PPA 723: Managerial Economics

1. PPA 723: Managerial Economics Study Guide: Production, Cost, and Supply

2. Managerial Economics, Study Guide Topics • Short-run product curves • Short-run cost curves • Short-run firm supply • Short-run market supply • Input mix decision • Long-run product curves • Long-run cost curves • Long-run firm supply • Long-run market supply

3. Managerial Economics, Study Guide Short-Run Product Curves • Question: • If some inputs (usually capital) are fixed (i.e. in the short run), how much output can a firm produce from different quantities of a variable input (usually labor)? • Analytical Tools: • Total product curve • Average product curve • Marginal product curve • Key Concepts/Results • Law of diminishing marginal product (MPL eventually slopes downward) • MPL = APL at minimum of APL curve

4. Managerial Economics, Study Guide Short-Run Cost Curves • Question: • If some inputs (usually capital) are fixed (i.e. in the short run), how much does it cost to produce various levels of output by varying a variable input (usually labor)? • Analytical Tools: • Average fixed cost curve • Average variable cost curve • Average total cost curve • Marginal cost curve • Key Concepts/Results • Law of diminishing marginal productivity leads to upward sloping MC curve after some point • U-shaped AVC (usually) and U-shaped ATC (always) • MC = AVC at minimum of AVC • MC = ATC at minimum of ATC

5. Managerial Economics, Study Guide Short-Run Firm Supply • Question: • If some inputs (usually capital) are fixed (i.e. in the short run), what is the most profitable level of output for the firm to produce? • Analytical Tools: • Average variable cost curve • Marginal cost curve • In a competitive market, marginal revenue = market price = P • Key Concepts/Results • The firm shuts down (supply = 0) if P < minimum of AVC curve. • If P > minimum of AVC curve, the firm sets P = MC, which implies that the MC curve is the supply curve.

6. Managerial Economics, Study Guide Short-Run Market Supply • Question: • What does the market supply curve look like in the short run? • Analytical Tools: • SR firm supply curve • Number of firms • Key Concepts/Results • The SR market supply curve is the horizontal summation of the firm supply curves for the firms in the market. • The more firms in the market, the more elastic the SR market supply curve.

7. Managerial Economics, Study Guide Long-Run Product Curves • Question: • If all inputs are variable (i.e. in the long run), how much output can a firm produce from combinations of inputs? • Analytical Tools: • Isoquant • Key Concepts/Results • Isoquants have the same properties as indifference curves, i.e. higher isoquants indicate more product, isoquants cannot slope upward, and isoquants cannot cross. • The slope of an isoquant is MPL/MPK (with L on the horizontal axis). • Constant returns to scale exist if product doubles when inputs double. • Economies [diseconomies] of scale exist if product more than doubles [less than doubles] when inputs double.

8. Managerial Economics, Study Guide The Input-Mix Decision • Question: • What is the least expensive input combination for producing a given output? • Analytical Tools: • Isoquants • Isocost lines • Key Concepts/Results: • The least expensive input combination is at the tangency between an isocost line and the relevant isoquant. • The slope of an isocost line is the wage rate over the capital rental rate = w/r (with labor on the horizontal axis). • The least cost combination is where MPL/w = MPK/r, that is, where each input has the same MP per dollar of cost.

9. Managerial Economics, Study Guide Long-Run Cost Curves • Question: • If all inputs are variable (i.e. in the long run), how much does it cost to produce various levels of output? • Analytical Tools: • Expansion path • Long-run average cost curve • Long-run marginal cost curve • Key Concepts/Results • Expansion path (from input-mix diagram) indicates the cost of every output at the optimal input mix, i.e. the long-run cost curve. • LR MC = LR AC at minimum of LR AC • SR cost  LR cost

10. Managerial Economics, Study Guide Long-Run Firm Supply • Question: • If all inputs are variable (i.e. in the long run), what is the most profitable level of output for the firm to produce? • Analytical Tools: • LR AC curve • LR MC curve • In a competitive market, marginal revenue = market price = P • Key Concepts/Results • The firm shuts down (supply = 0) if P < minimum of LR AC curve. • If P > minimum of LR AC curve, the firm sets P = LR MC, which implies that the LR MC curve is the supply curve.

11. Managerial Economics, Study Guide Long-Run Market Supply • Question: • What does the market supply curve look like in the long run? • Analytical Tools: • LR firm supply curve • Entry and exit • Key Concepts/Results • Firms enter the market in response to economic profits and exit in response to losses—thereby altering the market price. • LR equilibrium exists when no firms have an incentive to enter or exit, i.e. when economic profits equal zero. • In LR equilibrium P = minimum LR AC • With free entry and exist, the same costs for all firms, and constant input prices, the LR supply curve is horizontal.