480 likes | 717 Views
Principles of Economics. Production Costs Deduction of supply. Production. PRODUCTION is a process in which inputs are transformed into outputs. Outputs can be either consumed or used as an input for another production process (corn, corn flour, bread).
E N D
Principles of Economics Production Costs Deduction of supply
Production • PRODUCTION is a process in which inputs are transformed into outputs. Outputs can be either consumed or used as an input for another production process (corn, corn flour, bread). • PRODUCTION is organized in small, medium and large companies. Large companies have lower interest rates and attract more capital, while small companies are more adaptable to new circumstances
Total product • PRODUCTION FUNCTION (TP or q) expresses the maximum amount of production (output) that can be produced using the given amount of inputs (K, L, A) • q = TP(K, L, A) =B×f(K,L,A)
Marginalandaverageproduct • MARGINAL PRODUCT (MP) is a change in total productdue to anincreaseintheamount of inputsby 1 unit. MPL = TP(L)-TP(L-1) MPK = TP(K)-TP(K-1) • AVERAGE PRODUCT (AP) is theratio of total productandcurrentamount of inputs APL = TP/L APK = TP/K • GRANIČNI proizvod je porast ukupnog proizvoda uslijed porasta količine inputa za jednu jedinicu:
Verticalcut of a productionfunction q • Verticalcut of a productionfunction – intheshortrun (theotherinputs are heldconstant) • Shortrun: at least one input is fixed • Longrun: all inputs are variable TP L 0 q AP 0 L MP
Production elasticity • % change of theoutputcausedby a 1% change of theinput:
Returns • LAW OF DIMINISHING RETURNS saysthateveryadditionalunit of aninput, otherinputsbeingconstant, bringseach time less of theadditionaloutput(MP decreases). • RETURNS TO A FACTOR of productionobserve how theoutputchangeswhen a singleinputchanges, otherinputskeptconstant. • RETURNS TO SCALE observe how theoutputchangeswhen all theinputsincreaseinthe same proportion.
Technological progress • Technological progress (B) is the improvement of production processes by improvement of the old products or invention of the new ones. • Technological progress can be either a PRODUCT INNOVATION or PROCESS INNOVATION. • Product innovation: development of new goods • Process innovation: improvement of the production processes • Technological progress stretchesproductionfunctionupwardswithoutadditional use of inputs.
Technological progress q TP2 B↑ TP1 0 K, L
Isoquants • Isoquants are a horizontal cut of a production function showing all the combinations of inputs with which one can produce the same amount of goods q. • Slope of the isoquant is Marginal rate of technical substitution, MRTSab . It tells by how much the use of b has to increase of a decreases by 1 small unit (a and b are inputs)
L ISOQUANTS ΔK = 1 ΔL = MRTSKL q4 q3 q2 q1 0 K
Isocost • ISOCOST is a line thatconnects all thecombinations of inputsthatcausethe same cost. • Slope of theisocostequalstheratiooftheinputprices
y TC’ > TC 0 x
The minimum costproductioncombination • The minimum cost of productionofcertainamountofgoodsq* is achievedwhenisocostistangent to the isoquant thatcorresponds to theamount of goodsq*.
y q3 q2 q1 0 x
Exercise 1 • 1) Based on thevalues of averageproductoflabourfind total andmarginalproduct!
Exercise 2 • Ifmarginalproduct of labour (MPL) is 10, marginalproduct of capital (MPK) 20, andmarginalproduct of (MPN) 15, what are theprices of capital (PK) andland (PN) ifwages (PL) are 5 andcompanyhas minimum costs?
Costs • So far costs were expressed as a function of the amount of inputs TC(q(K,L)) • Now costs will be analyzed as a function of the quantity of production TC(q) • Costs are either VARIABLE (change with the quantity of production) or FIXED. • Average total costs (AC or ATC) are thecostsperunit of production: AC = TC/q • Averagefixedcosts (AFC) are fixedcostsperunit of production: AFC = AFC/q • Averagevariablecosts (AFC) are fixedcostsperunit of production: AFC = FC/q
TC/Q = VC/Q + FC/Q • AC = AVC + AFC • Marginal costs (MC) – increase in costs when q increases by 1. • MC(q) = TC(q) – TC(q-1) = VC(q) – VC(q-1) • MC = ΔTC/ Δq
TC p VC FC 0 q p AC AVC MC AFC 0 q
Productionandcostsrelation • TC(1) = wL1 + rK1 + iA1 where L1, K1, A1 are the amounts of inputs needed to produce 1 unit of output. • If prices of inputs (w, r, i) fall TC decrease • If technology progresses (B↑) the use of inputs fall (L1↓, K1↓, A1↓) and TC decrease
Economiesofscale • Economiesofscale is a situationinwhichaveragecostsofproductionfall as quantityofproductionincreases. • Diseconomiesofscale is a situationinwhichaveragecostsofproductionfall as quantityofproductionincreases. • Costelasticity: % change ofcostscausedby a 1% change inproducedquantity MC p AC 0 q Economiesofscale AC falls ETC < 1 Diseconomiesofscale AC rises ETC > 1 ETC = 1
Othertermsaboutcosts • Substitution rule: if an input becomes cheaper, it will be used more and the other inputs will be used less until MP/price of inputs becomes equal again. • Economic costs include opportunity costs, but not sunk costs • Accounting costs: • Profit&Loss Statement: Π = TR – TC (in a time period) • Balance sheet: Assets = Capital + Liabilities (at certainpoint of time)
Exercise 3 • Iffixedcosts are 100 andvariablecostsincreaseby 30 kn for eachadditionalunit of outputfind all costfunctions.
solution • FC = 100 • VC = 30Q • TC = FC + VC = 100 + 30Q • AFC = FC/Q = 100/Q • AVC = VC/Q = 30 • AC = 100/Q + 30 • MC = 30
Exercise 4 • Based on the dana inthe Table find total costs (TC), averagefixedcosts (AFC), averagevariablecosts (AVC), average total costs (AC) andmarginalcosts (MC) andthenshowthemgraphically.
140000 120000 100000 80000 60000 40000 20000 0 TC VC FC 0 5 10 15 20 25 30 35 Q
10000 8000 6000 4000 2000 0 MC AC AVC AFC 0 5 10 15 20 25 30 35 Q
Exercise 5: • Marginal costs and fixed costs are known and given in the following table. Find FC, VC, TC, AFC, AVC and AC.
Supplyand profit maximization on perfectlycompetitivemarkets • Perfect competition properties: • Many small companies unable to affect prices (price takers) • Market demand is horizontal (Ed = -∞) • Marginal revenue is equal to price since price is constant • Perfect information • Homogeneous product • Freeentryandexit
Assumption: companymaximizesits profit • Profit is a differencebetween total revenueandtotalcosts • TOTAL REVENUE (TR): TR = p×q • Profit maximizationcondition: • MR = MC • Since P = const.⟹ MR = P = MC • It meansthat for foreach price p suppliedquantitywillbedeterminedbyequationp = MC: MC p AC AVC MC 0 q
Shutdown and breakeven point If p = AVC then only variable costs are covered. Then company has to close immediately ⟹ SHUTDOWN POINT (SDP) Π = TR – TC = p×q – AVC×q – FC Π = q(p – AVC) – FC , p = AVC ⟹ Π = - FC • If p = AC then revenues match the costs covering both VC and FC (Π = 0) ⟹ BREAKEVEN POINT(BEP) Π = p×q – AC×q Π = q(p – AC) , p = AC ⟹ Π = 0
MC MC p p AC AC SSR SLR BEP Z AVC AVC MC MC 0 q 0 q Supplyintheshortrun (MC above AVC) Supplyinthelongrun (MC above AC)
Profit in perfect competition MC MC p p p AC AC p MC MC 0 q 0 q Extra profits (short run) Normalprofits (long run)
Exercise 6 • Dailyoutput of a companyearns it TR = 5000$. Companymaximizesits profit. Averagecost is AC = 8$, marginalcost MC = 10$ andaveragevariablecost AVC = 5$. What is theamount of productionandfixedcost FC?
solution TR = 5000 (TR=P*Q) P = MC = 10 => Q = 500 AC = AVC + AFC AFC = 8 – 5 = 3 FC = AFC*Q = 3*500 = 1500 kn
Exercise 7 Companysells a goodwhich price is p = 62 on a perfectlycompetitivemarket. Company’s averagevariablecosts are givenwiththefollowing table. Fixedcosts are 168. Findquantity at whichcompany a) maximizesits profit, b) shutsdownand c) hasbreakevenpoint
solution Shutdownpoint Breakevenpoint Optimalproductionlevel Shortrunsupply: MC for q > 5, Longrunsupply: MC for q ≥ 7
Exercise 8 There are 6 situationsinthefollowing table. Givetheadvicewhat to do ineverysituation: a) Keepthecurrentlevel of output b) Increasethe price c) Increaseproduction d) Lowerthe price e) Lowerproduction f) Stop production
solution 1. P=AVC -> f Stop production! 2. MC=ATC -> a Keepthecurrentproductionlevel! 3. MC>P -> e Lowerproduction! 4. P<AVC -> f Stop production! 5. P>MC -> c Increaseproduction! 6. P>MC -> c Increaseproduction!
Exercise 9 • A farmer rents 10 hectares of landandpays $5,50 perhectare. Depending on theworkinghoursemployed, farmer’s wheatproductionchanges (Table). Wage is $5. Find TC Find MC, AC, FC, AFC, AVC Find APLand MPL