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Microeconomics topic 3

Microeconomics topic 3. Economics 2013-14. SUPPLY. NATURE OF PRODUCTION. SPECIALISATION. Modern production is based on the principle of specialisation. Specialisation is using a resource in the productive capacity for which it is best suited. Helps to use scarce resources efficiently.

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Microeconomics topic 3

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  1. Microeconomicstopic 3 Economics 2013-14

  2. SUPPLY

  3. NATURE OF PRODUCTION

  4. SPECIALISATION • Modern production is based on the principle of specialisation. • Specialisation is using a resource in the productive capacity for which it is best suited. • Helps to use scarce resources efficiently.

  5. BENEFITS OF SPECIALISATION • Increases the amount produced • Reduces the cost per unit produced • Efficient use of scarce resources.

  6. APPLYING SPECIALISATION • Can be seen a number of different levels: • National – countries specialising eg coffee • Regional – different areas of one country eg farming • Industry eg whisky • Firm eg whisky distilling, bottling • Worker – called DIVISION OF LABOUR

  7. DIVISION OF LABOUR • ADVANTAGES FOR THE WORKER • Increased productivity leading to increased income • More skills acquired • Gain more job satisfaction

  8. DISADVANTAGES FOR THE WORKER • Increased risk of unemployment – too specialised and can’t do anything else • Interdependence of workers • Monotony of tasks – gets boring!!!

  9. PRODUCTION DECISIONS • Producers want to maximise their profits. • One way to do this is to use the most efficient method of production in order to keep cost per unit low. • In the short run, the capacity of the firm is fixed and so the firm will only be able to produce a maximum number of products • In the long run, the capacity of the firm can be increased or decreased, which can change the level of production.

  10. PRODUCTION IN THE SHORT RUN:LAW OF DIMINISHING RETURNS • Factors of production – land, labour, capital and enterprise. • Returns are what a producer gets back in output when they employ more of a variable factor of production. • Example – returns to labour means the output gained when more labour is employed.

  11. In the short run when deciding what output will be the most efficient to produce the firm must take into consideration the LAW OF DIMINISHING RETURNS • This states that as a producer uses more of a factor of production the returns to begin with will increase but diminishing returns will eventually happen.

  12. TYPES OF OUTPUT • Total Output – the total amount produced • Marginal Output – the extra output produced when an extra factor of production is employed • Average Output – the average amount produced. Normally TOTAL OUTPUT divided by NUMBER OF WORKERS

  13. EXAMPLE • LOOK AT PAGE 27 IN THE CORE NOTES

  14. Increasing Marginal Returns – occurs when marginal output is growing. • Diminishing Marginal Returns – occurs when marginal output is decreasing.

  15. PRODUCTION IN THE LONG RUN • in the long run allfactors of production are variable. • The firm can change its capacity which is also called changing the scale of its operations.

  16. RETURNS TO SCALE • Increasing Returns to Scale – output grows faster than the size of the firm. Also called ECONOMIES OF SCALE • Constant Returns to Scale – output rises at the same rate as the size of the firm. • Decreasing Returns to Scale – output rises slower than the size of the firm – also called DISECONOMIES OF SCALE

  17. Economies of Scale • The advantages of large scale production that result in lower unit (average) costs (cost per unit) • AC = TC / Q • Economies of Scale – spreads total costs over a greater range of output

  18. ECONOMIES OF SCALE • Often referred to as the ADVANTAGES OF BEING A BIG COMPANY • Two types: • Internal – improvements in output (productivity) as the firm grows in size • External – improvements in output which a firm gains from growth of its industry.

  19. INTERNAL ECONOMIES OF SCALE • Technical • Financial • Purchasing • Managerial • Marketing • Research and development (R&D) • Risk bearing • Welfare

  20. INTERNAL ECONOMIES OF SCALE • Technical • Increased division of labour and specialisation • Increased dimensions • Indivisibility • Principle of multiples

  21. Financial • Easier to attract investors due to low risk • Borrow money at lower rates of interest

  22. Purchasing • Gain large discounts for buying in bulk • Dictate to suppliers price, quality and delivery date they want

  23. Managerial • Can afford to employ specialist staff e.g. an accountant

  24. Marketing • Costs can be spread over a larger volume of sales • Transport costs per unit are lowered as ships, lorries etc are full.

  25. Research and Development • Can afford to research • Can gain a competitive advantage through innovation • Maintain market share through product development

  26. Risk Bearing • Diversify products to reduce risk from demand fluctuations • Diversify markets • Have different sources of supplies to reduce risk of fluctuating prices and availability.

  27. Welfare • Can afford to offer benefits to employees that will increase motivation and efficiency. • Pensions • Medical services • Fringe benefits • Recreational facilities

  28. Economies of Scale Assume each unit of capital = £5, Land = £8 and Labour = £2 Calculate TC and then AC for the two different ‘scales’ (‘sizes’) of production facility What happens and why?

  29. Economies of Scale Doubling the scale of production (a rise of 100%) has led to an increase in output of 200% - therefore cost of production PER UNIT has fallen Don’t get confused between Total Cost and Average Cost, Overall ‘costs’ will rise but unit costscan fall. Why?

  30. EXTERNAL ECONOMIES OF SCALE • Normally happens when firms in an industry are focused in a particular area. • They can gain the following advantages: • Lower training costs • Ancillary services provided by specialist suppliers • Co-operation of firms

  31. DISECONOMIES OF SCALE • These are the disadvantages of being a big company. • INTERNAL DISECONOMIES • Management problems – difficult to control • Waste is difficult to control or detect.

  32. EXTERNAL DISECONOMIES • Shortages of skilled labour and high wages • Shortage of raw materials • Congestion and high transport costs

  33. COSTS OF PRODUCTION

  34. These are the money values of resources used in producing a good or service. • Wages to labour • Rent for land • Interest on capital • The owner of the firm provides enterprise. If revenue earned is equal to cost of production this is called NORMAL PROFIT, if revenue is greater than costs, it is called SUPERNORMAL PROFITS

  35. TYPES OF COSTS • Fixed Costs • Costs which do not change with output. • If nothing is made fixed costs still need to be paid • Examples include rent and insurance.

  36. Variable Costs • These are costs which do change with output. • If output is zero then VC is zero • Examples include raw materials and wages

  37. Total Costs • This is fixed costs plus variable costs • Average (Total) Cost • Total Costs divided by Output • Can also be called UNIT COST

  38. Average Fixed Cost • Fixed cost divided by Output • Average Variable Cost • Variable cost divided by Output

  39. Marginal Cost • The extra cost of producing one additional unit of output. • E.g. The MC of the 50th unit is the Total Cost of the 50th unit minus the Total Cost of the 49th Unit. • MC = TC n – TCn-1

  40. SHORT RUN AND LONG RUN • In the short run the firm will have fixed capacity. • Some costs will be fixed and some variable • In the long run all costs are variable.

  41. SHORT RUN COSTS • LOOK AT TABLE ON PAGE 35 OF CORE NOTES • DRAW THE GRAPHS

  42. COST CURVES Cost TC VC FC Output

  43. Cost AC AVC Output AFC

  44. Cost MC AC AVC Output

  45. OBSERVATIONS • When output increases in the short run: • Fixed costs do not change • Variable costs increase, not always at a constant rate • Total costs increase at the same rate as variable costs

  46. Average fixed costs fall, This is because fixed cost do not change but is being spread over a larger volume • Average variable costs fall until a certain point but then increase. Falls due to improved efficiency and increasing returns. Rises due to inefficiency and diminishing returns. • Average costs fall while average variable costs and average fixed costs are falling. When the increase in AVC exceeds the falls in AFC then AC will rise.

  47. Combining the Factors of Production • In the short run a firm cannot change its fixed factors of production (eg land) but it can change its variable factors (eg labour)

  48. Law of Diminishing Returns • As successive units of one factor are added to fixed amounts of other factors the increments in total output at first rise and then decline.

  49. Marginal costs fall and then rise as output increases • Marginal cost is less than AVC and AC when AVC and AC are falling • Marginal cost is greater than AVC and AC when AVC and AC are rising • MC will cut both the AVC and AC at their lowest point.

  50. OPTIMUM OUTPUT • This is the output where the firm would be technically efficient. • At this point AC is at its lowest.

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