The Costs of Production Principles of Microeconomics Boris Nikolaev

It’s business time. Firms are in the business of making profits. max Profit = TR – TC

Sneak Preview MR=MC

So it’s all about efficiency

Profits Are profits bad? What is the function of profits in a free market economy? In a competitive market profits come not from increase in price, but from decrease in the cost of production. (500 most profitable companies)

Corporate Profits after tax

CP/GDP

The Weed Trail [read here]read here

Marxist View The stagnating wages since the 1970s – Technology – World war II – Outsourcing – Women in the labor force – Immigration Problem of effective demand – Work more hours – Borrowing binge (mortgage debt, credit cards) Greatest profit boom (in the history of the world) – Marginal productivity, wages, and profits

Productivity vs Wages

What do you do with the profits? CEO salaries [Forbes list]Forbes list Mergers & Acquisitions Lend to employees (e.g. GM, IBM, etc.)

Costs Resources are scarce, productive, and have alternative uses. Implicit cost is the opportunity cost of the resource you own (the benefit you could have extracted from it from its next best use). Explicit costs are the direct cash payments you make to use resources you don’t own such as wages, rent, insurance, taxes, etc.

Economic vs Accounting Profit

Practice Question Your current job pays $50K/year. You have $20K savings that earn you $3K interest a year. You own a garage, which you rent for $12K/ year. You decide to invest your savings and use your garage to start your own business. Did you make a good economic decision? Total Revenue$105K Explicit Costs labor $21K food $20K Total Cost $41K Accounting Profit_____ Implicit Costs salary _____ interest _____ rent_____ Total Implicit Cost_____ Economic Profit / Loss______

Production in the Short Run Q= f(L,K)

Class demonstration

The Law of Diminishing Marginal Returns

Practice Question # fishermenFish caughtMP of laborMRP Input (L)TP = f(L) Assume that only one input (L) is relevant in production. The wage / worker = $175 and one pound of fish is selling for $10

What about costs? Short Run vs Long Run Costs Fixed Costs (FC) Variable Costs (VC) Total Cost (TC) = FC + VC Average Cost (AC) = TC/Q AFC = FC/Q AVC=VC/Q AC = AFC + AVC

Total and Marginal Cost

Marginal and Average Cost

Cost in the Long Run

Diseconomies of scale

LR Average Cost Curve

Economies of Scale

Sources of Economies of Scale Spread of “overhead,” fixed cost over bigger production. Labor specialization. Technology. Learning by doing Agglomeration economies.

LR Cost Curves

Note on International Trade What goods are produced and where? David Ricardo (1800’s) – comparative advantage. Heckscher & Ohlin ( ’s) – differences in factor endowments. Example: Developed countries export more capital intensive goods (cars, airplanes, etc…) and import from developing countries more labor intensive goods (clothing, agricultural products, etc…) Empirical studies.

Krugman’s Model Uses economies of scale to explain international trade. 1.Mass production decreases average cost (ES) 2.Consumers prefer diversity of products Each country specializes and then trades. This is how countries with similar factor endowments engage in trade (e.g. Japan sells Toyota to US, US sells GM to Germany, etc…)