2 The Firm/ Production What is the aim of the firm? Profits=Revenue-Total Economic CostsRevenue=Price*QuantityTotal Economic Costs:Concepts:Total Economic Costs & Sunk Costs vs. Fixed and Variable CostsAverage CostsMarginal Costs
3 Profit maximisation Two steps Cost minimisation: Profit maximisation Find the optimal combination of inputs that minimizes costsFind optimum for each level of outputIsoquants vs. IsocostsWhat is the optimality condition?What are the slopes of the Isoquants and Isocosts?Profit maximisationFrom Cost minimization – get total costs as a function of ouputChoose: profit maximizing amount of outputOptimality conditionShut down rule
4 Question 1Four years ago Jacques signed a five-year lease of €1,000 per year on a custom-made ice cream packing machine. Given that he cannot sublet it, the lease contract currently implies for Jacques: An economic cost of €1,000An economic cost of €5,000A sunk expenditure of €1,000A sunk expenditure of €5,000
5 Question 1Total Economic Costs= Sum of opportunity costs of all inputs=> Sunk ExpenditureWhy is it 1000 pounds and not 5000 pounds?Depends somewhat on assumptionsBut: unless he has to pay 5000 upfront – would not be a sunk expenditure of 5000Need to discount the future!
6 Question 2The sales department of an ice cream producer has gathered the following information on the relation between price and quantity sold:When the firms sells 7,000 litres of ice cream per month, the corresponding total revenue is:€20,000€28,000€25,980€29,360
8 Question 3The finance department of an ice cream producer reports that the total costs of producing 5,000 litres and 6,000 litres of ice cream per months are €12,500 and €14,500 respectively. The marginal cost of raising production from 5,000 to 6,000 litres per month is therefore:€1,000€12,500€2,000€14,500
9 Question 4 Based on the figure, the ice cream seller should: Produce because it makes profit represented by area IProduce because it makes profit for any output levelShut down because makes a loss for any output levelShut down because it makes a loss represented by area IWhat is the shutdown rule in terms of AEC and not in terms of MC?Why is it important to take the Economic costs and not accounting cost?
10 Question 5The isoquant represents Springsteen Motors’s target of 200 cars per day. Before the superstorm Springsteen Motors could rely on 300 robots. However, due to the superstorm, 100 of those robots are now out of order. How many more workers do Springsteen Motors have to hire in order to achieve its target output of 200 cars per day after superstorm Wendy?1008001550750
11 Question 6The marginal physical product of labour when the plant has 60 units of capital and increases its labour from 4 to 5 workers is:67778757
12 Question 6 What is the Marginal Product of Labour? In this case: how much does output increase if we increase labour from 4 to 5 workers4 workers: output=705 workers: output=147Can we say anything about increasing vs. decreasing returns to scale?
13 Question 7Consider a firm with the production function F(L,K) = L x K that is using 10 units of labour and 5 units of capital. Its marginal physical product of labour, its marginal physical product of capital and its marginal rate of technical substitution are respectively:5, 10 and 1/210, 5 and 1/25, 10 and 210, 5 and 2
14 Question 7Increasing labour by ΔL raises output by: ΔX = (L + ΔL) × K − L × K = ΔL × K.=> MPPL = ΔX / ΔL = K = 5Capital: ΔX = L × (ΔK+ K) − L × K = L ×Δ K.MPPK =ΔX / ΔK= L = 10.MRTS = MPPL/MPPK = K/LGiven that MPPL = 5, MPPK = 10 => MRTS = 1/2.
15 Question 8 This illustrates the case of: Increasing marginal rate of technical substitutionDecreasing marginal rate of technical substitutionConstant marginal rate of technical substitution
16 Question 9 The production function F(L,K) = L x K exhibits: Decreasing returns to scaleConstant returns to scaleIncreasing returns to scale
17 Question 9 What are increasing returns to scale? How do we check? E.g. multiply all inputs by 2Increasing returns of scale imply:F(2L,2K)>2F(K,L)How about in this case:F(2L,2K) =2 L x 2KF(2L,2K) =4( L x K)=4F(L,K)Easy way to check: add exponents if of the form that we have here
18 Does a low wage guarantee competitiveness? Question 10“I think the rise of China is inevitable, because China has moved from a low-cost producer, at low levels of technology, to higher levels of technology, and because it's very competitive, even in some high-tech products they offer at very competitive rates - much lower than their competitors.” (Najib Razak)Does a low wage guarantee competitiveness?