Last class: Today: Next class: Important dates: CDAE 254 - Class 22 Nov 9 Last class: Problem set 5 questions 6. Costs Today: 7. Profit maximization and supply Quiz 7 Next class: Important dates: Problem set 6 due Thursday, Nov. 16 (6.1., 6.4., 6.6., 6.9., and 6.10 from the textbook) Final exam: 3:30 – 6:30pm, Friday, Dec. 15

6. Costs 6.1. Basic concepts of costs 6.2. Cost minimizing input choice 6.3. Cost curves 6.4. Short-run and long-run costs 6.5. Per unit short-run cost curves 6.6. Shifts in cost curves 6.7. An example 6.8. Applications

6.3. Cost curves 6.3.1. Possible shapes of the total cost curve (function): relation between TC and q (Fig. 6.3) (1) Constant returns to scale (2) Decreasing returns to scale (3) Increasing returns to scale (4) Optimal scale: increasing returns to scale followed by decreasing returns to scale Practice question: If TC=50 for Q=20 and TC=90 for Q=40, what is the returns to scale of this production?

6.3. Cost curves 6.3.2. Average cost (AC) and marginal cost (MC) (1) What is the AC and what is the MC? AC = TC/q MC = ΔTC/Δq (2) AC and MC curves (functions) (Fig. 6.4) (a) Constant returns to scale (b) Decreasing returns to scale (c) Increasing returns to scale (d) Optimal scale Practice question: If MC<AC, what is the returns to scale?

6.3. Cost curves 6.3.2. Average cost (AC) and marginal cost (MC) (3) Optimal scale: Relationship between AC and MC (4) Optimal scale: Lowest AC input choice When MC < AC, AC is decreasing When MC > AC, AC is increasing When MC = AC, AC is at the minimum level.

6.4. Short run and long run costs 6.4.1. Distinction between short run and long run Very short run: K and L are fixed  Q is also fixed Short run: K is fixed and L change  Q can change Long run: both K and L can change  Q can change 6.4.2. Input flexibility in the short-run and long run (Fig. 6.5) Short run: K is fixed and L can change Long run: both K and L can change

6.4. Short run and long run costs 6.4.3. Short-run total costs: STC = vK* + wL = SFC + SVC 6.4.4. Short-run fixed, variable & total cost curves Note that the concept “returns to scale” does not apply in the short run.

6.5. Per-unit short run cost curves 6.5.1. Short-run average cost SAC = STC / q 6.5.2. Short-run marginal cost SMC = ΔSTC/Δq 6.5.3. SAC and SMC curves 6.5.4. Long-run average cost and marginal cost 6.5.5. Relationship between short-run and long-run cost curves 6.5.6. An example: choosing an ink-jet printer or laser printer Ink-jet: STC = 80 + 0.07 q Laser: STC = 200 + 0.04 q

6.6. Shifts in cost curves 6.6.1. Change in input prices (w and v) (1) w & v change in the same proportion -- TC, AC and MC will change -- Expansion path will not change (2) w & v change in difference proportion -- Expansion path will change 6.6.2. Technology change -- Expansion path?

6.7. An example -- Production function -- Total cost TC = vK + wL= 5K + 5L -- Isoquant of q = 40 -- Total cost of producing 40 units of q -- Cost-minimizing input choice for q=40 L* = 4 and K* = 4, TC = 40 -- Long-run expansion path & costs -- Short-run total cost (STC), short-run average cost (SAC) and short-run marginal cost (SMC) -- Comparison of short-run & long-run costs

6.8. Applications

7. Profit maximization and supply 7.1. Goals of a firm 7.2. Profit maximization 7.3. Marginal revenue and demand 7.4. Marginal revenue curve 7.5. Alternatives to profit maximization 7.6. Short-run supply 7.7. Applications

7.1. Goals of a firm -- Maximize profit -- Maximize TR to increase market shares -- Maximize the utility of the manager -- Maximize the expected profit and reduce the risk …..

7.2. Profit maximization -- Profit  = TR – TC = Pq – TC -- A graphical analysis (TR, TC and ) (Fig. 7.1.) -- A better graph (handout) --  is at the maximum level when the slope of the profit curve is equal to zero Slope of the total profit = M = 0 “M = 0” is equivalent to “MR=MC” i.e., when the slope of the TR curve is equal to the slope of the TC curve

7.2. Profit maximization -- Conclusion:  is at the maximum level when MC=MR -- Why is this the decision rule? If MR > MC,  can be increased by increasing q If MR < MC,  can be increased by decreasing q If MR = MC,  can not be increased