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Economics by David Begg, Gianluigi Vernasca, Stanley Fischer & Rudiger Dornbusch TENTH EDITION ©McGraw-Hill Companies, 2010 Chapter 7 Costs and supply
Choosing output Costs Revenues Technology & costs of hiring factors of production TC curves (short & long run) AC (short & long run) MC Demand curve AR MR CHECK: produce in SR? close down in LR? Choose output level ©McGraw-Hill Companies, 2010
The production function The amount of output produced depends upon the inputs used in the production process. A factor of production (“input”) is any good or service used to produce output The production function specifies the maximum output which can be produced given inputs ©McGraw-Hill Companies, 2010
Short run vs. long run The short run is the period in which a firm can make only partial adjustment of inputs. E.g. the firm may be able to vary the amount of labour, but cannot change capital. The long run is the period in which a firm can adjust all inputs to changed conditions. The long run total cost curve describes the minimum cost of producing each output level when the firm is free to vary all input levels. ©McGraw-Hill Companies, 2010
Average cost The average cost of production is total cost divided by the level of output. Long-run average cost (LAC) is often assumed to be U- shaped: Average cost Output ©McGraw-Hill Companies, 2010
Economies of scale Economies of scale – or increasing returns to scale – occur when long-run average costs decline as output rises: Average cost Output ©McGraw-Hill Companies, 2010
Decreasing returns to scale occur when long-run average costs rise as output rises: Average cost Output ©McGraw-Hill Companies, 2010
Constant returns to scale occur when long-run average costs are constant as output rises: Average cost Output ©McGraw-Hill Companies, 2010
The firm’s long-run output decision The decision: –If the price is at or above LAC 1 the firm produces Q 1 –If the price is below LAC 1 the firm goes out of business NB: LMC always passes through the minimum point of LAC. £ Output (goods per week) MR LMC = MR ©McGraw-Hill Companies, 2010
The short run Fixed factor of production –a factor whose input level cannot be varied Fixed costs –costs that do not vary with output levels Variable costs –costs that do vary with output levels Short-run total cost (STC) = short-run fixed cost (SFC) + short-run variable cost (SVC) ©McGraw-Hill Companies, 2010
The marginal product of labour The marginal product of labour is the increase in output obtained by adding 1 unit of the variable factor but holding constant the inputs of all other factors. Labour is often assumed to be the variable factor –with capital fixed. ©McGraw-Hill Companies, 2010
The law of diminishing returns Holding all factors constant except one, the law of diminishing returns says that: beyond some value of the variable input further increases in the variable input lead to steadily decreasing marginal product of that input. E.g. trying to increase labour input without also increasing capital will bring diminishing returns. ©McGraw-Hill Companies, 2010
The firm’s short-run output decision Firm sets output at Q 1, where SMC=MR subject to checking the average condition: –if price is above SATC 1 firm produces Q 1 at a profit –if price is between SATC 1 and SAVC 1 firm produces Q 1 at a loss –if price is below SAVC 1 firm produces zero output. SAVC 1 £ Output MR Q1Q1 SATC 1 SMC = MR ©McGraw-Hill Companies, 2010
The long-run average cost curve LAC Output Average cost SATC 1 Each plant size is designed for a given output level. SATC 2 SATC 3 SATC 4 So there is a sequence of SATC curves, each corresponding to a different plant size. In the long-run, plant size itself is variable, and the long-run average cost curve LAC is found to be the ‘envelope’ of the SATCs. ©McGraw-Hill Companies, 2010
The firm’s output decisions – a summary Marginal Condition Check whether to produce Short run decision Long run decision Choose the output at which MR=SMC Choose the output at which MR=LMC Produce this output unless price lower than SAVC, in which case produce zero Produce this output unless price is lower than LAC, in which case produce zero. ©McGraw-Hill Companies, 2010
Some maths An example of a short-run total cost function: Where SFC=F and SVC = cQ+ Dq 2 and Thus the short-run average fixed cost decreases steadily as Q increases. ©McGraw-Hill Companies, 2010
Some maths (2) Short run average variable cost is: And short run average total cost: ©McGraw-Hill Companies, 2010
Copyright 2006 – Biz/ed The Theory of the Firm.
OUTPUT AND COSTS 10 CHAPTER. Objectives After studying this chapter, you will able to Distinguish between the short run and the long run Explain the relationship.
Chapter 7 Business organization and behaviour David Begg, Stanley Fischer and Rudiger Dornbusch, Economics, 6th Edition, McGraw-Hill, 2000 Power Point.
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© 2010 Pearson Addison-Wesley. What Is Perfect Competition? Perfect competition is an industry in which Many firms sell identical products to many buyers.
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Firms and Competitive Markets. Competitive Market Properties – Many buyers and sellers – Trading identical products – Each buyer and seller a price taker.
Slide 1 Long-run costs LONG-RUN COSTS In the long-run there are no fixed inputs, and therefore no fixed costs. All costs are variable. Another way to look.
John Sloman Keith Norris PowerPoint to accompany.
slide 1 Long-run costs LONG-RUN COSTS In the long-run there are no fixed inputs, and therefore no fixed costs. All costs are variable. Another way to.
13.1 ECONOMIC COST AND PROFIT Explicit Costs and Implicit Costs An explicit cost is a cost paid in money. An implicit cost is an opportunity cost incurred.
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When economists examine firms over time they must define the Short Run and Long Run Short Run –Only some inputs (e.g. labor) can be adjusted –Not enough.
Learning Objectives Delineate the nature of a firm’s cost – explicit as well as implicit. Outline how cost is likely to vary with output in the short run.
Chapter Nineteen Profit-Maximization. Economic Profit u A firm uses inputs j = 1…,m to make products i = 1,…n. u Output levels are y 1,…,y n. u Input.
Behind The Supply Curve: Production Function I 1. Production - short run 1. Production - short run –Productive efficiency –The Law of diminishing marginal.
© 2002 Prentice Hall Business PublishingPrinciples of Economics, 6/eKarl Case, Ray Fair 7 Prepared by: Fernando Quijano and Yvonn Quijano Short-Run Costs.
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1 Chapter 6: Firms and Production Firms’ goal is to maximize their profit. Profit function: π= R – C = P*Q – C(Q) where R is revenue, C is cost, P is price,
Chapter Eight Competitive Firms and Markets. © 2009 Pearson Addison-Wesley. All rights reserved. 8-2 Topics Competition. Profit Maximization. Competition.
© 2002 Prentice Hall Business PublishingPrinciples of Economics, 6/eKarl Case, Ray Fair 6 Prepared by: Fernando Quijano and Yvonn Quijano The Production.
fixed costs – costs that do not vary with the level of output. Fixed costs are the same at all levels of output (even when output equals zero). variable.
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