Theory of Production and Cost

Core concepts

1. 01Production function: Q = f(L, K) — relates output to inputs.
2. 02Law of Variable Proportions: as one input increases, marginal product rises then falls.
3. 03Returns to scale: increasing / constant / decreasing.
4. 04Fixed cost independent of output; variable cost changes with output.
5. 05Short-run: at least one input fixed. Long-run: all inputs variable.

Exam-critical pointers

• ⭐MC cuts AC and AVC at their minimum points.
• ⭐When MP > AP, AP rises; when MP < AP, AP falls.
• ⭐Economies of scale (internal: tech, managerial; external: industry-wide infrastructure).
• ⭐U-shaped AC due to law of variable proportions in short run.