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Economics for CED Noémi Giszpenc Spring 2004 Lecture 3: Micro: Supply February 24, 2004.

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Presentation on theme: "Economics for CED Noémi Giszpenc Spring 2004 Lecture 3: Micro: Supply February 24, 2004."— Presentation transcript:

1 Economics for CED Noémi Giszpenc Spring 2004 Lecture 3: Micro: Supply February 24, 2004

2 2/24/04Economics for CED: Lecture 3, Noémi Giszpenc 2 First, a little expansion of Demand From Lecture 2: The proximate causes of demand A B Tastes: Prices: Effective Demand

3 2/24/04Economics for CED: Lecture 3, Noémi Giszpenc 3 A 1 A 2 A 3 B 1 B 2 B 3 Tastes: Prices: Effective Demand Other: (e.g.laws) C 1 C 2 C 3 From Lecture 2: longer causal chains

4 2/24/04Economics for CED: Lecture 3, Noémi Giszpenc 4 A bigger picture Wants and desires Prices Effective demands Commercial persuaders Marketers’ perspective

5 2/24/04Economics for CED: Lecture 3, Noémi Giszpenc 5 An even bigger picture Wants and desires Prices Effective demands Commercial persuaders Environmentalists’ perspective Nature, Law, Culture, Home & School, other persuaders Provident or improvident uses of the environment

6 2/24/04Economics for CED: Lecture 3, Noémi Giszpenc 6 An even bigger picture Wants and desires Prices Effective demands= satisfied desires Commercial persuaders Sociologists’, social psychologists’ perspective Nature, Law, Culture, Home & School, other persuaders Fit or misfit between wants generated and wants satisfied Unsatisfied desires Deprivation, anxiety, unhappiness, bad behavior

7 2/24/04Economics for CED: Lecture 3, Noémi Giszpenc 7 An even bigger picture Wants and desires Prices Effective demands Commercial persuaders Left economists’ perspective Unsatisfied desires Deprivation, anxiety, unhappiness, bad behavior Few households own capital Bargaining strengths Many households contribute labor HH rewards =firms’ costs of production Incomes

8 2/24/04Economics for CED: Lecture 3, Noémi Giszpenc 8 Wants and desires Prices Effective demands Commercial persuaders Broad economists’ perspective Unsatisfied desires Deprivation, anxiety, unhappiness, bad behavior Few households own capital Bargaining strengths Many households contribute labor HH rewards =firms’ costs of production Incomes Nature, Law, Culture, Home & School, other persuaders Fit or misfit between wants generated and wants satisfied Provident or improvident uses of the environment

9 2/24/04Economics for CED: Lecture 3, Noémi Giszpenc 9 Can even that picture be broadened? “Sixto Roxas, a Filipino economist, argues that the main problem with conventional economics is that it focuses its analysis on the interests of the individual and the firm rather than those of the family and the community. ‘Neo-classical economics is not just a mathematical framework or analytical guideline to facilitate the understanding of reality: it is a full-fledged ideology and design for remaking the world,’ he says… People are reduced to flesh-and-blood machines that earn wages and salaries and generate profits but whose non- economic existence is not recognized.” [emphasis added]

10 2/24/04Economics for CED: Lecture 3, Noémi Giszpenc 10 Now, on to supply Who produces for the market? Firms. –Households and Government are also producers, but not for the market Relations between producers: –Organized relations (within-firm) –Market relations (beyond firm) Ex: Restaurant owner organizes menu, shoppers, cooks, and waiters But goes to market for meat, vegetables supplied by farmers, truckers, and shopkeepers

11 2/24/04Economics for CED: Lecture 3, Noémi Giszpenc 11 Firms’ purposes (1) Maximize profit, silly Remember, profits = revenue - costs Or π = PxQ - C(Q) Assume firm’s Q has no effect on P (for now) So main focus is effect of Q on C

12 2/24/04Economics for CED: Lecture 3, Noémi Giszpenc 12 Another way to see profit At what point is profit maximized? What is the slope of the cost curve? Rev=3Q Cost=5+Q 2 /4 And π=Rev-Cost

13 2/24/04Economics for CED: Lecture 3, Noémi Giszpenc 13 Firms’ costs (Do not include all costs--i.e., external) In the “short run” means during the time that you cannot replace existing fixed K –What is the most economical way to use existing fixed K (capital): or, how to produce goods at least cost? A dual problem: productivity (subject to diminishing marginal returns) and costs

14 2/24/04Economics for CED: Lecture 3, Noémi Giszpenc 14 First, costs: a few simple definitions Total costs –All the accrued costs of producing Average cost –Total cost divided by number of units produced Marginal cost –Additional cost of producing the last unit

15 2/24/04Economics for CED: Lecture 3, Noémi Giszpenc 15 Let’s produce some widgets! Typical good produced in economics classes. Nobody knows what they are, really. At left, a drawing of a widget by Leonardo da Vinci.

16 2/24/04Economics for CED: Lecture 3, Noémi Giszpenc 16 A numerical example Quantity produced Total cost Average cost Marginal cost of last unit 05-- 1883 21052 31242 41644 5$25$5$9

17 2/24/04Economics for CED: Lecture 3, Noémi Giszpenc 17 The example graphed

18 2/24/04Economics for CED: Lecture 3, Noémi Giszpenc 18 Marginal cost drives TC and AC Marginal cost is always positive: total cost is always rising If marginal cost < average cost, then marginal cost is pulling average cost down If marginal cost > average cost, then marginal cost is pulling average cost up

19 2/24/04Economics for CED: Lecture 3, Noémi Giszpenc 19 What happens to profits? Assume the price for output sold is $6 units Total cost Sell for Total π Avg. cost Sell for Avg π/uni t Add’l cost Add’l rev. Add’l π 312186462264 416248462462 52530556196-3

20 2/24/04Economics for CED: Lecture 3, Noémi Giszpenc 20 Information from Costs All three cost measures show that biggest total profit comes from producing 4 units. Only marginal cost shows when firm is actually losing, and how much. Rule: Produce until MC = price –This will give us the supply curve

21 2/24/04Economics for CED: Lecture 3, Noémi Giszpenc 21 Types of costs Fixed: can’t be altered at short notice –Factory, equipment, salaried staff –Also called sunk costs, overheads –Predictable economies of scale average fixed cost per unit output declines w/ Q Variable: can vary w/ Q of output –Raw materials, fuel, temp workers –May not vary evenly

22 2/24/04Economics for CED: Lecture 3, Noémi Giszpenc 22 Costs = Fixed + Variable Total Costs: C(Q) = F + V(Q) Average Costs: AC = (F + V(Q) ) ÷ Q –Average Fixed costs = F ÷ Q –Average Variable costs = V(Q) ÷ Q Marginal Costs: MC = d(F+V(Q))/dQ –Fixed costs have no effect on MC

23 2/24/04Economics for CED: Lecture 3, Noémi Giszpenc 23 Some cost curves MC=AC=1 F = 0, V(Q) = Q TC F = 1, V(Q) = Q TC VC AC MC=AVC AFC

24 2/24/04Economics for CED: Lecture 3, Noémi Giszpenc 24 Another cost curve: “U-shaped” V(Q)=(Q/3-2) 2

25 2/24/04Economics for CED: Lecture 3, Noémi Giszpenc 25 Yet another cost curve: very high fixed costs, low MC F=100 V(Q)=Q/100 TC MC

26 2/24/04Economics for CED: Lecture 3, Noémi Giszpenc 26 A counter-intuitive result If a firm has fixed costs, and if it can keep meeting its variable costs, it should keep producing regardless of whether it is making a loss. –Making a little toward meeting fixed costs is better than making nothing at all –Explains success of early railroads despite lack of profitability--they just kept chugging!

27 2/24/04Economics for CED: Lecture 3, Noémi Giszpenc 27 Now, productivity: diminishing returns Holding other factor(s) of production fixed, increasing a factor eventually adds less and less output –Not all producers encounter rising costs and diminishing returns as output increases Some producers don’t get demand for that level of volume Some factors of production have fixed capacity –Beyond limit, no production at all Some factors of production are variable (can vary in proportion to each other)

28 2/24/04Economics for CED: Lecture 3, Noémi Giszpenc 28 Production Function In general, Production is the transformation of inputs into outputs. –Inputs are the factors of production -- land, labor, and capital -- plus raw materials and business services. A production function -- f(L,K, etc.)=q -- describes how combinations of inputs produce output (given a certain technology) –We saw a production function in first class

29 2/24/04Economics for CED: Lecture 3, Noémi Giszpenc 29 Average and marginal productivity Productivity is ratio of output to input Average productivity is total output divided by total input Marginal productivity is increase in output with addition of last unit of input –With all other inputs held steady (cet. par.)

30 2/24/04Economics for CED: Lecture 3, Noémi Giszpenc 30 A numerical example: farmer Ted Hours of Labor Output: bushels of wheat Average Productivity Marginal Productivity 0009.45 1009459.458.35 20017808.97.25 30025058.356.15 40031207.85.05 50036257.253.95 60040206.72.85 70043056.151.75 80044805.60.65 90045455.05-0.45 100045004.50

31 2/24/04Economics for CED: Lecture 3, Noémi Giszpenc 31 Output Diagram As the variable input increases, output increases at a decreasing rate. This is the Law of Diminishing Marginal Productivity

32 2/24/04Economics for CED: Lecture 3, Noémi Giszpenc 32 Average and marginal productivity Marginal productivity is decreasing and pulling average productivity down.

33 2/24/04Economics for CED: Lecture 3, Noémi Giszpenc 33 What happens to profits? Assume: –cost of variable input fixed (wage rate of farmer=opportunity cost of working elsewhere), and –price of good produced fixed (price of wheat determined by world markets) Profits ≈ revenue - costs = PxQ - C(Q) = Pxf(L,K) - C(L,K) for given L,K

34 2/24/04Economics for CED: Lecture 3, Noémi Giszpenc 34 The relationship will look like this As labor input increases, output does not increase as fast. Cost of labor input goes up steadily but return, or value of marginal product slows down

35 2/24/04Economics for CED: Lecture 3, Noémi Giszpenc 35 How to maximize Profit What does one additional labor unit add to cost? w = wage What does one additional labor unit add to revenue? p*MP = value of marginal product Profit is max’ed when p*MP = w

36 2/24/04Economics for CED: Lecture 3, Noémi Giszpenc 36 Costs and types of firms Natural monopolies –Ex: power & gas, water & sewerage, canals & RR Continually increasing returns to scale –Big firms out-compete small firms –Ex: steel, machine-making, petro-chemicals U-shaped costs –Medium-sized firms –Ex: house-building, furniture-making, textiles

37 2/24/04Economics for CED: Lecture 3, Noémi Giszpenc 37 Costs and types of firms Constant unit costs –Can be big or small –Ex: book publishing, brewing, wineries Diseconomies of scale –Small firms have lower unit costs than big –Ex: tailoring, repair, individual arts, some farming Each type of industry has different temptations and remedies

38 2/24/04Economics for CED: Lecture 3, Noémi Giszpenc 38 Firms’ purposes (2) Working and managing for owners –When firms were mostly sole propietorships –Maximizing profit or return on equity Directors’ purposes –In 20th C., more separation of ownership and control –Adolf A. Berle and Gardner C. Means, The modern corporation and private property (1932) –What are the directors going to do?

39 2/24/04Economics for CED: Lecture 3, Noémi Giszpenc 39 Berle and Means: 3 alternatives 1.Directors maximize owners’ π but own π motive weakened 2.Manage for their own benefit Just enough π paid out to comply with law, attract K Keeps π motive but leads to corp. plunder 3.Manage for good of all society Purely neutral technocracy

40 2/24/04Economics for CED: Lecture 3, Noémi Giszpenc 40 “The state seeks in some aspects to regulate the corporation, while the corporation, steadily becoming more powerful, makes every effort to avoid such regulation.” Berle and Means (1932)

41 2/24/04Economics for CED: Lecture 3, Noémi Giszpenc 41 Firms are responsible to… –(Can’t survive without any of the below) Owners Creditors Employees Customers Community Local & National government

42 2/24/04Economics for CED: Lecture 3, Noémi Giszpenc 42 Firms’ policy choices Profit: maximize, moderate, or (for tax purposes) minimize? Short, medium, or long-term profit? How to divide profit between dividends and reinvestment in growth? Aim for big revenue, market share, profit, profit/sales, profit/equity? Stability or growth? Safety or risk? Working conditions? Neighborliness? Sketchiness: offshore taxes, unsavory partners, bribery?


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