1 Lecture 3: Supply Advanced Micro Theory MSc.EnviNatResEcon. 1/2005 Charit Tingsabadh

2 Outline Supply concept Production function Cost function Empirical examples

3 Supply concept Supply: offer of goods at a price Goods are produced-output Using inputs-- as factors of production—in combination Factors include: land, labour, capital, energy, materials, etc. Technology of production

4 Supply concept Scale effect: constant, increasing, decreasing return to scale Relation between output and input at different levels of output Division of labour as an example:

5 Supply concept The short run and the long run Short run: all factors fixed except one Usually capital/technology are fixed, only labour variable. Capacity utilization index. Long run: all factors variable, new technology Let’s have some case examples: IT, automation etc.

6 Representation Production function Relation between output Q and factors of production – labour, capital, materials, energy, nature etc. Various functional forms Cobb-Douglas, CES, Translog etc.

7 Production function Example: Q=f(K,L) Cobb-Douglas: Q=aK a L (1- a ) Other forms Total, average, marginal product Factor substitution as part of technology option-may be possible, may be not.

8 Cost function Dual of production function Factors have prices, so can calculate cost of production C = wL + rK, So, what is the production problem? What combination of factors (what technology) to choose to produce the output?

9 Supply concept So far, assume fixed output But decision is about how much to produce, with what combination of factors, so need to account for the output side as well So, cost expressed in terms of output. Total, average, marginal cost, with respect to output.

10 Supply concept Types of costs Fixed cost and variable cost Varies with output

11 Supply concept Demand for factors of production-labour, capital As derived demand Demand determined by marginal product of factor Consider case of labour, when to employ new worker? And capital, when to invest?

12 Dynamic perspectives Technology on the move, innovations Types of innovation: product, process Stable vs. disruptive Types of technical progress: Hicks-neutral, capital/labour saving;Harrod-neutral; vintage- embodied/disembodied technical progress Measurement of technical progress: growth accounting

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14 Empirical functions Search and destroy mission: Find your own production/cost function and write a critique of the study.

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18 Homework Using the internet, obtain data on bananas: quantities, prices, etc. Develop 1 demand function and 1 supply function for your bananas and Estimate the price and income elasticities for your bananas, using the equation that you have developed. Enjoy!