Theory of Production, Costs and Economies of Scale
Production and costs examines how firms combine inputs, the law of variable proportions, short-run cost curves and economies of scale. Questions often require calculation from a table and clear distinction between the short run and the long run.
Production in the short run
The short run has at least one fixed factor, usually capital. Total product (TP) rises, then may rise at a diminishing rate, then fall. Marginal product (MP) is the change in TP from one more unit of labour. The law of variable proportions says that as more variable input is added to fixed input, MP eventually diminishes. Average product (AP) = TP ÷ labour. MP cuts AP at AP's maximum.
Costs
Fixed costs do not vary with output; variable costs do. TC = TFC + TVC. AC = TC ÷ Q; MC = change in TC ÷ change in Q. MC is independent of fixed cost. When MC is below AC, AC falls; when MC is above AC, AC rises; MC cuts AC at minimum AC. In the long run all factors are variable.
Economies and diseconomies of scale
Internal economies of scale include technical, managerial, marketing, financial and risk-bearing economies; they lower long-run average cost as the firm grows. External economies come from the industry's growth, such as skilled labour pools and better infrastructure. Diseconomies arise from management problems, coordination difficulties and industrial congestion, raising long-run average cost.
Worked example
A firm has fixed cost 40,000 CFA and each worker costs 10,000 CFA. With 2 workers, TP = 24; with 3 workers, TP = 36. Moving from 2 to 3 workers adds 12 units and 10,000 CFA of cost, so MC = 10,000 ÷ 12 = 833 CFA per unit. At 3 workers, TC = 40,000 + 30,000 = 70,000 CFA and AC = 70,000 ÷ 36 = 1,944 CFA. Because MC (833) is below AC (1,944), AC is falling over this range.
Traps that cost marks
Do not call diminishing returns a long-run concept; do not say fixed costs affect marginal cost; do not confuse economies of scale with the law of variable proportions; and do not claim AC always falls as output rises. Check whether a cost is total, average or marginal before calculating.