The Theory of the Firm What is Theory of the Firm? Short v. Long Run Total v. Average v. Marginal Product.

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Presentation transcript:

The Theory of the Firm What is Theory of the Firm? Short v. Long Run Total v. Average v. Marginal Product

WHAT IS THE THEORY OF THE FIRM? Basically, it is how businesses behave.

SHORT RUN V. LONG RUN Short Run = Time period during which at least 1 input is fixed and cannot be changed by the firm Long Run = Time period in which all inputs can be changed

IS THERE A SET AMOUNT OF TIME FOR THE SHORT AND LONG RUNS? NO! It varies from firm to firm.. Main Q: How long does it take to increase the fixed factor(s)?

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 mowers that is has available and that it takes a week to order and get delivery of a new lawn mower. Its short run is one week.

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.

The Law of Diminishing Marginal Returns

Read Tragakes p & answer these Qs ■Define Total Product (TP), Marginal Product (MP), & Average Product (AP) ■Write the equations for MP & AP ■Summarize the concepts of increasing marginal product, decreasing marginal product, and negative marginal product ■Include graphs (a) and (b) from p. 141 in your notes. Understand why TP, AP, and MP have different shapes. (Be able to explain that to your neighbor.) ■Why is AP sometimes less than and sometimes greater than MP? ■Define the law of diminishing returns ■(FYI: This is looking production. Later on, the graphs for costs, revenue, and profits will be different.)

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. 25/2 = 45/3 = 70/4 = 90/5 = 105/6 = 115/7 = 120/8 = 10/1 = 25-10= 45-25= 70-45= 90-70= = = = MP: How much extra output each workers contributes.

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