Chapter 5 The Firm Chapter 5 The Firm SHORT-RUN THEORY OF PRODUCTION Profits and the aims of the firm Profit maximisation Manager/Shareholder separation.

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Presentation transcript:

Chapter 5 The Firm Chapter 5 The Firm

SHORT-RUN THEORY OF PRODUCTION Profits and the aims of the firm Profit maximisation Manager/Shareholder separation Manager/Worker Capture Capital Market => Profit maximisation Profits and the aims of the firm Profit maximisation Manager/Shareholder separation Manager/Worker Capture Capital Market => Profit maximisation

SHORT-RUN THEORY OF PRODUCTION So first objective: Produce as efficiently as possible What is maximum output per worker So first objective: Produce as efficiently as possible What is maximum output per worker

Wheat production per year from a particular farm (tonnes)

Wheat production per year from a particular farm Number of farm workers Tonnes of wheat produced per year Number of workers TPP

Wheat production per year from a particular farm Number of farm workers Tonnes of wheat produced per year TPP TPP=Total Physical Product

Next, we are interested in the Marginal Physical Product:Next, we are interested in the Marginal Physical Product: This is the additional output gained as a result of employing one more worker (or unit of Labour or other inputs)This is the additional output gained as a result of employing one more worker (or unit of Labour or other inputs)

Wheat production per year from a particular farm (tonnes)

Wheat production per year from a particular farm Number of farm workers Tonnes of wheat produced per year TPP MPP=  TPP/  L = 7/1  TPP = 7  L = 1 And MPP = Slope of the TPP curve

Wheat production per year from a particular farm Number of farm workers (L) Tonnes of wheat per year TPP Tonnes of wheat per year Number of farm workers (L)  TPP = 7  L = 1 MPP =  TPP /  L = 7

Number of farm workers (L) Tonnes of wheat per year TPP Tonnes of wheat per year Number of farm workers (L)  TPP = 7  L = 1 MPP =  TPP /  L = 7

Tonnes of wheat per year TPP Tonnes of wheat per year MPP MPP =  TPP /  L Number of farm workers (L) Number of farm workers (L)

Tonnes of wheat per year TPP Tonnes of wheat per year APP MPP b Diminishing returns set in here Number of farm workers (L) Number of farm workers (L) b

Tonnes of wheat per year TPP Tonnes of wheat per year APP MPP b Maximum output occurs here Number of farm workers (L) Number of farm workers (L) b

SHORT-RUN THEORY OF PRODUCTION Long-run and short-run production: – –Here changing only one factor of production at a time The law of diminishing returns Long-run and short-run production: – –Here changing only one factor of production at a time The law of diminishing returns

Tonnes of wheat per year TPP Tonnes of wheat per year MPP MPP =  TPP /  L Number of farm workers (L) Number of farm workers (L)

SHORT-RUN THEORY OF PRODUCTION Long-run and short-run production: – –Here changing only one factor of production at a time The law of diminishing returns Fixed and variable factors Fixed Factors: – –Factory – –Equipment Variable Factors: – –Labour – –Raw materials, electricity etc Long-run and short-run production: – –Here changing only one factor of production at a time The law of diminishing returns Fixed and variable factors Fixed Factors: – –Factory – –Equipment Variable Factors: – –Labour – –Raw materials, electricity etc

Average Physical Product The next concept we are interested in is Average ProductThe next concept we are interested in is Average Product That is, the average output per workerThat is, the average output per worker (per year)(per year)

Wheat production per year from a particular farm (tonnes)

How would we represent the average on a diagram?How would we represent the average on a diagram? Average= Height of TPP/Length of L

Wheat production per year from a particular farm Tonnes of wheat per year TPP Tonnes of wheat per year APP MPP b b d d Number of farm workers (L) Number of farm workers (L) Slope = TPP / L = APP c c

Wheat production per year from a particular farm Tonnes of wheat per year TPP Tonnes of wheat per year APP MPP b b d d Number of farm workers (L) Number of farm workers (L) Slope = TPP / L = APP c c Average rises and then falls

Wheat production per year from a particular farm Tonnes of wheat per year TPP Tonnes of wheat per year APP MPP b b d d Number of farm workers (L) Number of farm workers (L) Slope = TPP / L = APP c c How does the average compare with the marginal?

Wheat production per year from a particular farm Tonnes of wheat per year TPP Tonnes of wheat per year APP MPP b b d d Number of farm workers (L) Number of farm workers (L) Slope = TPP / L = APP c c At point c the Marginal = Average What about below c?

Wheat production per year from a particular farm Tonnes of wheat per year TPP Tonnes of wheat per year APP MPP b b d d Number of farm workers (L) Number of farm workers (L) Slope = TPP / L = APP c c What about above c?

Wheat production per year from a particular farm Tonnes of wheat per year TPP Tonnes of wheat per year APP MPP b b d d Number of farm workers (L) Number of farm workers (L) Slope = TPP / L = APP c c

Wheat production per year from a particular farm Tonnes of wheat per year TPP Tonnes of wheat per year APP MPP APP = TPP / L Number of farm workers (L) Number of farm workers (L)

Relationship between average and marginal If the marginal is above the average,If the marginal is above the average, The average risesThe average rises If the marginal is below the average,If the marginal is below the average, The average fallsThe average falls If the marginal is the same as the average,If the marginal is the same as the average, The average stays the sameThe average stays the same

Relationship between average and marginal e.g. Ballroom Dancing Scores

Relationship between average and marginal Ballroom Dancing Scores

Relationship between average and marginal Ballroom Dancing Scores

Relationship between average and marginal Ballroom Dancing Scores

Relationship between average and marginal Ballroom Dancing Scores

Relationship between average and marginal Cricket Averages

Can see these rules in operation, here M> A, A UP etc Tonnes of wheat per year TPP Tonnes of wheat per year APP MPP APP = TPP / L Number of farm workers (L) Number of farm workers (L)

TPP tells us about Production PossibilitiesTPP tells us about Production Possibilities And MPP tells us the effect of hiring more workersAnd MPP tells us the effect of hiring more workers But need to translate production information into costs per unit of production.But need to translate production information into costs per unit of production. That way can compare cost of producing with revenue (price) from selling.That way can compare cost of producing with revenue (price) from selling.