Micro chapter II & III


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  • Micro chapter II & III

    1. 1. Theory of Producers’ Behavior-Production-Cost of Production-Profit Maximizing 1
    2. 2. Vinashin case In 3/2003, Vinashin Jacobsen signed a contract of providing machines for diezel factory
    3. 3.  From the first operation in 4/2007, there were many times the mentioned factory has to stop working for fixing. From 10/2009, the diezel factory terminated its work
    4. 4.  All equipment sold by Jacobsen are “secondhand” equipment dated back 1995, 1996, from Italy, Germany, Finland, Taiwan, China and also Vietnam
    5. 5. Can you explain about the behavior of people who lead the contract ???Do they follow the purpose of maximizing profit of all firms?
    6. 6.  The way people organize a firm may vary its behaviors
    7. 7. Note: The producers’ behavior may vary if the owner and the administrator are different Purpose of firm may vary
    8. 8. I. Production Technology of Production Production with One Variable Input (Labor) Production with Two Variable Inputs (Labor and Capital)  Returns to Scale  Isoquant  Isocost 9
    9. 9. 1. Production Decisions of a Firma. Production Technology  Describe how inputs transformed into outputs  Inputs: land, labor, capital and raw materials  Outputs: cars, desks, books, etc.  Firms produce different amounts of outputs using combinations of inputsb. Cost Constraints  Firms consider prices of labor, capital and other inputs  Minimize total production costs partly determined by input pricesc. Input Choices  Given input prices and production technology, firm chooses how much of each input to use  Given prices of inputs, firm choose combinations of inputs to minimize costs 10
    10. 10. Technology of Production Production Function:  Indicates highest output (q) that firm can produce for every specified combination of inputs  For simplicity, only labor (L) and capital (K)  Shows what is technically feasible when firm operates efficiently Production function for two inputs: q = F(L,K) 11
    11. 11.  Short Run  Period of time in which quantities of one or more production factors (fixed inputs) cannot be changed Long Run  Time needed to make all production inputs variable
    12. 12. 2. Production: One Variable Input (Short-run) Assume capital fixed and labor variable Observations:  When labor is zero, output is zero  With additional labor, output (q) increases initially  Beyond this, output declines  More labor becomes counterproductive 13
    13. 13. 2.1 Definitions Average Product of Labor - Output per unit of particular product  Measures productivity of firm’s labor in terms of how much, on average, each worker can produce Output q APL = = Labor Input L Marginal Product of Labor – additional output produced when labor increases by one unit ∆Output ∆q MPL = = ∆Labor Input ∆L 14
    14. 14. Production: One Variable InputOutput perMonth D 112 C Total Product At point D, output is 60 maximized. B A 0 1 2 3 4 5 6 7 8 9 10 Labor per Month 15
    15. 15. Production: One Variable InputOutput •Left of E: MP > AP & AP is increasing per •Right of E: MP < AP & AP is decreasingWorker •At E: MP = AP & AP is at its maximum •At 8 units, MP is zero and output is at max 30 Marginal Product E Average Product 20 10 0 1 2 3 4 5 6 7 8 9 10 Labor per Month 16
    16. 16. 2.2 Law of Diminishing MarginalReturns Law of Diminishing Marginal Returns: As input use increases with other inputs fixed, resulting additions to output eventually decrease  When labor use is small and capital fixed, output increases since workers specialize;  MP of labor increases  When labor use is large, some workers become less efficient  MP of labor decreases Explains declining marginal product, not necessarily negative one  Technology changes cause shifts in total product curve  More output produced with same inputs 17
    17. 17.  Diminishing marginal product 18
    18. 18. 3.Production: Two Variable Inputs Firm can produce output by combining different amounts of labor and capital In long run, capital and labor are both variable Information can be represented graphically using isoquants  Curves showing all possible combinations of inputs that yield same output Curves are smooth to allow for use of fractional inputs 19
    19. 19. Diminishing ReturnsCapital 5 Increasing labor holding capital constant (A, B, C) 4 OR Increasing capital holding labor constant 3 (E, D, C) A B C D 2 q3 = 90 1 E q2 = 75 q1 = 55 1 2 3 4 5 Labor 20
    20. 20. 3.1 Isoquant -A and B bring the same level of quantity to the firm. -A is the combination of more both capital and labor. In comparison with B, A is less efficient.
    21. 21. Production: Two Variable Inputs Substituting Among Inputs  Producers decide what combination of inputs to use to produce certain quantity of output  Slope of Isoquant shows how one input can be substituted and keep level of output the same  Negative of slope is marginal rate of technical substitution (MRTS)  Amount by which quantity of one input reduced when one extra unit of another input used, so that output remains constant 22
    22. 22. Production: Two Variable Inputs Change in Capital Input MRTSLK =− Change in Labor Input MRTSLK = − ∆K ( for fixed level of q ) ∆L As labor increases to replace capital  Labor relatively less productive  Capital relatively more productive  Need less capital to keep output constant  Isoquant becomes flatter 23
    23. 23. Marginal Rate of Technical Substitution (MRTS)Capital 5 Negative slope measures MRTS; 2 MRTS decreases as move down 4 isoquant curve 1 3 1 1 2 2/3 1 Q3 =90 1/3 Q2 =75 1 1 Q1 =55 1 2 3 4 5 Labor 24
    24. 24. MRTS and Marginal Products Diminishing MRTS occurs because of diminishing returns; implies isoquants are convex If holding output constant, net effect of increasing labor and decreasing capital is zero Using changes in output from capital and labor: ( MPL )(∆L) + ( MPK )(∆K ) = 0 ( MPL )(∆L) = - ( MPK )(∆K ) ( MPL ) ∆K =− = MRTS LK ( MPK ) ∆L 25
    25. 25. Isoquants: Special Cases Two extreme cases show range of input substitution Perfect Substitutes  MRTS constant at all points on isoquant  Same output produced with a lot of capital or of labor or balanced mix Perfect Complements  Perfect fixed proportions production function  Output made with only a specific proportion of capital and labor  Cannot increase output unless increase both capital and labor in specific proportion 26
    26. 26. Perfect SubstitutesCapital per A Same output can bemonth reached with mostly capital or mostly labor (A or C) or with equal amount of both (B). B C Q1 Q2 Q3 Labor per month 27
    27. 27. Perfect ComplementsCapital per Same output canmonth only be produced with one set of inputs. Q3 C Q2 B K1 Q1 A Labor per month L1 28
    28. 28. Returns to Scale How does firm decide, in long run, best way to increase output?  Can change scale of production by increasing all inputs in proportion  If double inputs, output will most likely increase but by how much? Rate at which output increases as inputs are increased proportionately 29
    29. 29. Increasing Returns to Scale Capital(machine •Output more than hours) doubles when all inputs are doubled •e.g., Larger output associated with lower cost (cars) •e.g., One firm more 4 efficient than many (utilities) •Isoquants get closer together 2 20 10 Labor (hours) 5 10 30
    30. 30. Constant Returns to Scale Capital(machine hours) 6 30 •Output doubles when 4 all inputs doubled •Size does not affect productivity 20 •May have large number of producers 2 •Isoquants are equidistant apart 10 Labor (hours) 5 10 15 31
    31. 31. Decreasing Returns to Scale Capital(machine hours) •Output less than doubles when all inputs doubled •Decreasing efficiency with large size 4 20 •Reduction of entrepreneurial abilities •Isoquants become farther apart 2 10 5 10 Labor (hours) 32
    32. 32. 3.2 Isocost-Equal cost curve TC = K.R + L.w TC WK= − L R R
    33. 33. - Factors explain Isocost: - R, W constant, TC change shift the Isocost - TC, R constant, W change will turn the Isocost - TC, R constant, R change will turn the Isocost
    34. 34. 3.3 Optimum choice MPPL W = MPPK R MPPL MPPK = W R
    35. 35. Cost Minimizing Input Choice Isocost Line  Line showing all combinations of L and K that can be purchased for same cost  Total cost of production is sum of firm’s labor cost, wL, and capital cost, rK: C = wL + rK  Price of labor: wage rate (w)  Price of capital: user cost/rental rate (r) Rewriting:  K = C/r - (w/r)L  Slope of isocost:  -(w/r) is ratio of wage rate to rental cost of capital  Shows rate at which capital can be substituted for labor with no cost change 36
    36. 36. Producing Given Output at Minimum CostCapital per Q1 is isoquant for output Q1. year There are three isocost lines, of which 2 are possible choices in which to produce Q1. K2 Isocost C2 shows quantity Q1 can be produced with combination K2,L2 or K3,L3. However, both A are higher cost combinations K1 than K1,L1. Q1 K3 C0 C1 C2 Labor per year L2 L1 L3 37
    37. 37. Input Substitution When an Input Price ChangeCapital per If price of labor year rises, isocost curve becomes steeper due to change in slope -(w/r). New combination of K and L is used to produce Q1. B Combination B is used in K2 place of combination A. A K1 Q1 C2 C1 L2 L1 Labor per year 38
    38. 38. Cost in Long Run How does isocost line relate to firm’s production process? MRTSLK = - ∆K = MPL ∆L MPK Slope of isocost line = ∆K = −w ∆L r MPL =w when firm minimizes cost MPK r 39
    39. 39. Cost in Long Run Minimum cost combination can be written: MPL = MPK w r  Minimum cost for given output will occur when each dollar of input added to production process will add equivalent output Cost minimization with varying output levels  For each output level, there is an isocost curve showing minimum cost  Firm’s expansion path shows minimum cost combinations of labor and capital at each output level  Slope equals ∆K/∆L 40
    40. 40.  All firms, from Delta Air Lines to your local deli, incur costs as they make the goods and services that they sell. As we will see in the coming chapters, a firm’s costs are a key determinant of its production and pricing decisions. Establishing what a firm’s costs are, however, is not as straightforward as it might seem 41
    41. 41. I. Cost of ProductionA. Cost of Production in Short-run2. FC, VC and TC a. FC-fixed cost
    42. 42. b. VC-Variable Cost
    43. 43. c. TC-Total Cost:  Give some comments on the relationship between TC and VC
    44. 44. 2. Average cost, Marginal costb. Average cost - AFC (Average Fixed Cost) - AVC (Average Variable Cost) - ATC (Average Total Cost)
    45. 45.  Note: Under the effect of Law of Diminishing Marginal Product, AVC, ATC and MC have U shape.
    46. 46. b. MC (Marginal Cost)
    47. 47.  Notes:- MC intersects with AVC at the minimum point of AVC- MC intersects with ATC at the minimum point of ATC
    48. 48. B. Long-run Cost of Production 1. Long-run Total Cost - LTC In long-run there is no cost can be considered as fixed cost.  All of the cost are variable
    49. 49. Firm’s Expansion PathCapital per Expansion path illustrates least-cost combinations of year labor and capital that can be 150 $3000 used to produce each level of output in long-run. Expansion Path $2000 100 C 75 B 50 $1000 300 Units A 25 200 Units 100 Units Labor per year 50 100 150 200 300 50
    50. 50. Firm’s Long Run Total Cost CurveCost/Year Long Run Total Cost F 3000 •To move from expansion path to LR cost curve E •Find tangency with 2000 isoquant and isocost •Determine min cost of producing output level D selected 1000 •Graph output-cost combination Output, Units/yr 100 200 300 51
    51. 51. Long Run Versus Short Run CostCurves In short run, some costs fixed In long run, firm can change anything including plant size  Can produce at lower average cost  Capital and labor flexible Show this by holding capital fixed in short run and flexible in long run 52
    52. 52. Inflexibility of Short Run ProductionCapital E Capital is fixed at K1. per To produce Q1, min cost at K1,L1. year C If increase output to Q2, min cost is K1 and L3 in short run. In LR, can Long-Run change Expansion Path A capital and min costs falls to K2 and K2 L2. Short-Run P Expansion Path K1 Q2 Q1 Labor per year L1 L2 B L3 D F 53
    53. 53. Production with Two Outputs –Economies of Scope Firms produce multiple products that are linked Advantages:  Both use capital and labor  Firms share management resources  Same labor skills and types of machinery Alternative quantities produced illustrated using product transformation curves  Product transformation curves negatively sloped since to get more of one output, must give up some of other  Product transformation curves are concave if joint production has advantages 54
    54. 54. 2.Long-run Average Total Cost - LATC LTC LATC = Q- The shape of LATC depends on the return on scale of each production process
    55. 55. Long Run VersusShort Run Cost Curves Long-Run Average Cost (LAC)  Determinant of shape of LAC and LMC is relationship between scale of firm’s operation and cost-minimizing inputs2. Constant Returns to Scale  If input doubled, output doubles  AC cost is constant at all levels of output3. Increasing Returns to Scale  If input doubled, output more than doubles  AC decreases at all levels of output4. Decreasing Returns to Scale  If input doubled, output less than doubles  AC increases at all levels of output 57
    56. 56. C Increasing returns to scale LATC Q
    57. 57. C LATC QDecreasing returns to scale
    58. 58. C Constant returns to scale LATC Q
    59. 59. 3. Long-run Marginal Cost (LMC)-Definition:- Calculation ∆LTC LMC = = LTC (Q) ∆Q
    60. 60. C Increasing Returns to Scale LAT LMC C Q
    61. 61. C LMC LATC QDecreasing Returns to Scale
    62. 62. C Constant Returns to Scale LATC≡LMC Q
    63. 63. Long Run Average and Marginal Cost Cost •If LMC < LAC,($ per unit LAC will fall of output) LMC •If LMC > LAC, LAC will rise LAC •LMC = LAC at the minimum of LAC •In special case where LAC is constant, LAC A and LMC are equal Output 65
    64. 64. Long Run Costs As output increases, firm’s AC of producing is likely to decline 1. On larger scale, workers specialize 2. Scale can provide flexibility, managers organize production effectively 3. Quantity discounts for inputs, lower prices lead to different input mix At some point, AC begins to increase 1. Factory space and machinery make it difficult for efficient work 2. Managing larger firm may become more complex and inefficient as tasks increase 3. Limited input availability may cause price increases 66
    65. 65. Long Run Costs Economies of scale reflects input proportions that change as firm changes production level Economies of Scale  Increase in output greater than increase in inputs Diseconomies of Scale  Increase in output less than increase in inputs U-shaped LAC shows economies of scale for relatively low output levels and diseconomies of scale for higher levels 67
    66. 66. Long Run Costs Economies of scale measured in terms of cost-output elasticity, EC  EC is percentage change in production cost resulting from 1-percent increase in output EC = ∆C C = MC ∆Q Q AC EC is equal to 1, MC = AC  Costs increase proportionately with output  Neither economies nor diseconomies of scale EC < 1 when MC < AC  Economies of scale  Both MC and AC are declining EC > 1 when MC > AC  Diseconomies of scale  Both MC and AC are rising 68
    67. 67. Long Run Cost with Economiesand Diseconomies of Scale 69
    68. 68. Long Run Cost withConstant Returns to Scale What is firm’s long run cost curve?  Firms can change scale to change output in long run  Long run cost curve represents minimum cost for any output level  Firm choose plant that minimizes average cost of production Long-run average cost curve envelops short-run average cost curves  LAC curve exhibits economies of scale initially but diseconomies at higher output levels 70
    69. 69. IV. Profit 1. Definitions Profit a.  There are some circumstances that the enterprise does not want to have profit
    70. 70. Marginal Revenue, Marginal Cost,and Profit Maximization Can study profit maximizing output for any firm, whether perfectly competitive or not  Profit (π) = Total Revenue - Total Cost π (q) = R(q) − C (q)  If q is output of firm:  TotalRevenue (R) = Pq  Total Cost (C) = C(q) Firm selects output to maximize difference between revenue and cost 72
    71. 71. Marginal Revenue, Marginal Cost,and Profit Maximization Slope of revenue curve is marginal revenue  Change in revenue from one-unit increase in output Slope of total cost curve is marginal cost  Additional cost of producing additional unit of output Profit is negative to start since revenue is not large enough to cover fixed and variable costs As output rises, revenue rises faster than costs 73
    72. 72. Profit Maximization – Short Run Profits are maximized where MR (slope at Cost, A) and MC (slope at B) are equalRevenue, Profit Profits are C(q) ($s per maximized year) where R(q) – A C(q) is R(q) maximized B 0 Output q0 q* π(q) 74
    73. 73. Marginal Revenue, Marginal Cost,and Profit Maximization Profit maximized at point at which additional increment to output leaves profit unchanged π = R −C ∆π ∆R ∆C = − = MR − MC = 0 ∆q ∆q ∆q MR = MC 75
    74. 74. b. Accounting and Economic Profit- Accounting profit- Economic profitc. MR (Marginal Revenue)
    75. 75. Exercise Josh, a second year MBA student, takes three hours off one evening and uses his car to go to a movie with a friend. A ticket to the movie costs Josh $5, gasoline for the trip costs $1, and Josh passed up tutoring a student that night at $10 an hour. He could also have used the three hours to work as a grader for a professor at $15 an hour. What is Josh’s economic cost of going to the movie? 77
    76. 76. 2. Profit maximizing MR = MC3. Total revenue maximizing MR = 0
    77. 77. Production with Two Outputs –Economies of Scope Degree of economies of scope (SC) measured by percentage of cost saved producing two or more products jointly: C(q1 ) + C(q2 ) − C(q1 ,q2 ) SC = C(q1 ,q2 )  C(q1) is cost of producing q1  C(q2) is cost of producing q2  C(q1,q2) is joint cost of producing both products Interpretation:  If SC > 0  Economies of scope  If SC < 0  Diseconomies of scope  Greater value of SC, greater economies of scope 79