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Background to Supply

Learn about short-run production theory, including the law of diminishing returns, production functions, costs of production, and marginal cost in this comprehensive guide on economic principles.

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Background to Supply

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  1. Background to Supply

  2. Background to Supply The Short-run Theory of Production

  3. Short-run theory of production • Profits and the aims of the firm • traditional and alternative theories of the firm • Long-run and short-run production: • fixed and variable factors of production • The law of diminishing returns When increasing amounts of a variable factor are used with a given amount of a fixed factor, there will come a point when each extra unit of the variable factor will produce less extra output than the previous unit.

  4. Short-run theory of production • The short-run production function: • total physical product (TPP) • average physical product (APP) • APP = TPP/QV • marginal physical product (MPP) • MPP = TPP/QV

  5. Wheat production per year from a particular farm (tonnes)

  6. Wheat production per year from a particular farm (tonnes)

  7. Wheat production per year from a particular farm (tonnes)

  8. Wheat production per year from a particular farm (tonnes)

  9. Short-run theory of production • The short-run production function: • total physical product (TPP) • average physical product (APP) • APP = TPP/QV • marginal physical product (MPP) • MPP = TPP/QV • graphical relationship between TPP, APP and MPP

  10. Wheat production per year from a particular farm Number of workers 0 1 2 3 4 5 6 7 8 TPP 0 3 10 24 36 40 42 42 40 Tonnes of wheat produced per year Number of farm workers

  11. Wheat production per year from a particular farm Number of workers 0 1 2 3 4 5 6 7 8 TPP 0 3 10 24 36 40 42 42 40 Tonnes of wheat produced per year Number of farm workers

  12. Wheat production per year from a particular farm Maximum output Diminishing returns set in here d TPP Tonnes of wheat produced per year b Number of farm workers

  13. Wheat production per year from a particular farm DTPP = 7 DL = 1 MPP = DTPP / DL = 7 TPP Tonnes of wheat per year Number of farm workers (L) Tonnes of wheat per year Number of farm workers (L)

  14. Wheat production per year from a particular farm TPP Tonnes of wheat per year Number of farm workers (L) Tonnes of wheat per year Number of farm workers (L) MPP

  15. Wheat production per year from a particular farm TPP Tonnes of wheat per year Number of farm workers (L) APP = TPP / L Tonnes of wheat per year APP Number of farm workers (L) MPP

  16. Wheat production per year from a particular farm b Diminishing returns set in here b TPP Tonnes of wheat per year Number of farm workers (L) Tonnes of wheat per year APP Number of farm workers (L) MPP

  17. Wheat production per year from a particular farm d Maximum output d TPP Tonnes of wheat per year b Number of farm workers (L) b Tonnes of wheat per year APP Number of farm workers (L) MPP

  18. Wheat production per year from a particular farm c Slope = TPP / L = APP c d TPP Tonnes of wheat per year b Number of farm workers (L) b Tonnes of wheat per year APP d Number of farm workers (L) MPP

  19. Background to Supply Short-run Costs

  20. Short-run costs • Measuring costs of production: opportunity costs • explicit costs • implicit costs • Fixed costs and variable costs • Total costs • total fixed cost (TFC) • total variable cost (TVC) • total cost (TC = TFC + TVC)

  21. Total costs for firm X Output (Q) 0 1 2 3 4 5 6 7 TFC (£) 12 12 12 12 12 12 12 12

  22. Total costs for firm X Output (Q) 0 1 2 3 4 5 6 7 TFC (£) 12 12 12 12 12 12 12 12 TFC

  23. Total costs for firm X Output (Q) 0 1 2 3 4 5 6 7 TVC (£) 0 10 16 21 28 40 60 91 TFC (£) 12 12 12 12 12 12 12 12 TFC

  24. Total costs for firm X Output (Q) 0 1 2 3 4 5 6 7 TVC (£) 0 10 16 21 28 40 60 91 TFC (£) 12 12 12 12 12 12 12 12 TVC TFC

  25. Total costs for firm X Output (Q) 0 1 2 3 4 5 6 7 TVC (£) 0 10 16 21 28 40 60 91 TC (£) 12 22 28 33 40 52 72 103 TFC (£) 12 12 12 12 12 12 12 12 TVC TFC

  26. Total costs for firm X Output (Q) 0 1 2 3 4 5 6 7 TVC (£) 0 10 16 21 28 40 60 91 TC (£) 12 22 28 33 40 52 72 103 TFC (£) 12 12 12 12 12 12 12 12 TC TVC TFC

  27. Total costs for firm X Diminishing marginal returns set in here TC TVC TFC

  28. Short-run costs • Marginal cost • marginal cost (MC) and the law of diminishing returns

  29. Average and marginal physical product Diminishing returns set in here b MPP Output Quantity of the variable factor

  30. Average and marginal physical product c b Output APP MPP Quantity of the variable factor

  31. Marginal cost MC Diminishing marginal returns set in here x Costs (£) Output (Q)

  32. Short-run costs • Marginal cost • marginal cost (MC) and the law of diminishing returns • the relationship between the marginal and total cost curves

  33. Total costs for firm X Bottom of the MC curve TC TVC TFC

  34. Short-run costs • Marginal cost • marginal cost (MC) and the law of diminishing returns • the relationship between the marginal and total cost curves • Average cost • average fixed cost (AFC) • average variable cost (AVC) • average (total) cost (AC) • relationship between AC and MC

  35. Average and marginal costs MC AC AVC z y x AFC Costs (£) Output (Q)

  36. Background to Supply The Long-run Theory of Production

  37. Long-run theory of production • All factors variable in long run • The scale of production: • constant returns to scale • increasing returns to scale • decreasing returns to scale

  38. Short-run and long-run increases in output

  39. Short-run and long-run increases in output

  40. Short-run and long-run increases in output

  41. Long-run theory of production • Economies of scale • specialisation & division of labour • indivisibilities • container principle • greater efficiency of large machines • by-products • multi-stage production • organisational & administrative economies • financial economies • economies of scope

  42. Long-run theory of production • Diseconomies of scale • Managerial complexity • Alienation • Industrial relations problems • Disruption if part of complex production chains fail • External economies and diseconomies of scale • Optimum combination of factors • MPPa/Pa = MPPb/Pb ... = MPPn/Pn(the equi-marginal principle)

  43. Background to Supply Isoquant–Isocost Analysis

  44. Isoquant–isocost analysis • Isoquants • their shape

  45. An isoquant Units of K 40 20 10 6 4 Units of L 5 12 20 30 50 Point on diagram a b c d e Units of capital (K) Units of labour (L)

  46. An isoquant a Units of K 40 20 10 6 4 Units of L 5 12 20 30 50 Point on diagram a b c d e Units of capital (K) Units of labour (L)

  47. An isoquant a Units of K 40 20 10 6 4 Units of L 5 12 20 30 50 Point on diagram a b c d e Units of capital (K) b Units of labour (L)

  48. An isoquant a Units of K 40 20 10 6 4 Units of L 5 12 20 30 50 Point on diagram a b c d e Units of capital (K) b c d e Units of labour (L)

  49. Isoquant–isocost analysis • Isoquants • their shape • diminishing marginal rate of substitution

  50. Diminishing marginal rate of factor substitution DK = 2 DL = 1 g MRS = DK / DL MRS = 2 h Units of capital (K) isoquant Units of labour (L)

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