Contents Chapter MICROECONOMICS Theories of Producer Behavior The Production Theory The Production Cost Theory The Profit Theory By Tran ThiKieu Minh, MSc 2015, FTU Kieu Minh 5.1.1 Production Technology  Chapter ◦ Inputs: land, labor, capital & raw materials ◦ Outputs: cars, desks, books, etc 5.1.THE PRODUCTION THEORY Basic Microeconomics Describe how inputs can be transformed into outputs  Firms can produce different amounts of outputs using different combinations of inputs Short- run and Long-run Production Function   We can represent the firm’s production technology in form of a production function Production Function:  Short Run ◦ Period of time in which quantities of one or more production factors cannot be changed ◦ These inputs are called fixed inputs ◦ Short-run Production Function: Q = F(L) or Q = f(K) ◦ Indicates the highest output (Q) that a firm can produce for every specified combination of inputs ◦ Shows what is technically feasible when the firm operates efficiently ◦ For simplicity, we will consider only labor (L) and capital (K)  Long-run ◦ Amount of time needed to make all production inputs variable ◦ Long-run Production Function: Q = F(K, L) ◦ The production function is true for a given technology  Q = F(K,L) Short run and long run are not time specific Returns to Scale  Returns to Scale How does a firm decide, in the long run, the best way to increase output Rate at which output increases as inputs are increased proportionately  Production technology:Q = f (K,L)  ◦ Can change the scale of production by increasing all inputs in proportion ◦ If double inputs, output will most likely increase but by how much? ◦ Increasing returns to scale: F (mK,mL) > mQ (m > 1) ◦ Constant returns to scale: F (mK,mL) = mQ, (m > 1) ◦ Decreasing returns to scale: F (mK,mL) < mQ (m > 1) Quiz  5.1.2 Production in the Short-run How is the return to scale of the following production technologies? with One Variable Input  We assume capital (K) is fixed and labor (L) is variable  a Q b.K 0.7 L0.6 ◦ Output can only be increased by increasing labor ◦ Must know how output changes as the amount of labor is changed (Table 6.1) Q c.3K  5L Q d.2 K  L Q  K  L2 10 Total Product Example Output D 112 C 60 B Total Product At point D, output is maximized at 112 units A 10 Labor per Month 11 12 Product Curves Average product of Labor Output per unit of a particular product  Measures the productivity of a firm’s labor in terms of how much, on average, each worker can produce AP is slope of line from origin to point on TP curve  q q/L 112 60 AP  30 C Output Q  Labor Input L 20 B 10 10 10 Labor Labor 13 14 Product Curves Marginal Product of Labor Additional output produced when labor increases by one unit  Change in output divided by the change in labor MP is slope of line tangent to corresponding point on TP curve  q q D 112 30 60 Output Q MPL   Labor Input L 30 15 10 A 10 Labor 15 10 Labor 16 Marginal & Average Product Law of Diminishing Marginal Returns MPL  APL  APL  Law of Diminishing Marginal Returns: As the use of an input increases with other inputs fixed, the resulting additions to output will eventually decrease MPL  APL  APL max ◦ As we increase labor the additional output produced MPL declines MPL  APL  APL   MPL   Q max 17 18 Quiz:  Short-run Production technology of a firm can be shown as: L 10 What are the function of MPL, APL Q  10 L  L2  a b c d How much is the maximum quantity of this firm? How much labor are used then? At which level can the law of diminishing return of labor be seen At which level is the average product of labor maximum? 19 5.2.THE PRODUCTION COST THEORY 20 Economic Cost 5.2.1 Which Costs Matter? Accountants tend to take a retrospective view of firms costs, where as economists tend to take a forward-looking view  Accounting Cost = AC   ◦ EC = AC +OC ◦ Actual expenses plus depreciation charges for capital equipment  Economic costs distinguish between costs the firm can control and those it cannot Economic Cost = EC ◦ Cost to a firm of utilizing economic resources in production, including opportunity cost  Opportunity cost (of firm’s resources) ◦ Cost associated with opportunities that are foregone when a firm’s resources are not put to their highest-value use 21 22 Sunk Cost 5.2.2 Costs vary with Output Expenditure that has been made and cannot be recovered  Should not influence a firm’s future economic decisions  Firm buys a piece of equipment that cannot be converted to another use  Fixed Cost - FC ◦ Does not vary with the level of output Variable Cost - VC ◦ Cost that varies as output varies ◦ Has no alternative use so cost cannot be recovered – opportunity cost is zero ◦ Decision to buy the equipment might have been good or bad, but now does not matter Total Cost - TC TC  FC  VC 23 24 Average Costs  Marginal Cost (MC): ◦ The cost of expanding output by one unit ◦ Fixed cost have no impact on marginal cost, so it can be written as: Average Total Cost (ATC) ◦ Cost per unit of output ◦ Also equals average fixed cost (AFC) plus average variable cost (AVC) MC  TC  AFC  AVC q TC TFC TVC ATC    q q q ATC  ΔVC ΔTC  Δq Δq 25 Quiz: fill in blanks Q AFC VC ATC Graph MC 30 50 C TC 10 VC 20 40 TC = FC + VC TC 100 10 26 11 420 390 C* FC Q 16 Graph: Average Cost Marginal Cost - MC C ◦ Average Fixed Cost: AFC = FC / Q ◦ Average Variable Cost:AVC = VC / Q ◦ Average Total cost:ATC= TC / Q ATC = AFC + AVC MC A TC AVC A TC C Q AVC When MC is below AVC, AVC is falling  When MC is above AVC, AVC is rising  When MC is below ATC, ATC is falling  When MC is above ATC, ATC is rising  Therefore, MC crosses AVC and ATC at the minimums  A FC Q 30 5.3.1 Revenue  Revenue (R) /Total Revenue (TR) ◦ TR = P x Q Chapter ◦ Revenue is curved showing that a firm can only sell more if it lowers its price 5.3.THE PROFIT THEORY  Average Revenue ◦ AR = TR/Q  ◦ 31 TR  TRQ'  Q Slope in revenue curve is the marginal revenue (MR) Marginal Revenue MR  32 Revenue Maximizing Cost, Revenue, Profit ($s per year) 5.3.2 Profit TRmax  TR '   MR   Profit for the firm, , is difference between revenue and costs  (q)  R(q)  C(q) B A R(q) ◦ Profit () = Total Revenue - Total Cost ◦ Total revenue (TR) = R (q) = P x q ◦ Total Cost (TC) = C (q) MR Q0   Output Accounting Profit Economic Profit 34 34 33 Variables affecting to Profit   TR  TC  P  Q  ATC  Q  ( P  ATC )  Q   Market Price (P) ATC ◦ Return to Scale  Quantity - Q ◦ Depend of demand of the products Profit Maximization  Profit is maximized at the point at which an additional increment to output leaves profit unchanged   TR  TC  TR TC   0 q q q  MR  MC  MR  MC 36 Profit Maximization Cost, Revenue, Profit ($s per year) Quiz Profits are maximized where MR (slope at A) and MC (slope at B) are equal A C(q ) A firm faces a demand curve of their goods and knows their production cost as: P  12  0.4Q Profits are maximized where R(q) – C(q) is maximized TC  0.6Q  4Q  R(q ) B a b q0 q* c Output  (q)  max   '   MR  MC 37 Quiz Kurt Vile produces and distributes the Libertarian Magazine, "Anarchy." Demand is given by P = 55 - 2Q His cost function is TC = 100 - 5Q + Q a What is Kurt’s marginal revenue as a function of Q? b If Kurt wants to maximize profits, what price does he charge? How much profit and consumer surplus is generated at this price? c If Kurt wants to maximize total social surplus what price does he charge? What are his profits at this price? d What is the deadweight loss if profits are maximized? 2015, FTU Kieu Minh 39 How much is the optimum quantity, selling price, revenue and profit of this firm In order to maximizing profit? In order to maximizing revenue? In order to maximizing revenue as subject to profit is 10 ? ... production cost as: P  12  0.4Q Profits are maximized where R(q) – C(q) is maximized TC  0.6Q  4Q  R(q ) B a b q0 q* c Output  (q)  max   '   MR  MC 37 Quiz Kurt Vile produces and distributes... Which Costs Matter? Accountants tend to take a retrospective view of firms costs, where as economists tend to take a forward-looking view  Accounting Cost = AC   ◦ EC = AC +OC ◦ Actual expenses... ΔVC ΔTC  Δq Δq 25 Quiz: fill in blanks Q AFC VC ATC Graph MC 30 50 C TC 10 VC 20 40 TC = FC + VC TC 100 10 26 11 42 0 390 C* FC Q 16 Graph: Average Cost Marginal Cost - MC C ◦ Average Fixed Cost: