EC102: Class 4 Christina Ammon

The Firm/ Production What is the aim of the firm? Profits=Revenue-Total Economic Costs Revenue=Price*Quantity Total Economic Costs: Concepts: Total Economic Costs & Sunk Costs vs. Fixed and Variable Costs Average Costs Marginal Costs

Profit maximisation Two steps Cost minimisation: Profit maximisation Find the optimal combination of inputs that minimizes costs Find optimum for each level of output Isoquants vs. Isocosts What is the optimality condition? What are the slopes of the Isoquants and Isocosts? Profit maximisation From Cost minimization – get total costs as a function of ouput Choose: profit maximizing amount of output Optimality condition Shut down rule

Question 1 Four years ago Jacques signed a five-year lease of €1,000 per year on a custom-made ice cream packing machine. Given that he cannot sublet it, the lease contract currently implies for Jacques:  An economic cost of €1,000 An economic cost of €5,000 A sunk expenditure of €1,000 A sunk expenditure of €5,000

Question 1 Total Economic Costs= Sum of opportunity costs of all inputs => Sunk Expenditure Why is it 1000 pounds and not 5000 pounds? Depends somewhat on assumptions But: unless he has to pay 5000 upfront – would not be a sunk expenditure of 5000 Need to discount the future!

Question 2 The sales department of an ice cream producer has gathered the following information on the relation between price and quantity sold:   When the firms sells 7,000 litres of ice cream per month, the corresponding total revenue is: €20,000 €28,000 €25,980 €29,360

Question 2

Question 3 The finance department of an ice cream producer reports that the total costs of producing 5,000 litres and 6,000 litres of ice cream per months are €12,500 and €14,500 respectively. The marginal cost of raising production from 5,000 to 6,000 litres per month is therefore: €1,000 €12,500 €2,000 €14,500

Question 4 Based on the figure, the ice cream seller should: Produce because it makes profit represented by area I Produce because it makes profit for any output level Shut down because makes a loss for any output level Shut down because it makes a loss represented by area I What is the shutdown rule in terms of AEC and not in terms of MC? Why is it important to take the Economic costs and not accounting cost?

Question 5 The isoquant represents Springsteen Motors’s target of 200 cars per day. Before the superstorm Springsteen Motors could rely on 300 robots. However, due to the superstorm, 100 of those robots are now out of order. How many more workers do Springsteen Motors have to hire in order to achieve its target output of 200 cars per day after superstorm Wendy? 100 800 1550 750

Question 6 The marginal physical product of labour when the plant has 60 units of capital and increases its labour from 4 to 5 workers is: 67 77 87 57

Question 6 What is the Marginal Product of Labour? In this case: how much does output increase if we increase labour from 4 to 5 workers 4 workers: output=70 5 workers: output=147 Can we say anything about increasing vs. decreasing returns to scale?

Question 7 Consider a firm with the production function F(L,K) = L x K that is using 10 units of labour and 5 units of capital. Its marginal physical product of labour, its marginal physical product of capital and its marginal rate of technical substitution are respectively: 5, 10 and 1/2 10, 5 and 1/2 5, 10 and 2 10, 5 and 2

Question 7 Increasing labour by ΔL raises output by: ΔX = (L + ΔL) × K − L × K = ΔL × K. => MPPL = ΔX / ΔL = K = 5 Capital: ΔX = L × (ΔK+ K) − L × K = L ×Δ K. MPPK =ΔX / ΔK= L = 10. MRTS = MPPL/MPPK = K/L Given that MPPL = 5, MPPK = 10 => MRTS = 1/2.

Question 8 This illustrates the case of: Increasing marginal rate of technical substitution Decreasing marginal rate of technical substitution Constant marginal rate of technical substitution

Question 9 The production function F(L,K) = L x K exhibits: Decreasing returns to scale Constant returns to scale Increasing returns to scale  

Question 9 What are increasing returns to scale? How do we check? E.g. multiply all inputs by 2 Increasing returns of scale imply: F(2L,2K)>2F(K,L) How about in this case: F(2L,2K) =2 L x 2K F(2L,2K) =4( L x K) =4F(L,K) Easy way to check: add exponents if of the form that we have here

Does a low wage guarantee competitiveness? Question 10 “I think the rise of China is inevitable, because China has moved from a low-cost producer, at low levels of technology, to higher levels of technology, and because it's very competitive, even in some high-tech products they offer at very competitive rates - much lower than their competitors.” (Najib Razak) Does a low wage guarantee competitiveness?