1 / 23

The Theory of the Firm COSTS, REVENUES AND PROFIT

The Theory of the Firm COSTS, REVENUES AND PROFIT. BLINK & DORTON, (2007 p73-94). COST THEORY . The Short Run and the Long Run

myron
Download Presentation

The Theory of the Firm COSTS, REVENUES AND PROFIT

An Image/Link below is provided (as is) to download presentation Download Policy: Content on the Website is provided to you AS IS for your information and personal use and may not be sold / licensed / shared on other websites without getting consent from its author. Content is provided to you AS IS for your information and personal use only. Download presentation by click this link. While downloading, if for some reason you are not able to download a presentation, the publisher may have deleted the file from their server. During download, if you can't get a presentation, the file might be deleted by the publisher.

E N D

Presentation Transcript

  1. The Theory of the Firm COSTS, REVENUES AND PROFIT BLINK & DORTON, (2007 p73-94)

  2. COST THEORY The Short Run and the Long Run • When a firm is producing some of its factors of production will be fixed in the short run. Eg: The firm will not be able to quickly increase the quantity of them that it has. • Often the fixed factor is some element of capital or land, but this is not always the case. It could be a type of highly skilled labour such as specialist machine worker. However, in our examples, the quantity of labour will be a variable factor.

  3. COST THEORY The Short Run and the Long Run • If a firm wishes to increase output in the short run, it may only do so by applying more units of its variable factors, to the fixed factors that is possess, while it plans ahead to change the number of fixed factors that is has.

  4. Short Run vs Long Run Short Run • Is that period of time in which at least one factor of production is fixed. • All production takes place in the short run. Long Run • Is that period of time in which all factors of production are variable, but the state of technology is fixed. • All planning takes place in the long run.

  5. How long is the short term? • The length of the short run for a firm will be determined by the time it takes to increase the quantity of the fixed factor. • This will vary from industry to industry.

  6. How long is the short term?Small Company Example • A small firm in involved in gardening may find that its fixed factor is the number of lawn movers that is has available and that it takes a week to order and get delivery of new law mower. Its short run is one week.

  7. How long is the short term?Large Company Example • A national electricity provider is constrained by its fixed factors, the number of electricity generating plants that is has. • Building a new electricity plant may take up to two years (more if a nuclear plant is built) and so its short run is a lot longer.

  8. Long Run Planning • If the firm plans ahead to change its fixed factors, then all factors of production are variable as the plans are being made. • The firm is planning in the long run. BUT.. • If the fixed factors are changed the firm is once again in the short turn; it simply has a different number of fixed factors.

  9. How can output be increased in the short run? • The only way that output can be increased is to apply more units of variable factors to the new quantity of fixed factors. • All production takes place in the long run.

  10. Total Average and Marginal Product Total Product (TP) • Total product (TP) is the total output that a firm producers, using its fixed and variable factors in a given time period.

  11. Average Product Average Product • Average product (AP) is the output that is produced, on average, by each unit of the variable factor. AP = _____Total Output Produced (TP)_____________ Number of Units of the Variable Factor employed (V)

  12. Marginal Product Marginal Product • Marginal Product (MP) is the extra output that is produced by using an extra unit of the variable factor MP = Change in the Total Output Produced TP Change in the Number of Units of variable factor employed V

  13. Example: A firm has four machines (fixed factors) and increases it output by using more operators to work the machines. Production figures for each week are below. MP: How much extra output each workers contributes. 10/1 = 25-10= 25/2 = 45-25= 45/3 = 70-45= 70/4 = 90-70= 90/5 = 105-90= 105/6 = 115-105= 115/7 = 120-115= 120/8 =

  14. How many workers should this firm employ? Justify your decision 10/1 = 25-10= 25/2 = 45-25= 45/3 = 70-45= 70/4 = 90-70= 90/5 = 105-90= 105/6 = 115-105= 115/7 = 120-115= 120/8 =

  15. The Law of Diminishing Returns The Hypothesis of eventually Diminishing Marginal Returns • As extra units of a variable factor are added to a given quantity of a fixed factor, the output from each additional unit of the variable factor will eventually diminish.

  16. The Law of Diminishing Returns The Hypothesis of eventually Diminishing Average Returns • An extra units of variable factor are added to a given quantity of a fixed factor, the output per unit of the variable factor will eventually diminish.

  17. The Law of Diminishing ReturnsHamburger Stand example (p76) Part 1 A young entrepreneur named Ben sets up a new Business, which is small hamburger stand. The stand consists of a fridge, and grill for preparing the burgers and implements for burger making. These are the fixed factors. When he starts out, Ben works alone and does everything. He can make 20 burgers per hour

  18. The Law of Diminishing ReturnsHamburger Stand example (p76) Part 2 Ben finds demand to be high and he cannot make enough burgers so hires a friend, Caroline. They divide up jobs and manage to produce 50 Burgers per hour. Demand still increases, so Nick also joins the team. They divide up the worker again and produce 90 burgers each hour. Demand increases so Niki. With four workers, they produce 124 burgersper hour.

  19. The Law of Diminishing ReturnsHamburger Stand example (p76 Part 3 • When Ben worked alone, output was 20 per hour. • When Caroline joined, output was 50 burgers per hour. • Caroline’s marginal product was 30 burgers. • When Nick joined total output was 90 burgers per hour. • Nick’s marginal product was 40. • When Niki, the total output rose to 124. • Niki’s marginal product was 34

  20. The Law of Diminishing ReturnsHamburger Stand example Why did marginal product fall when Niki (4th person was added to the workforce? • It was efficient to add extra people, up to three workers, but because the space in the shop, the counter tops, and the grill are all fixed, it became less efficient when there were four people. • The workers started to get in each other’s way and so could not increase the output of burgers by as great an amount when the previous worker was added.

  21. The Law of Diminishing Returns • Whether we measure it from the amount added by the extra variable factor (marginal product) or amount added per unit of the variable factor (average product), logic tells us that inefficiency must eventually begin to occur.

More Related