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Production and Costs

Production and Costs. Microeconomics - Dr. D. Foster. $. $. $. Supply side of the market. Why firms exist. Production and cost relationships. Model of perfect competition. Model of monopoly. Regulation

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Production and Costs

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  1. ProductionandCosts Microeconomics - Dr. D. Foster $ $ $

  2. Supply side of the market • Why firms exist. • Production and cost relationships. • Model of perfect competition. • Model of monopoly. • Regulation • Later: Monopolistic competition, oligopoly, game theory, factor markets, general equilibrium

  3. Why do firms exist? • They combine resources to produce goods and services. • Why not use markets? • Transaction costs are high. • Role of managers - monitor workers to minimize shirking. • Chinese barge-pullers. • Firm’s objective: maximize profit

  4. $ Costs & Profits • All costs are “opportunity costs.” • Costs may be explicit or implicit. • Total cost = TC = all relevant costs. • (Economic) Profit = TR-TC • If positive, firms will enter. • If negative, firms will exit. • If zero, the market is stable. • Accounting profit may/will not equal Economic Profit.

  5. Short Run vs. Long Run • We are interested in the short run:At least one input is fixed • Fixed - capital; variable – labor • In the Long Run, all factors are variable. • Next - Production & Cost relationships

  6. Output Total Product = TP (=Q) Labor L3 L1 Production Relationships • From 0 to L1 there are “increasing returns.” • From L1 onwards, there are “diminishing marginal returns.” • After L3 additional workers lower output. Why?

  7. Marginal Product = MP TP (=Q) Average Product = AP L2 Production Relationships Output • Average Product = AP = TP/L;this shows how much the average worker adds to output. Labor L3 L1 • Marginal Product = MP = ΔTP/ΔL;this shows how much the last worker (unit) adds to output.

  8. $ Cost Relationships • As noted, TC = TFC + TVC • TFC is fixed, by definition. • TVC can be written as w*L, where w is the (constant) wage rate. • Average Fixed Cost, AFC = TFC/Q • Average Variable Cost, AVC = TVC/Q . . . or, = wL/Q = w/AP • As AP rises, AVC falls . . . • Average Total Cost, ATC = TC/Q = AFC + AVC

  9. $ Cost Relationships • Marginal Cost, MC = ΔTC/ΔQ or, can be written as = ΔTVC/ΔQ (Why?)… = Δ(wL)/ΔQ = w(ΔL)/ΔQ = w/MP MC $ ATC AVC AFC quantity (TP)

  10. Complete the Production and Cost Worksheets

  11. $ Key Formulas MP = ΔTP/ΔL AP = TP/L TC = TFC + TVC TVC = w*L AFC = TFC/Q AVC = TVC/Q = wL/Q = w/AP ATC = TC/Q = AFC + AVC MC = ΔTC/ΔQ= ΔTVC/ΔQ = Δ(wL)/ΔQ = w(ΔL)/ΔQ = w/MP

  12. ProductionandCosts Microeconomics - Dr. D. Foster $ $ $

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