FINA251 Fundamentals of Microeconomics Week 11 2016 HBC608 ECON582 FINA251 Fundamentals of Microeconomics Week 11 2016 HBC608HBC608 Chapter-11 College of Business – Rabigh Dr. Mazharul Islam Finance notes Finance NotesFinance notes 1

11 OUTPUT AND COSTS Dr. Mazharul Islam

Lesson Objectives Distinguish between the short run and the long run Explain the relationship between a firm’s output and labor employed in the short-run. Explain and illustrate a firm’s short-run product curves Dr. Mazharul Islam

Decision The three decisions that all firms must make include: 1. 2. How much output to supply 1. Which production technology to use 2. How much of each input to demand 3. Dr. Mazharul Islam

Some Basic Concepts Economic Costs: Explicit costs A firm’s economic costs are the opportunity costs of the resources used, whether those resources are owned by others or by the firm. Economic Costs = Explicit costs + Implicit costs Explicit costs Refer to the firm’s actual cash payments for resources owned by others  wages, rent, interest, insurance, taxes, etc. Like every firm, they must decide How much to produce. How many people to employ. How much and what type of capital equipment to use. How do firms make these decisions? Dr. Mazharul Islam

Some Basic Concepts Implicit costs: Total Revenue: Refer to the opportunity costs of using its self-owned, self-employed resources. Implicit costs are the money payments that self-employed resources could have earn in their best alternative use. Total Revenue: It is the amount received from the sale of the product; it is equal to the number of units sold (Q) times the price received per unit (P). So TR = P x Q Dr. Mazharul Islam

Example Khaleed operates a small furniture firm. He hires one assistant at SR21,000 per year, pays annual rent of SR5000 a year for his shop, an invested SR20,000 from his savings on materials that could have earn him SR1000 per year as interest rate. He has been offered SR24,000 per year to work as a manager for competitor. He estimates his entrepreneurial talents are worth SR3000 per year. Total annual revenue from furniture sales is SR100,000. Dr. Mazharul Islam

Some Basic Concepts Economic Profits: Production Function: Refer to the difference between total revenue and economic costs. Production Function: The relationship between the amount of resources employed and a firms total product is called firm’s production function. Economic Profit Total Revenue Economic Cost Dr. Mazharul Islam

Time Frame All decisions can be placed in two time frames: The short run The long run The firm makes many decisions to achieve its main objective: profit maximization. Some decisions are critical to the survival of the firm Some decisions are irreversible (or very costly to reverse). Other decisions are easily reversed and are less critical to the survival of the firm, but still influence profit. Dr. Mazharul Islam

Time Frame Short Run The short run is a time frame in which the quantity of at least one resource used in production is fixed. For most firms, the capital, called the firm’s plant, is fixed in the short run. Other resources used by the firm (such as labor, raw materials, and energy) can be changed in the short run. Short-run decisions are easily reversed. Dr. Mazharul Islam

Time Frame Long Run The long run is a time frame in which the quantity of all resource used in production is variable. Long-run decisions are not easily reversed. Variable resources can be varied quickly to change the output rate. Fixed resources are those resources which cannot be easily changed. Dr. Mazharul Islam

Short-Run Production Relationships To increase output in the short run, a firm must increase the amount of labor employed because technology is constrained. Three concepts describe the relationship between output and the quantity of labor employed: 1. Total product 2. Marginal product 3. Average product Dr. Mazharul Islam

Short-Run Production Relationships Total Product (TP): It means total quantity or total output of a particular good produced in a given period. Marginal Product (MP): it is extra output associated with adding an unit of variable resource (in this case, labor) to production process while all other inputs remaining the same. Change in Total Product Marginal Product = Change in Labor Input Dr. Mazharul Islam

Short-Run Production Relationships Average Product (AP): It is called labor productivity. The output of per unit of resource (in this case per unit labor output). Total Product Average Product = Units of Labor Dr. Mazharul Islam

Short-Run Production Relationships Table 11.1 shows a firm’s product schedules. As the quantity of labor employed increases: Total product increases. Marginal product increases initially but eventually decreases. Average product decreases. Dr. Mazharul Islam

Short-Run Production Relationships To make a graph of the marginal product of labor, we can stack the bars in the left side graph side by side. The marginal product of labor curve passes through the mid-points of these bars. When marginal product exceeds average product, average product increases. When marginal product is below average product, average product decreases. When marginal product equals average product, average product is at its maximum. Dr. Mazharul Islam

Short-Run Production Relationships Increasing marginal returns: The marginal products of a variable resource (labor) increases as each additional unit of that resource is employed. Increasing marginal returns arise. Why? Due specialization and division of labor. Law of diminishing marginal return states that the more of a variable resource is added with a given amount of a fixed resource, other things constant, marginal product eventually declines and could become negative. Dr. Mazharul Islam

Short-Run Production Relationships Diminishing marginal returns arises. Why? Because each additional worker has less access to capital and less space in which to work. Dr. Mazharul Islam

Now it’s over for today. Do you have any question? Dr. Mazharul Islam