micro chapter ii & iii
TRANSCRIPT
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Theory of Producers’ Behavior
-Production-Cost of Production-Profit Maximizing
Vinashin case
In 3/2003, Vinashin Jacobsen signed a contract of providing machines for diezel factory
From the first operation in 4/2007, there were many times the mentioned factory has to stop working for fixing.
From 10/2009, the diezel factory terminated its work
All equipment sold by Jacobsen are “secondhand” equipment dated back 1995, 1996, from Italy, Germany, Finland, Taiwan, China and also Vietnam
Can you explain about the behavior of people who lead the contract ???
Do they follow the purpose of maximizing profit of all firms?
The way people organize a firm may vary its behaviors
Note:The producers’ behavior may vary if the owner and the administrator are different
Purpose of firm may vary
I. Production
Technology of Production
Production with One Variable Input (Labor)
Production with Two Variable Inputs (Labor and Capital) Returns to Scale
Isoquant
Isocost
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1. Production Decisions of a Firm
a. Production Technology Describe how inputs transformed into outputs
Inputs: land, labor, capital and raw materials Outputs: cars, desks, books, etc.
Firms produce different amounts of outputs using combinations of inputs
b. Cost Constraints Firms consider prices of labor, capital and other
inputs Minimize total production costs partly determined
by input pricesc. Input Choices
Given input prices and production technology, firm chooses how much of each input to use
Given prices of inputs, firm choose combinations of inputs to minimize costs
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Technology of Production
Production Function: Indicates highest output (q) that firm can
produce for every specified combination of inputs
For simplicity, only labor (L) and capital (K) Shows what is technically feasible when
firm operates efficiently Production function for two inputs:
q = F(L,K)
Short Run Period of time in which quantities of
one or more production factors (fixed inputs) cannot be changed
Long Run Time needed to make all production
inputs variable
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2. Production: One Variable Input(Short-run)
Assume capital fixed and labor variable Observations:
1. When labor is zero, output is zero2. With additional labor, output (q) increases
initially3. Beyond this, output declines
More labor becomes counterproductive
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2.1 Definitions
Average Product of Labor - Output per unit of particular product Measures productivity of firm’s labor in terms
of how much, on average, each worker can produce
Marginal Product of Labor – additional output produced when labor increases by one unit
L
q
Input Labor
Output APL
L
q
Input Labor
Output MPL
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At point D, output is maximized.
Labor per Month
Outputper
Month
0 2 3 4 5 6 7 8 9 101
Total Product
60
112
A
B
C
D
Production: One Variable Input
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Average Product
Production: One Variable Input
10
20
Outputper
Worker
30
80 2 3 4 5 6 7 9 101 Labor per Month
E
Marginal Product
•Left of E: MP > AP & AP is increasing•Right of E: MP < AP & AP is decreasing•At E: MP = AP & AP is at its maximum•At 8 units, MP is zero and output is at max
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2.2 Law of Diminishing Marginal Returns
Law of Diminishing Marginal Returns: As input use increases with other inputs fixed, resulting additions to output eventually decrease When labor use is small and capital fixed,
output increases since workers specialize; MP of labor increases When labor use is large, some workers
become less efficient MP of labor decreases
Explains declining marginal product, not necessarily negative one Technology changes cause shifts in total
product curve More output produced with same inputs
Diminishing marginal product
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3.Production: Two Variable Inputs
Firm can produce output by combining different amounts of labor and capital
In long run, capital and labor are both variable
Information can be represented graphically using isoquants Curves showing all possible combinations
of inputs that yield same output Curves are smooth to allow for use of
fractional inputs
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Diminishing Returns
Labor1 2 3 4 5
Increasing labor holding capital
constant (A, B, C) OR
Increasing capital holding labor constant
(E, D, C)
q1 = 55
q2 = 75
q3 = 90
1
2
3
4
5Capital
D
E
A B C
3.1 Isoquant3.1 Isoquant
-A and B bring the same level of quantity to the firm. -A is the combination of more both capital and labor. In comparison with B, A is less efficient.
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Production: Two Variable Inputs
Substituting Among Inputs Producers decide what combination of inputs to
use to produce certain quantity of output Slope of Isoquant shows how one input can be
substituted and keep level of output the same Negative of slope is marginal rate of technical
substitution (MRTS) Amount by which quantity of one input
reduced when one extra unit of another input used, so that output remains constant
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Production: Two Variable Inputs
)( q of level fixed forLKMRTS
InputLaborinChange
InputCapitalinChangeMRTS
LK
LK
As labor increases to replace capital Labor relatively less productive Capital relatively more productive Need less capital to keep output constant Isoquant becomes flatter
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Marginal Rate ofTechnical Substitution (MRTS)
Labor
1
2
3
4
1 2 3 4 5
5Capital
Negative slope measures MRTS; MRTS decreases as move down isoquant curve
1
1
1
1
2
1
2/3
1/3
Q1 =55
Q2 =75
Q3 =90
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MRTS and Marginal Products
Diminishing MRTS occurs because of diminishing returns; implies isoquants are convex
If holding output constant, net effect of increasing labor and decreasing capital is zero
Using changes in output from capital and labor:
LKK
L
KL
KL
MRTSL
K
MP
MP
KMP- LMP
KMP LMP
)(
)(
))(())((
0))(())((
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Isoquants: Special Cases
Two extreme cases show range of input substitution
Perfect Substitutes MRTS constant at all points on isoquant Same output produced with a lot of capital or
of labor or balanced mix Perfect Complements
Perfect fixed proportions production function Output made with only a specific proportion
of capital and labor Cannot increase output unless increase both
capital and labor in specific proportion
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Perfect Substitutes
Laborper month
Capitalper
month
Q1 Q2 Q3
A
B
C
Same output can be reached with mostly capital or mostly labor (A or C) or with equal amount of both (B).
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Perfect Complements
Labor per month
Capitalper
month
L1
K1Q1
A
Q2
Q3
B
C
Same output can only be produced with one set of inputs.
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Returns to Scale
How does firm decide, in long run, best way to increase output? Can change scale of production by
increasing all inputs in proportion If double inputs, output will most likely
increase but by how much? Rate at which output increases as inputs
are increased proportionately
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Increasing Returns to Scale
10
20
•Output more than doubles when all inputs are doubled•e.g., Larger output associated with lower cost (cars)•e.g., One firm more efficient than many (utilities)•Isoquants get closer together
Labor (hours)5 10
Capital(machine
hours)
2
4
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Constant Returns to Scale
•Output doubles when all inputs doubled•Size does not affect productivity•May have large number of producers•Isoquants are equidistant apart
20
30
Labor (hours)155 10
10
Capital(machine
hours)
2
4
6
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Decreasing Returns to Scale
Labor (hours)
Capital(machine
hours)•Output less than doubles when all inputs doubled•Decreasing efficiency with large size•Reduction of entrepreneurial abilities•Isoquants become farther apart
10
20
10
4
5
2
3.2 Isocost-Equal cost curve
TC = K.R + L.w
K = LR
W
R
TC
- Factors explain Isocost:- R, W constant, TC change shift the
Isocost- TC, R constant, W change will turn the
Isocost- TC, R constant, R change will turn the
Isocost
3.3 Optimum choice
R
MPP
W
MPP
R
W
MPP
MPP
KL
K
L
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Cost Minimizing Input Choice Isocost Line
Line showing all combinations of L and K that can be purchased for same cost
Total cost of production is sum of firm’s labor cost, wL, and capital cost, rK:
C = wL + rK Price of labor: wage rate (w) Price of capital: user cost/rental rate (r)
Rewriting: K = C/r - (w/r)L Slope of isocost:
-(w/r) is ratio of wage rate to rental cost of capital Shows rate at which capital can be substituted
for labor with no cost change
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Producing Given Output at Minimum Cost
Labor per year
Capitalper
year
Isocost C2 shows quantity Q1 can be produced with
combination K2,L2 or K3,L3.However, both
are higher cost combinationsthan K1,L1.
Q1
Q1 is isoquant for output Q1.
There are three isocost lines, of which 2 are possible choices in
which to produce Q1.
C0 C1 C2
AK1
L1
K3
L3
K2
L2
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Input Substitution When an Input Price Change
C2
New combination of K and L is used to produce Q1.
Combination B is used in place of combination A.K2
L2
B
C1
K1
L1
A
Q1
If price of laborrises, isocost curve
becomes steeper due to change in slope -(w/r).
Labor per year
Capitalper
year
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Cost in Long Run
How does isocost line relate to firm’s production process?
K
LLK MPMP- MRTS
LK
rw
LK
lineisocost of Slope
costminimizesfirmwhenrw
MPMP
K
L
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Cost in Long Run
Minimum cost combination can be written:
Minimum cost for given output will occur when each dollar of input added to production process will add equivalent output
Cost minimization with varying output levels For each output level, there is an isocost curve
showing minimum cost Firm’s expansion path shows minimum cost
combinations of labor and capital at each output level
Slope equals K/L
rwKL MPMP
All firms, from Delta Air Lines to your local deli, incur costs as they make the goods and services that they sell.
As we will see in the coming chapters, a firm’s costs are a key determinant of its production and pricing decisions.
Establishing what a firm’s costs are, however, is not as straightforward as it might seem
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A. Cost of Production in Short-run1. FC, VC and TC
a. FC-fixed cost
I. Cost of Production
b. VC-Variable Cost
c. TC-Total Cost:
Give some comments on the relationship between TC and VC
2. Average cost, Marginal costa. Average cost
- AFC (Average Fixed Cost)- AVC (Average Variable Cost)- ATC (Average Total Cost)
Note:
Under the effect of Law of Diminishing Marginal Product, AVC, ATC and MC have U shape.
b. MC (Marginal Cost)
Notes:- MC intersects with AVC at the minimum
point of AVC- MC intersects with ATC at the minimum
point of ATC
1. Long-run Total Cost - LTC
In long-run there is no cost can be considered as fixed cost.
All of the cost are variable
B. Long-run Cost of Production
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Firm’s Expansion Path
Expansion Path
Expansion path illustratesleast-cost combinations of
labor and capital that can be used to produce each level of
output in long-run.
Capitalper
year
25
50
75
100
150
50Labor per year
100 150 300200
A
$2000
200 Units
B
$3000
300 Units
C
$1000
100 Units
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Firm’s Long Run Total Cost Curve
Long Run Total Cost
Output, Units/yr100 300200
Cost/ Year
1000
2000
3000
D
E
F•To move from expansion path to LR cost curve•Find tangency with isoquant and isocost•Determine min cost of producing output level selected•Graph output-cost combination
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Long Run Versus Short Run Cost Curves
In short run, some costs fixed In long run, firm can change
anything including plant size Can produce at lower average cost Capital and labor flexible
Show this by holding capital fixed in short run and flexible in long run
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Capital is fixed at K1.To produce Q1, min cost at K1,L1.If increase output to Q2, min cost
is K1 and L3 in short run.
Inflexibility of Short Run Production
Long-RunExpansion Path
Labor per year
Capitalper
year
L2
Q2
K2
D
C
F
E
Q1
A
BL1
K1
L3
PShort-RunExpansion Path
In LR, can change capital and min costs falls to K2 and L2.
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Production with Two Outputs – Economies of Scope
Firms produce multiple products that are linked Advantages:
1. Both use capital and labor2. Firms share management resources3. Same labor skills and types of machinery
Alternative quantities produced illustrated using product transformation curves Product transformation curves negatively sloped since
to get more of one output, must give up some of other Product transformation curves are concave if joint
production has advantages
2.Long-run Average Total Cost - LATC
- The shape of LATC depends on the
return on scale of each production process
Q
LTCLATC
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Long Run VersusShort Run Cost Curves
Long-Run Average Cost (LAC) Determinant of shape of LAC and LMC is
relationship between scale of firm’s operation and cost-minimizing inputs
1. Constant Returns to Scale If input doubled, output doubles AC cost is constant at all levels of output
2. Increasing Returns to Scale If input doubled, output more than doubles AC decreases at all levels of output
3. Decreasing Returns to Scale If input doubled, output less than doubles AC increases at all levels of output
LATC
C
Q
Increasing returns to scale
LATC
C
QDecreasing returns to scale
C
Q
LATC
Constant returns to scale
3. Long-run Marginal Cost (LMC)-Definition:- Calculation
)(' QLTCQ
LTCLMC
LATC
C
Q
LMC
Increasing Returns to Scale
LATC
C
Q
LMC
Decreasing Returns to Scale
C
Q
LATC≡LMC
Constant Returns to Scale
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Long Run Average and Marginal Cost
Output
Cost($ per unitof output)
LAC
LMC
A
•If LMC < LAC, LAC will fall•If LMC > LAC, LAC will rise•LMC = LAC at the minimum of LAC•In special case where LAC is constant, LAC and LMC are equal
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Long Run Costs
As output increases, firm’s AC of producing is likely to decline
1. On larger scale, workers specialize2. Scale can provide flexibility, managers organize
production effectively3. Quantity discounts for inputs, lower prices lead to
different input mix At some point, AC begins to increase
1. Factory space and machinery make it difficult for efficient work
2. Managing larger firm may become more complex and inefficient as tasks increase
3. Limited input availability may cause price increases
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Long Run Costs
Economies of scale reflects input proportions that change as firm changes production level
Economies of Scale Increase in output greater than increase in
inputs Diseconomies of Scale
Increase in output less than increase in inputs
U-shaped LAC shows economies of scale for relatively low output levels and diseconomies of scale for higher levels
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Long Run Costs
Economies of scale measured in terms of cost-output elasticity, EC
EC is percentage change in production cost resulting from 1-percent increase in output
EC is equal to 1, MC = AC Costs increase proportionately with output Neither economies nor diseconomies of scale
EC < 1 when MC < AC Economies of scale Both MC and AC are declining
EC > 1 when MC > AC Diseconomies of scale Both MC and AC are rising
ACMC
QQCCEC
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Long Run Cost with Economiesand Diseconomies of Scale
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Long Run Cost withConstant Returns to Scale
What is firm’s long run cost curve? Firms can change scale to change output
in long run Long run cost curve represents minimum
cost for any output level Firm choose plant that minimizes
average cost of production Long-run average cost curve envelops
short-run average cost curves LAC curve exhibits economies of scale
initially but diseconomies at higher output levels
1. Definitions
a. Profit There are some circumstances
that the enterprise does not want to have profit
IV. Profit
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Marginal Revenue, Marginal Cost, and Profit Maximization
Can study profit maximizing output for any firm, whether perfectly competitive or not Profit () = Total Revenue - Total Cost
If q is output of firm: Total Revenue (R) = Pq Total Cost (C) = C(q)
Firm selects output to maximize difference between revenue and cost
)()()( qCqRq
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Marginal Revenue, Marginal Cost, and Profit Maximization Slope of revenue curve is marginal revenue
Change in revenue from one-unit increase in output
Slope of total cost curve is marginal cost Additional cost of producing additional
unit of output Profit is negative to start since revenue is
not large enough to cover fixed and variable costs
As output rises, revenue rises faster than costs
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Profit Maximization – Short Run
0
Cost,Revenue,
Profit($s per
year)
Output
C(q)
R(q)A
B
(q)q0 q*
Profits are maximized where MR (slope at A) and MC (slope at B) are equal
Profits are maximized where R(q) – C(q) is maximized
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Marginal Revenue, Marginal Cost, and Profit Maximization
Profit maximized at point at which additional increment to output leaves profit unchanged
MCMR
MCMRq
C
q
R
q
CR
0
b. Accounting and Economic Profit- Accounting profit- Economic profit
c. MR (Marginal Revenue)
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Exercise
Josh, a second year MBA student, takes three hours off one evening and uses his car to go to a movie with a friend. A ticket to the movie costs Josh $5, gasoline for the trip costs $1, and Josh passed up tutoring a student that night at $10 an hour. He could also have used the three hours to work as a grader for a professor at $15 an hour. What is Josh’s economic cost of going to the movie?
2. Profit maximizingMR = MC
3. Total revenue maximizingMR = 0
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Production with Two Outputs – Economies of Scope
Degree of economies of scope (SC) measured by percentage of cost saved producing two or more products jointly:
C(q1) is cost of producing q1 C(q2) is cost of producing q2 C(q1,q2) is joint cost of producing both products
Interpretation: If SC > 0 Economies of scope If SC < 0 Diseconomies of scope Greater value of SC, greater economies of scope
)qC(q
)qC(q)C(q)C(q SC
,
,
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