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BUSINESS economics

BUSINESS economics. Class 5 30 November, 2009. Recap. Elasticity of Demand Price, Income, Cross Production Function Factors of Production Cobb-Douglas, Linear function Cost Theory Opportunity costs, Marginal costs Accounting costs, Transaction costs. Demand Analysis. Law of Demand

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BUSINESS economics

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  1. BUSINESS economics Class 5 30November, 2009

  2. Recap • Elasticity of Demand • Price, Income, Cross • Production Function • Factors of Production • Cobb-Douglas, Linear function • Cost Theory • Opportunity costs, Marginal costs • Accounting costs, Transaction costs

  3. Demand Analysis • Law of Demand • As quantity demanded increases, prices fall • Exceptions to law of demand • Giffen goods, substitutes, supply • Determinants of Demand • Income levels • Population • Price and supply of substitutes • Tastes and preferences

  4. Isoquants For a given Capital (K) and Labour (L), quantities of output (Q) can be produced A given isoquant shows all technologically efficient combinations of labour and capital that can produce a given number of units.

  5. Isoquants • Always slope downward • Isoquants do not intersect • Isoquants further from the origin represent greater output • Marginal rate of technical substitution • MRTSLK = - ΔK/ΔL • Slope of isoquant = MRTSLK = MPL /MPK

  6. Isocosts • Isoquants graphically illustrate a firm’s production function for all quantities of output the firm could possibly produce. Given these isoquants, how much should the firm produce? • More specifically, what is the firm’s profit-maximising level of output? • The answer depends on the cost of resources and on the amount of money the firm plans to spend.

  7. Isocosts • Assume a unit of labour costs the firm $15000 per year, and the cost for each unit of capital is $25000 per year. The total cost (TC) of production is: • TC = (w x L) + (r x K)= $15000 L + $25000 K, where w is the annual wage rate, L is the quantity of labour employed, r is the annual cost of capital, and K is the quantity of capital employed • Each isocost line shows combinations of labour and capital that can be purchased for a fixed amount of total cost. • The slope of each is equal to minus the wage rate divided by the rental rate of capital. • Higher levels of cost are represented by isocost lines further from the origin. • Slope = - w/r

  8. Optimal choice of input • The point of tangency between the isocost line and the isoquant shows the minimum cost required to produce a given output. • This equality shows that the firm adjusts resource use so that the rate at which one input can be substituted for another in production, that is, the MRTS equals the rate at which one resource can be traded for another in resource markets, that is the resource price ratio w/r. • MPL/w = MPK/r • The points of tangency between isoquants and isocost lines each show the least expensive way of producing a particular level of output. Connecting these tangency points gives the firm’s expansion path.

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