1. Production and Costs Microeconomics - Dr. D. Foster $ $ $

2. Supply side of the market  Why firms exist.  Production and cost relationships.  Model of perfect competition.  Model of monopoly.  Regulation  Later: Monopolistic competition, oligopoly, game theory, factor markets, general equilibrium

3. Why do firms exist?  They combine resources to produce goods and services.  Why not use markets?  Transaction costs are high.  Role of managers - monitor workers to minimize shirking.  Chinese barge-pullers. maximize profit  Firm’s objective: maximize profit

4. Costs & Profits  All costs are “opportunity costs.”  Costs may be explicit or implicit.  Total cost = TC = all relevant costs.  (Economic) Profit = TR-TC –If positive, firms will enter. –If negative, firms will exit. –If zero, the market is stable.  Accounting profit may/will not equal Economic Profit. $

5. Short Run vs. Long Run  We are interested in the short run: At least one input is fixed  Fixed - capital; variable – labor  In the Long Run, all factors are variable.  Next - Production & Cost relationships

6. Production Relationships  From 0 to L 1 there are “increasing returns.”  From L 1 onwards, there are “diminishing marginal returns.”  After L 3 additional workers lower output. Why? L1L1 L3L3 Labor Output Total Product = TP (=Q)

7. Production Relationships L1L1 L3L3 Labor Output TP (=Q) Marginal Product = MP L2L2 Average Product = AP  Average Product = AP = TP/L; this shows how much the average worker adds to output.  Marginal Product = MP = ΔTP/ΔL; this shows how much the last worker (unit) adds to output.

8. Cost Relationships  As noted, TC = TFC + TVC  TFC is fixed, by definition.  TVC can be written as w*L, where w is the (constant) wage rate.  Average Fixed Cost, AFC = TFC/Q  Average Variable Cost, AVC = TVC/Q... or, = wL/Q = w/AP  As AP rises, AVC falls...  Average Total Cost, ATC = TC/Q = AFC + AVC $

9. Cost Relationships  Marginal Cost, MC = ΔTC/ΔQ or, can be written as = ΔTVC/ΔQ (Why?) … = Δ(wL)/ΔQ = w(ΔL)/ΔQ = w/MP AFC quantity (TP) AVC ATC MC $ $

10. Complete the Production and Cost Worksheets

11. Key Formulas MP = ΔTP/ΔL AP = TP/L TC = TFC + TVC TVC = w*L AFC = TFC/Q AVC = TVC/Q = wL/Q = w/AP ATC = TC/Q = AFC + AVC MC = ΔTC/ΔQ = ΔTVC/ΔQ = Δ(wL)/ΔQ = w(ΔL)/ΔQ = w/MP $

12. Production and Costs Microeconomics - Dr. D. Foster $ $ $