Week 8 background to supply production and cost
Transcript of Week 8 background to supply production and cost
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Economics 1A
Chapter 11
Background to Supply: Production
and Cost
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CHAPTER 11Introduction
Goal of the firm – maximise profits
Profit – the surplus of revenue over cost
Total revenue – total value of sales
(price x quantity, or P x Q = PQ)
Average revenue – total revenue divided by quantity sold (PQ/Q)
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Marginal revenue – the additional revenue earned by selling an additional unit of the product
Short run vs. long run:Short run – the period during which at least one of the inputs is
fixed
Long run – all the inputs are variable
Difference not calendar time!
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Basic cost and profit concepts
Opportunity cost – the best alternative sacrificed (or forgone)
Accounting costs = explicit costs
Economic costs = explicit costs + implicit costs
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• Normal profit – the monetary payments that the firm’s resources could have earned in their best alternative uses, forms part of the firm’s cost of production
• Economic profit – the difference between total revenue from the sale of the firm’s product(s) and total explicit and implicit costs
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Economic profit and accounting profit
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Production in the short run
Simplifying assumptions:
•One product
•Homogeneous
•Inputs - infinitely divisible units
•Production function is given
•Prices of product and inputs are given
•Fixed inputs and one variable input
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In the short run, a firm can expand output only by increasing the quantity of its variable input
Production schedule of a maize farmer with one variable input
EXAMPLE
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The law of diminishing returns or the law of diminishing marginal returns – when more of a variable input is combined with one or more fixed inputs in a production process, points will eventually be reached where first the marginal product, then the average product and finally the total product start to decline
Marginal and average product of a maize farmer with one variable input
EXAMPLE 1
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Total, average and marginal product of labour
EXAMPLE 2
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Marginal product and average product
EXAMPLE 3
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Costs in the short runFixed cost – cost that remains constant irrespective
of the quantity of output produced
Variable cost – cost that changes when total product changes
Total cost (TC) = Total fixed cost + Total variable cost
Average cost (AC) = Average fixed cost + Average variable cost
Marginal cost (MC) = the increase in total cost when one additional unit of output is produced
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Total, fixed and variable cost schedules of a maize farmer
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Marginal and average cost
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Marginal and average cost: smoothed curves
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Production and costsin the long run
In the long run there are no fixed inputs, thus all the costs are variable
Returns to scale – the long-run relationship between inputs and output (vary all inputs by a certain percentage)
• Constant returns to scale
• Increasing returns to scale
• Decreasing returns to scale
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Economies of scale – costs per unit of output fall as the scale of production increases
Diseconomies of scale – unit costs rise as output increases
(Note difference between returns to scale and economies of scale)
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Two broad groups:
• Internal economies or diseconomies of scale – can be controlled by the firm
• External economies or diseconomies of scale – cannot be controlled by the firm
Economies of scope – the cost savings achieved by producing related goods in one firm rather than in two separate firms
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Long-run average costs:
Three basic possibilities
Alternative long-run average cost curves
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Three key assumptions:
/̶ The prices of factors of production are given
/̶ The state of technology and the quality of factors of production are given
/̶ Firms always choose the least-cost combination of factors of production to produce each level of output
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• Typical long-run average cost curve
A typical long-run average cost curve