COST PRODUCTION
Costs in the Short run
TOPIC
 Marginal cost
 marginal cost (MC) and the law of diminishing returns
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7. CHAPTER 5: COST PRODUCTION
Costs in the Short run
TOPIC
 Marginal cost
 marginal cost (MC) and the law of diminishing returns
 the relationship between MC and TC curves
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8. CHAPTER 5: COST PRODUCTION
Costs in the Short run
TOPIC
 Average cost
 average fixed cost (AFC)
 average variable cost (AVC)
 average (total) cost (AC)
 Relationship between average and marginal cost
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9. CHAPTER 5: COST PRODUCTION
Production in the Long run
TOPIC
 All factors variable in long run
 The scale of production:
 constant returns to scale
 increasing returns to scale
 decreasing returns to scale
 Returns to scale and economies and diseconomies of scale
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10. CHAPTER 5: COST PRODUCTION
Production in the Long run
TOPIC
 Economies of scale
 specialisation & division of labour
 indivisibilities
 container principle
 greater efficiency of large machines
 by-products
 multi-stage production
 organisational & administrative economies
 financial economies
 Economies of scope
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11. CHAPTER 5: COST PRODUCTION
Production in the Long run
TOPIC
 Diseconomies of scale
 managerial diseconomies
 effects of workers and industrial relations
 risks of interdependencies
 External economies of scale
 External diseconomies of scale
 Location
 balancing the distance from suppliers and consumers
 importance of transport costs
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12. CHAPTER 5: COST PRODUCTION
Production in the Long run
TOPIC
 Optimum combination of factors
 MPPa/Pa = MPPb/Pb ... = MPPn/Pn
 Decision making in different time periods
 very short run
 short run
 long run
 very long run
 decisions can be made for all time periods at the same time
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13. CHAPTER 5: COST PRODUCTION
Costs in the Long run
TOPIC
 Long-run average costs
 shape of the LRAC curve
 assumptions behind the curve
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14. CHAPTER 5: COST PRODUCTION
Costs in the Long run
TOPIC
 Long-run average costs
 shape of the LRAC curve
 assumptions behind the curve
 Long-run marginal costs
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15. CHAPTER 5: COST PRODUCTION
Costs in the Long run
TOPIC
 Long-run average costs
 shape of the LRAC curve
 assumptions behind the curve
 Long-run marginal costs
 Relationship between long-run and short-run average costs
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16. CHAPTER 5: COST PRODUCTION
Costs in the Long run
TOPIC
 Long-run average costs
 shape of the LRAC curve
 assumptions behind the curve
 Long-run marginal costs
 Relationship between long-run and short-run average costs
 the envelope curve
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17. CHAPTER 5: COST PRODUCTION
Costs in the Long run
TOPIC
 Long-run average costs
 shape of the LRAC curve
 assumptions behind the curve
 Long-run marginal costs
 Relationship between long-run and short-run average costs
 the envelope curve
 Long-run cost curves in practice
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18. CHAPTER 5: COST PRODUCTION
Costs in the Long run
TOPIC
 Long-run average costs
 shape of the LRAC curve
 assumptions behind the curve
 Long-run marginal costs
 Relationship between long-run and short-run average costs
 the envelope curve
 Long-run cost curves in practice
 the evidence
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19. CHAPTER 5: COST PRODUCTION
Costs in the Long run
TOPIC
 Long-run average costs
 shape of the LRAC curve
 assumptions behind the curve
 Long-run marginal costs
 Relationship between long-run and short-run average costs
 the envelope curve
 Long-run cost curves in practice
 the evidence
 minimum efficient plant size
Slide 19 of 17

20. CHAPTER 5: COST PRODUCTION
Class Activity
TOPIC
 Before leaving the class, you should submit the following:
 Identify the following
 Short run
 Long run
 Total cost
 Total average cost
 Name, ID, classcode
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