Production, Costs and Supply

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Production, Costs and Supply

• Getting Behind the Supply Curve

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Question of the Day

• After some point, the average cost (per unit
  cost) goes up as a firm tries to increase its
  output. Why?

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Getting Behind the Supply Curve

• Costs and Firm Behavior
• Production Functions and Costs Functions
• Average Variable Costs and Price
• Fixed Costs and the Irrelevance of Sunk Costs
• Fixed Costs in the Short Run and the Long Run
• Marginal Costs and Marginal Revenues and
  Maximizing Profits

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Some preliminary distinctions

• Short Run vs. Long Run
• Sunk Costs vs. Non-sunk Costs
• Fixed Costs vs. Variable Costs
• Explicit Costs vs. Implicit Costs
• Normal Profits vs. Economic Profits vs.
  Accounting Profits

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Production Functions and Cost Functions

• Last time we started with a simple relationship
  between Labor input (L) and output (Q) the rest
  of this can be derived (see definitions
  formulas below)
• See new spreadsheet

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Definitions, Relationships and Assumptions for
Production Function Example Above

• L Units of Labor Input in Person Hours (total
  number of hours worked by all workers)
• Q Quantity of Output of Some Good Total
  Product TP
• K the amount of capital 5 here
• r price of capital 5 here
• w the hourly wage rate or price of an hour of
  labor 5 here
• MPL Marginal Product of Labor ?Q /? L
• MPK Marginal Product of Capital ?Q /? K
• APL Average Product of Labor Q / L
• APK Average Product of Capital Q / K

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Definitions, Relationships and Assumptions for
Production Function Example Above

• VC Variable Cost wL, assuming labor and
  capital are the only inputs. Here w 5 per
  hour.
• FC Fixed Cost rK (and for now, we will
  consider this a sunk cost)
• TC Total Cost VC FC wL rK
• AVC Average Variable Cost VC/Q wL/Q
  w/APL
• AFC Average Fixed Cost FC/Q r/APK
• ATC Average Total Cost TC/Q (VCFC)/Q
  w/APL r/APK
• MC Marginal Cost ?VC /?Q ?(wL)/?Q w
  ?L/?Q w/MPL

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Long-Run Costs

• Economies and Diseconomies of Scale (Increasing,
  Constant and Decreasing Returns to Scale)
• Reasons for Scale Economies
• Economies and Diseconomies of Scope
• Reasons for Economies (and dis) of Scope

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Rules for Profit Maximization

• MRMC
• Necessary, but not sufficient condition, also
  called first-order condition
• Are Profits Max if MRgtMC?
• If MRgtMC?
• MC cuts MR from below
• With MRMC, this assures Local Maximum, but not
  global Maximum
• What if MC cuts MR from above?

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Rules for Profit Maximization

• PAVC (Same as RVC)
• End-point check
• If P lt AVC
• Profit max Loss min
• Loss TC R
• FC (VC R)
• P x QR, AVC x QVC,
• so if P lt AVC, then RltVC
• What does VC, R equal if Q0?
• Shut down if PltAVC, Operate if PAVC

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Marginal Costs and Supply

• Maximizing Profit MR MC, Why?
• Competitive Case P MR, Why?
• If Competitive Market, maximize profit where P
  MC.

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RevenuePQ
RevenuePQ
RevenuePQ
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Price
Price
Profit
ATC
PxQRev.
Total Cost
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Shut Down Decision

• Do you shut down if PgtAVC?

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Some Relevant Course Notes

• THE SHORT RUN VS. THE LONG RUN
• LAW OF DIMINISHING RETURNS
• SHORT RUN COSTS
• THE LONG RUN AVERAGE COST CURVE

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Coordinating Supply and Demand

• Example--Energy
• Individual Decisions
• Non-price coordination
• Price coordination