KINH TẾ VI MÔ Chapter 5 production

Production function 1.2 Short-run production Assumption: Labour is variable while capital is fixed à Firm can increase output only by using more labour... Production function n Marg

Chapter 5: Firm theory

Nguyen Thi Minh Thu

Introduction

of International Economics, Foreign

Trade University

Chapter outline

1 Production function

1.1 Key definitions

-   Production is the process that transforms inputs into

outputs, i.e goods and services, to satisfy human wants

-   Common types of inputs

Capital (K) : machines and building

Labour (L) : human services

Material (M): raw inputs and processed products

Production function

n  Production function is a mathematic representation of

the relationship between quantities of inputs used and maximum quantity of output that can be produced given the current technology

Production function

n  Production function with two inputs

Q = f (K, L) Where

Q: output quantity

K: physical capital

L: labour

Production function

n   Short run: The period of time during which at

least one input is fixed

n   Long run: the period of time which is lengthy

enough for all inputs to vary

Production function

1.2 Short-run production

Assumption: Labour is variable while capital is fixed

à   Firm can increase output only by using more labour

Production function

n   Marginal product labour, or MPL, is the change

in total output resulting from the use of an extra unit of labour, given the other production factor (K) held constant

€

ΔL

Production function

n   The law of diminishing marginal product

Diminishing marginal product is the property whereby the marginal product of an input declines as the quantity of the input increases, holding the other input fixed

For example, if a firm holds the number of its equipment constant, hiring more workers would make the capital- labour ratio fall Thus, each additional worker would contribute less and less to the whole production process

è MPL first rises and then falls.

Production function

n   The relationship between average product of

labour and marginal product of labour

MPL > APL : APL é

MPL < APL : APL ê

MPL = APL : APL max

2 Production cost

2.1 Economic cost versus accounting cost

-   Explicit costs are input costs that require a direct

outlay of money by the firm

-   Implicit costs are input costs that do not require an outlay of money by the firm

Production cost

n   Sunk costs are costs that a firm have already

incurred and cannot be recovered

è Sunk cost fallacy

Production cost

2.2 Short run production cost

§   Fixed costs (FC) are those costs that do not vary

with the output level

§   Variable cost( VC) are those costs that do vary with the output level

Production cost

n   Average fixed cost is the fixed cost of each

typical unit of product

n   Average variable cost is the variable cost of each typical unit of product

n   Average total cost is the total cost of each typical unit of product

Production cost

à ATC = AFC + AVC

Production cost

n   Relationship between AVC and APL

n   As average product falls, average variable cost will rise substantially

Production cost

n   Relationship between MC and MPL

n   MPL first rises and then falls

è  MC first declines and then goes up

Production cost

n   Relationship between MC and AVC

MC > AVC : AVC é

MC < AVC : AVC ê

MC = AVC : AVC min

Production cost

n   Relationship between MC and ATC

MC > ATC : ATC é

MC < ATC : ATC ê

MC = ATC : ATC min

Profit maximization

P = αQ +β è TR = PQ = αQ 2 + βQ è MR = 2αQ +β

Profit maximization

§   Profit is the firm s total revenue minus its total cost

Profit = Total revenue - Total cost

à   Economic profit versus accounting profit

§   Economic profit is zero à the firm earns normal profit

§   Economic profit is positive à abnormal profit

§   Economic profit is negative à loss

n   MR < MC : Decrease output

n   MR = MC : optimal output level

PRACTICE

n   Demand is given by P = 55 - 2Q

n   Cost function is TC = 100 - 5Q + Q2

a   What is the marginal revenue as a function of Q?

b   If the firm wants to maximize profits, what price does it charge? How much profit and consumer surplus is

generated at this price?

c   If the firm wants to maximize total revenue, what price does it charge? Calculate quantity and profit

Summary

n   The goal of firms is to maximize profit, which equals

total revenue minus total cost

n   When analyzing a firm s behavior, it is important to

include all the opportunity costs of production

n   Some opportunity costs are explicit while other

opportunity costs are implicit

Summary

n   A firm s costs reflect its production process

n   A typical firm s production function gets flatter as the quantity of input increases, displaying the property of diminishing marginal product

n   A firm s total costs are divided between fixed and

variable costs Fixed costs do not change when the firm alters the quantity of output produced; variable costs do change as the firm alters quantity of output produced

Summary

n   Average total cost is total cost divided by the quantity of output

n   Marginal cost is the amount by which total cost would rise

if output were increased by one unit

n   The marginal cost always rises with the quantity of

output

n   Average cost first falls as output increases and then rises

Summary

average-total-cost curve at the minimum of ATC