1 Chapter 6 Supply The Cost Side of the Market

2 Market: Demand meets Supply Demand: –Consumer –buy to consume Supply: –Producer –produce to sell

3 Recall: demand willingness vs. ability to consume Willingness: satisfaction (total utility) Ability: budget

4 similarly: supply willingness vs. ability to produce Willingness: produce to sell for profit –Profit = total revenue – total cost = PxQ - TC –total production (Q) when P and C are given Ability: cost （ to pay for production factors ）

5 Recall: Consumer Decision-Making The goal: to maximize Total Utility (willingness) by choosing: –the Optimal Quantities of goods and services to consume subject to: (ability) –limited income –market prices of the goods and services

6 similarly: Producer Decision-Making The goal: to maximize Profit (willingness) by choosing: –the Optimal Quantities of goods and services to produce subject to: production cost (ability) –inputs –prices of inputs

7 The goal for producers Maximize profit Profit = price of output x quantity produced - production cost Price of output: –determined by market (not affected by single producer in perfectly competitive market) Production cost: determined by –quantity of input based on quantity of output produced and technology applied –Input prices

8 The Production Function the relationship between the quantity of inputs a firm uses and the quantity of output it produces.

9 Inputs (Production Factors) Resources used in the production process labor (L) capital (K) natural resources (N) entrepreneurship (E)

10 Inputs: Fixed vs. Variable Fixed input: –the level of its usage cannot be readily changed (the level of its usage does not change along with level of output) –An input whose quantity cannot be altered in the short run Variable input: –the level of its usage may be readily changed (the level of its usage changes along with the level of output) –An input whose quantity can be altered in the short run

11 Short-run vs. Long-run Short-run: –the period of time in which at least one input is fixed. –A period of time sufficiently short that at least some of the firm’s factors of production are fixed Long-run: –the period of time in which all inputs are variable.

12 Production Function Q = f (L, K, N, E) A relationship between inputs and outputs, assuming technical efficiency.

13 Technical Efficiency The maximum level of output is obtained from a given combination of inputs

14 Economic Efficiency A given amount of output is produced using the combination of inputs that costs the least (at minimum cost)

15 Short-Run Production: some inputs are fixed Total Product: Q = f (L, K, N, E) Usually assume N and E given Total Product of Labor: Q = f (L) (K, N, E fixed)

16 TP Curve: Total Product

17 Recall: Sarah ’ s Total Utility from Ice Cream Consumption Figure 5.2, p.130 Based on table 5.1, p.129

18 Recall: Diminishing Marginal Utility for Sarah from ice-cream Figure 5.3, p. 131 Based on Table 5.2, p.130

19 MP: Marginal Product The marginal product of an input is the additional quantity of output that is produced by using one more unit of that input.

20 TP Curve: Total Product

21 Marginal Product of Labor Curve

22 Diminishing Returns to an Input (diminishing marginal product) diminishing returns to an input: an increase in the quantity of an input leads to a decline in the marginal product of that input, holding the levels of all other inputs fixed Other things held constant, as more of a variable input is used in production, its marginal productivity will decline after a certain point.

23 Recall: Key Points for Sarah’s example TU first increases then max out and starts to decrease TU increases at a slower pace TU is maximized when MU=0 MU is decreasing but positive when TU is increasing MU is decreasing and negative when TU is decreasing MU = 0 when TU is maximized

24 similarly: TP first increases then max out and starts to decrease TP increases at a slower pace TP is maximized when MP=0 MP is decreasing but positive when TP is increasing MP is decreasing and negative when TP is decreasing MP = 0 when TP is maximized

25 Total Product, Marginal Product, and the Fixed Input

26 Short-Run Production: some inputs are fixed Total Product: Q = f (L, K, N, E) Total Product of Labor: Q = f (L) (K, N, E fixed) Marginal Product of Labor: MPL= dQ / dL Average Product of labor: APL=Q/L

27 Short-Run Production: Q, AP, MP, and shift in Q

28 K=1 LTP=QMPAP

29 Production: one input TP = Q = f(L,K,N,E) When K,N,E fixed: SR TP(L) = f (L) AP(L) = TP(L) / L MP(L) = dTP(L) /dL MP is the slope of TP TP maximized when MP = 0

30 Short-Run Production: Summary L=0 leads to Q=0 when MP is increasing, Q is increasing at an increasing rate when MP is decreasing, Q may still increase but at a decreasing rate When MP=0, Q stop increasing and start decreasing (Q is maximized). AP reaches its maximum when AP=MP

31 Q L 0 TP AP MP E AB Ⅰ Ⅱ Ⅲ F MP>AP AP  MP<AP AP  MP<0 TP  MP=AP AP Max MP=0 TP Max