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Producer Decision Making Chapter 4

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Production - a process by which resources are transformed into products or services that are usable by consumers. Producer Decision Making

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Decisions a Producer Must Make What to Produce? How Much to Produce? How to Produce? How Big to Be? Producer Decision Making

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Resource (input) - A factor that can be used to produce a product that can satisfy a human want or desire. Producer Decision Making

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Physical Relationships Land - everything you see in viewing the earth’s surface. Labor - physical act of performing a task. Management - the sole responsibility of decision making. Capital - every manufactured thing that can be used to aid or enhance production. Producer Decision Making

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Different quantities and combinations of these four things will produce different amounts of the product. Producer Decision Making

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Production Function Y = Output X = inputs (land, labor, capital, management) Function Y = f ( x1, x2, x3,..., xn ) This function is used to determine the level of output given the units of inputs. Producer Decision Making

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Mapping a Production Function I II III IV Producer Decision Making

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Constant Returns - if all inputs were increased in a constant ratio, the output will increase by the same percentage as the inputs. Producer Decision Making

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Total Physical Product Curve TPP X Y TPP = Total Physical Product Producer Decision Making

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X = 1 acre of land, $1000 of capital, 1 week of management time. 2 X = 2 acres of land, $2000 of capital, 2 weeks of management time. X produces 5 units of output 2 X produces 10 units of output Producer Decision Making

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Law of diminishing returns - as successive amounts of a variable input are combined with a fixed input in a production process, the total product will rise, reach a maximum, then eventually decline. Changing the Level of One Input Producer Decision Making

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Changing the Level of One Input Y TPP X1 X2, X3,...,Xn Producer Decision Making

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Marginal Physical Product - the amount added to total physical product when another unit of the variable input is used. Changing the Level of One Input Producer Decision Making

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Y TPP X1 X2, X3,...,Xn Change in Y Change in one unit of X Marginal Physical Product Producer Decision Making

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Y TPP X1 X2, X3,...,Xn Or it could be measured at a point of Tangency.. Marginal Physical Product Producer Decision Making

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Y TPP X1 X2, X3,...,Xn What is MPP Here? Marginal Physical Product Producer Decision Making

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Y TPP X1 X2, X3,...,Xn What is MPP Here? Marginal Physical Product Producer Decision Making

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MPP = Change in output TPP Y Change in input X1 == Marginal Physical Product Producer Decision Making

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Average Physical Product Y TPP X1 X2, X3,...,Xn APP Producer Decision Making Change in Y Change in X

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Y TPP X1 X2, X3,...,Xn Average Physical Product APP Producer Decision Making

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Y TPP X1 X2, X3,...,Xn Average Physical Product APP Producer Decision Making

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Average Physical Product APP Output Y Input X1 = = Producer Decision Making

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Y X1 X2, X3,...,Xn Marginal and Average Product Curves Stage I Stage II Stage III APP MPP Producer Decision Making

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Stage I Irrational As long as MPP > APP it will always be profitable to use more of that particular input. So because in Stage I MPP > APP everywhere, we will not produce in this region. Producer Decision Making

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Y X1 X2, X3,...,Xn Marginal and Average Product Curves Stage I Stage II Stage III APP MPP Producer Decision Making

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Stage II Rational In Stage II profit maximization will occur. APP > MPP everywhere, and production is still increasing with increases in inputs. Producer Decision Making

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Y X1 X2, X3,...,Xn Marginal and Average Product Curves Stage I Stage II Stage III APP MPP Producer Decision Making

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Stage III Irrational Stage III is irrational because as we increase the use of the input X1 output actually falls as a result. This cannot possibly be a profitable region of production. Producer Decision Making

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Y X1 X2, X3,...,Xn Marginal and Average Product Curves Stage I Stage II Stage III APP MPP Y TPP X1 X2, X3,...,Xn Stage I Stage II Stage III Total Physical Product Curve

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To determine the optimum level of an input, we need information about the value of the product and the cost of the input. Value of Product TVP = Price of Product * Amount of Product AVP = TVP / Quantity of Input (X1) MVP = Change in TVP / Change in Quantity of Input (X1) Producer Decision Making

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$Y X1 X2, X3,...,Xn Marginal and Average Value Curves AVP MVP Producer Decision Making

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Cost of the input Marginal Factor Cost - is the amount added to total cost when an additional unit of the variable input is used. MFC X 1 = Price X 1 Producer Decision Making

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$Y X1 X2, X3,...,Xn Marginal and Average Value Curves AVP MVP MFC= P X 1 Optimal Input Usage. Producer Decision Making

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Total Factor Cost TFC = Price X1 * Units of X1 used Producer Decision Making

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$Y X1 X2, X3,...,Xn AVP MVP MFC= P X 1 Optimal Input Usage. Total Factor Cost TF C Producer Decision Making

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Adjusting to Price Changes PRODUCT PRICE CAN CHANGE AND WILL INPUT PRICES CAN ALSO CHANGE Producer Decision Making

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Changing the level of Product Price $Y X1 X2, X3,...,Xn AVP MVP MFC= P X 1 Optimal Input Usage TF C Increasing Output Price Producer Decision Making

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Changing the level of Product Price $Y X1 X2, X3,...,Xn AVP MVP MFC= P X 1 Optimal Input Usage. TF C Increasing Output Price Producer Decision Making

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$Y X1 X2, X3,...,Xn AVP MVP MFC= P X 1 Optimal Input Usage. TF C Changing the level of an input price An increase in MFC Producer Decision Making

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$Y X1 X2, X3,...,Xn AVP MVP MFC= P X 1 Optimal Input Usage. TFC Changing the level of an input price An increase in MFC Producer Decision Making

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Deriving the demand for an input Producer Decision Making Price of InputQuantity of Input 1530 1040 560 280

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Product Price $ Quantity of Input Demand 3040 80 2 10 15 Producer Decision Making

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$Y X1 X2, X3,...,Xn AVP MVP or Demand for X1 0120 $ Demand for input from MVP Producer Decision Making

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$Y X1 X2, X3,...,Xn AVP MVP or Demand for X1 0120 $ Demand for input from MVP MFC = Px1 60 Producer Decision Making

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$Y X1 X2, X3,...,Xn AVP MVP or Demand for X1 0120 $ Demand for input from MVP MFC = Px1 60 Producer Decision Making

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$Y X1 X2, X3,...,Xn AVP MVP or Demand for X1 0120 $ Demand for input from MVP MFC = Px1 60 Producer Decision Making

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