1. PPA 723: Managerial Economics Study Guide: Production, Cost, and Supply

2. Managerial Economics, Study Guide Topics  Short-run product curves  Short-run cost curves  Short-run firm supply  Short-run market supply  Input mix decision  Long-run product curves  Long-run cost curves  Long-run firm supply  Long-run market supply

3. Managerial Economics, Study Guide Short-Run Product Curves  Question:  If some inputs (usually capital) are fixed (i.e. in the short run), how much output can a firm produce from different quantities of a variable input (usually labor)?  Analytical Tools:  Total product curve  Average product curve  Marginal product curve  Key Concepts/Results  Law of diminishing marginal product (MP L eventually slopes downward)  MP L = AP L at minimum of AP L curve

4. Managerial Economics, Study Guide Short-Run Cost Curves  Question:  If some inputs (usually capital) are fixed (i.e. in the short run), how much does it cost to produce various levels of output by varying a variable input (usually labor)?  Analytical Tools:  Average fixed cost curve  Average variable cost curve  Average total cost curve  Marginal cost curve  Key Concepts/Results  Law of diminishing marginal productivity leads to upward sloping MC curve after some point  U-shaped AVC (usually) and U-shaped ATC (always)  MC = AVC at minimum of AVC  MC = ATC at minimum of ATC

5. Managerial Economics, Study Guide Short-Run Firm Supply  Question:  If some inputs (usually capital) are fixed (i.e. in the short run), what is the most profitable level of output for the firm to produce?  Analytical Tools:  Average variable cost curve  Marginal cost curve  In a competitive market, marginal revenue = market price = P  Key Concepts/Results  The firm shuts down (supply = 0) if P < minimum of AVC curve.  If P > minimum of AVC curve, the firm sets P = MC, which implies that the MC curve is the supply curve.

6. Managerial Economics, Study Guide Short-Run Market Supply  Question:  What does the market supply curve look like in the short run?  Analytical Tools:  SR firm supply curve  Number of firms  Key Concepts/Results  The SR market supply curve is the horizontal summation of the firm supply curves for the firms in the market.  The more firms in the market, the more elastic the SR market supply curve.

7. Managerial Economics, Study Guide Long-Run Product Curves  Question:  If all inputs are variable (i.e. in the long run), how much output can a firm produce from combinations of inputs?  Analytical Tools:  Isoquant  Key Concepts/Results  Isoquants have the same properties as indifference curves, i.e. higher isoquants indicate more product, isoquants cannot slope upward, and isoquants cannot cross.  The slope of an isoquant is MP L /MP K (with L on the horizontal axis).  Constant returns to scale exist if product doubles when inputs double.  Economies [diseconomies] of scale exist if product more than doubles [less than doubles] when inputs double.

8. Managerial Economics, Study Guide The Input-Mix Decision  Question:  What is the least expensive input combination for producing a given output?  Analytical Tools:  Isoquants  Isocost lines  Key Concepts/Results:  The least expensive input combination is at the tangency between an isocost line and the relevant isoquant.  The slope of an isocost line is the wage rate over the capital rental rate = w/r (with labor on the horizontal axis).  The least cost combination is where MP L /w = MP K /r, that is, where each input has the same MP per dollar of cost.

9. Managerial Economics, Study Guide Long-Run Cost Curves  Question:  If all inputs are variable (i.e. in the long run), how much does it cost to produce various levels of output?  Analytical Tools:  Expansion path  Long-run average cost curve  Long-run marginal cost curve  Key Concepts/Results  Expansion path (from input-mix diagram) indicates the cost of every output at the optimal input mix, i.e. the long-run cost curve.  LR MC = LR AC at minimum of LR AC  SR cost  LR cost

10. Managerial Economics, Study Guide Long-Run Firm Supply  Question:  If all inputs are variable (i.e. in the long run), what is the most profitable level of output for the firm to produce?  Analytical Tools:  LR AC curve  LR MC curve  In a competitive market, marginal revenue = market price = P  Key Concepts/Results  The firm shuts down (supply = 0) if P < minimum of LR AC curve.  If P > minimum of LR AC curve, the firm sets P = LR MC, which implies that the LR MC curve is the supply curve.

11. Managerial Economics, Study Guide Long-Run Market Supply  Question:  What does the market supply curve look like in the long run?  Analytical Tools:  LR firm supply curve  Entry and exit  Key Concepts/Results  Firms enter the market in response to economic profits and exit in response to losses—thereby altering the market price.  LR equilibrium exists when no firms have an incentive to enter or exit, i.e. when economic profits equal zero.  In LR equilibrium P = minimum LR AC  With free entry and exist, the same costs for all firms, and constant input prices, the LR supply curve is horizontal.