Understanding Production Function and Costs

The relationship between factors of production and the output is called as Production Function

As more workers are added, the production function is flatter.

As the number of workers increases, the marginal product of labor reduces i.e. the incremental output per worker reduces.

Marginal Product of Labor (MPL)

Take the example of a toy manufacturer. A toy manufacturer is a commodity business with no key differentiation of its product. It follows perfect competition with quantity and price decided by demand and supply equilibrium. Marginal Product of Labor (MPL) is the change in output per addition of a worker. With addition of employees, you observe that the output per employee/worker reduces. This is due to shared resources example land, workstations, etc. This phenomenon is known as the diminishing product of labor. MPL has a diminishing marginal product property i.e., output per worker reduces with the addition of each worker due to shared resources etc. Refer to the figure of no. of workers and the toys they manufacture per day. To calculate the marginal product of labor for each addition of workers, calculate the difference between toys manufactured per day with the addition of each worker. For example, when the workers increase from 3 to 4, the marginal product of labor is 10 i.e., the difference between 75 toys and 65 toys. The recruitment of the first worker is the most productive, MPL is at 30 units, compared to the addition of the 5th worker, where the MPL is 5 units. Look at the figure on right, The MPL decreases as the number of workers increases.

The brief video discusses total cost curve and fixed and variable costs.

Café DAL Makhani

Let’s take a look at Café DAL Makhani to look at how to calculate variable, fixed and total cost. This is an excellent example to understand the concept of marginal cost.

An entrepreneur opens a café that serves Dal Makhani (lenticels) with rice and bread and shares a common kitchen. The rental and equipment are about 50 units per month. The café has two cooks, an accountant, and a server. Their salary is fixed at 10 units per month. In the past couple of months, the business is booming so the owner has recruited two part-time servers getting paid 20 units per month. Highlight and differentiate costs into fixed and variable costs. (The middle Road) 

Video: The middle Road | Cafe DAL Makhani

Key takeaways: first differential between variable and fixed cost that sums up the total cost. Change in total cost per unit change in quantity gives marginal cost. Derive average total, fixed and variable cost to tabulate the cost curves. The video explains in depth how to solve the problem. 

Next lesson discusses opportunity cost taking an example.