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Micro economics

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Microeconomics ­ECO402
VU
Lesson 16
Introduction
Our focus is the supply side.
The theory of the firm will address:
­ How a firm makes cost-minimizing production decisions
­ How cost varies with output
­ Characteristics of market supply
The Technology of Production
The Production Process
­ Combining inputs or factors of production to achieve an output
Categories of Inputs (factors of production)
­ Labor
­ Materials
­ Capital
Production Function:
­ Indicates the highest output that a firm can produce for every specified combination of
inputs given the state of technology.
­ Shows what is technically feasible when the firm operates efficiently.
The production functions for two inputs:
Q = F(K,L)
Q = Output, K = Capital, L = Labor
For a given technology
Isoquants
Assumptions
­ Food producer has two inputs
 Labor (L) & Capital (K)
Observations:
1) For any level of K, output increases with more L.
2) For any level of L, output increases with more K.
3) Various combinations of inputs produce the same output.
Isoquants
­ Curves showing all possible combinations of inputs that yield the same output
78
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Microeconomics ­ECO402
VU
Production Function for Food
Labor Input
Capitan Input
1
2
3
4
5
1
20
40
55
65
75
2
40
60
75
85
90
3
55
75
90
100
105
4
65
85
100
110
115
5
75
90
105
115
120
Production with Two Variable Inputs (L,K)
Capital
The Isoquant Map
per year
E
5
4
The isoquants are derived
from the production
function for output of
3
A
B
C
of 55, 75, and 90.
2
Q3 = 90
D
Q2 = 75
1
Q1 = 55
1
2
3
4
5
Labor per year
Input Flexibility
­ The isoquants emphasize how different input combinations can be used to
produce the same output.
­ This information allows the producer to respond efficiently to changes in the
markets for inputs.
The Short Run vs. long Run
­ Short-run:
 Period of time in which quantities of one or more production factors cannot be
changed.
 These inputs are called fixed inputs.
­ Long-run
 Amount of time needed to make all production inputs variable.
79
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Microeconomics ­ECO402
VU
Production with One Variable Input (Labor)
Amount
Amount
Total
Average
Marginal
of Labor (L)
of Capital (K)
Output (Q)
Product
Product
0
10
0
---
---
1
10
10
10
10
2
10
30
15
20
3
10
60
20
30
4
10
80
20
20
5
10
95
19
15
6
10
108
18
13
7
10
112
16
4
8
10
112
14
0
9
10
108
12
-4
10
10
100
10
-8
Observations:
1) With additional workers, output (Q) increases, reaches a maximum, and
then
decreases.
2) The average product of labor (AP), or output per worker, increases and
then
decreases.
Output
Q
AP =
=
Labor Input
L
3) The marginal product of labor (MP), or output of the additional worker,
increases rapidly initially and then decreases and becomes negative..
80
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Microeconomics ­ECO402
VU
Δ Output
ΔQ
MP  L =
=
Δ Labor Input
ΔL
Output
per
Month
D
112
Total Product
C
60
A: slope of tangent = MP (20)
B
B: slope of OB = AP (20)
C: slope of OC= MP & AP
A
10 Labor per Month
0
1
2
3
4
5
6
7
8
9
Output
Observations:
Left of E: MP > AP & AP is
per
increasing
Month
Right of E: MP < AP & AP is
decreasing
E: MP = AP & AP is at its maximum
30
Marginal
E
Average Product
20
10
0 1 2 3 4 5 6 7 8 9 10 Labor per Month
Observations:
­ When MP = 0, TP is at its maximum
­ When MP > AP, AP is increasing
­ When MP < AP, AP is decreasing
­ When MP = AP, AP is at its maximum
81
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Microeconomics ­ECO402
VU
AP = slope of line from origin to a point on TP, lines b, & c.
MP = slope of a tangent to any point on the TP line, lines a & c.
The Law of Diminishing Marginal Returns
Output
Output
per
per
Month
Month
D
112
30
C
E
20
60
B
10
A
Labor
Labor
0 1 2 3 4 5 6 7 8 9 10 per Month
0 1 2 3 4 5 6 7 8 9 10 per Month
­ As the use of an input increases in equal increments, a point will be reached at which
the resulting additions to output decreases (i.e. MP declines).
­ When the labor input is small, MP increases due to specialization.
­ When the labor input is large, MP decreases due to inefficiencies.
The Law of Diminishing Marginal Returns
­ Can be used for long-run decisions to evaluate the trade-offs of different plant
configurations
­ Assumes the quality of the variable input is constant
­ Explains a declining MP, not necessarily a negative one
­ Assumes a constant technology
The Effect of Technological Improvement
Output
Labor productivity
per
C
can increase if there
time
are improvements in
period
technology, even though
100
any given production
B
O3
process exhibits
diminishing returns to
labor.
A
O2
50
O1
Labor per
time period
0
1
2
3
4
5
6
7
8
9
10
82
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Microeconomics ­ECO402
VU
Malthus and the Food Crisis
Malthus predicted mass hunger and starvation as diminishing returns limited agricultural
output and the population continued to grow.
Why did Malthus' prediction fail?
Index of World Food Consumption Per Capita
Year
Index
1948-1952
100
1960
115
1970
123
1980
128
1990
137
1995
135
1998
140
The data show that production increases have exceeded population growth.
Malthus did not take into consideration the potential impact of technology which has allowed
the supply of food to grow faster than demand.
Technology has created surpluses and driven the price down.
Question
­ If food surpluses exist, why is there hunger?
Answer
­ The cost of distributing food from productive regions to unproductive regions and the low
income levels of the non-productive regions.
Labor Productivity
Total Output
Average Productivity =
Total Labor Input
Labor Productivity and the Standard of Living
­ Consumption can increase only if productivity increases.
­ Determinants of Productivity
 Stock of capital
 Technological change
83
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Microeconomics ­ECO402
VU
Labor Productivity in Developed Countries
United
United
France  Germany
Japan
Kingdom
States
Output per Employed Person (1997)
$54,507
$55,644
$46,048
$42,630
$60,915
Annual Rate of Growth of Labor Productivity (%)
1960-1973
4.75
4.04
8.30
2.89
2.36
1974-1986
2.10
1.85
2.50
1.69
0.71
1987-1997
1.48
2.00
1.94
1.02
1.09
Trends in Productivity
1) U.S. productivity is growing at a slower rate than other countries.
2) Productivity growth in developed countries has been decreasing.
Explanations for Productivity Growth Slowdown
1) Growth in the stock of capital is the primary determinant of the growth in
productivity.
2) Rate of capital accumulation in the U.S. was slower than other
developed countries because the
others were rebuilding after WWII.
3) Depletion of natural resources
4) Environment regulations
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Table of Contents:
  1. ECONOMICS:Themes of Microeconomics, Theories and Models
  2. Economics: Another Perspective, Factors of Production
  3. REAL VERSUS NOMINAL PRICES:SUPPLY AND DEMAND, The Demand Curve
  4. Changes in Market Equilibrium:Market for College Education
  5. Elasticities of supply and demand:The Demand for Gasoline
  6. Consumer Behavior:Consumer Preferences, Indifference curves
  7. CONSUMER PREFERENCES:Budget Constraints, Consumer Choice
  8. Note it is repeated:Consumer Preferences, Revealed Preferences
  9. MARGINAL UTILITY AND CONSUMER CHOICE:COST-OF-LIVING INDEXES
  10. Review of Consumer Equilibrium:INDIVIDUAL DEMAND, An Inferior Good
  11. Income & Substitution Effects:Determining the Market Demand Curve
  12. The Aggregate Demand For Wheat:NETWORK EXTERNALITIES
  13. Describing Risk:Unequal Probability Outcomes
  14. PREFERENCES TOWARD RISK:Risk Premium, Indifference Curve
  15. PREFERENCES TOWARD RISK:Reducing Risk, The Demand for Risky Assets
  16. The Technology of Production:Production Function for Food
  17. Production with Two Variable Inputs:Returns to Scale
  18. Measuring Cost: Which Costs Matter?:Cost in the Short Run
  19. A Firmís Short-Run Costs ($):The Effect of Effluent Fees on Firmsí Input Choices
  20. Cost in the Long Run:Long-Run Cost with Economies & Diseconomies of Scale
  21. Production with Two Outputs--Economies of Scope:Cubic Cost Function
  22. Perfectly Competitive Markets:Choosing Output in Short Run
  23. A Competitive Firm Incurring Losses:Industry Supply in Short Run
  24. Elasticity of Market Supply:Producer Surplus for a Market
  25. Elasticity of Market Supply:Long-Run Competitive Equilibrium
  26. Elasticity of Market Supply:The Industryís Long-Run Supply Curve
  27. Elasticity of Market Supply:Welfare loss if price is held below market-clearing level
  28. Price Supports:Supply Restrictions, Import Quotas and Tariffs
  29. The Sugar Quota:The Impact of a Tax or Subsidy, Subsidy
  30. Perfect Competition:Total, Marginal, and Average Revenue
  31. Perfect Competition:Effect of Excise Tax on Monopolist
  32. Monopoly:Elasticity of Demand and Price Markup, Sources of Monopoly Power
  33. The Social Costs of Monopoly Power:Price Regulation, Monopsony
  34. Monopsony Power:Pricing With Market Power, Capturing Consumer Surplus
  35. Monopsony Power:THE ECONOMICS OF COUPONS AND REBATES
  36. Airline Fares:Elasticities of Demand for Air Travel, The Two-Part Tariff
  37. Bundling:Consumption Decisions When Products are Bundled
  38. Bundling:Mixed Versus Pure Bundling, Effects of Advertising
  39. MONOPOLISTIC COMPETITION:Monopolistic Competition in the Market for Colas and Coffee
  40. OLIGOPOLY:Duopoly Example, Price Competition
  41. Competition Versus Collusion:The Prisonersí Dilemma, Implications of the Prisoners
  42. COMPETITIVE FACTOR MARKETS:Marginal Revenue Product
  43. Competitive Factor Markets:The Demand for Jet Fuel
  44. Equilibrium in a Competitive Factor Market:Labor Market Equilibrium
  45. Factor Markets with Monopoly Power:Monopoly Power of Sellers of Labor