Transcript Presentation 1- Producer Decision Making

Producer Decision Making
Frederick University
2013
Producer Decision Making
The firm
Profit = total revenues – total cost
Production
Inputs
Labor
Land
Capital
Process
Product or
service
generated
– value added
Output
Production Function
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The relationship between inputs and outputs is stated
by the PRODUCTION FUNCTION
Inputs – the factors of production classified as:

Land – all natural resources of the earth
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
Labour – all physical and mental human effort involved in
production
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Price paid to acquire land = Rent
Price paid to labour = Wages and salaries
Capital – buildings, machinery and equipment not used for
its own sake but for the contribution it makes to production

Price paid for capital = Interest
Production Function


Mathematical representation of the
relationship:
Q = f (L,N,K)
Output (Q) is dependent upon the
amount of capital (K), Land (N) and
Labour (L) used
Economic and Accounting
Costs
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Costs vs. expenditures
Opportunity cost
Explicit and implicit cost
Sunk cost
Depreciation
Economic cost vs. Accounting
cost – an example
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One year ago, Tom and Jerry set up a vinegar bottling firm
(called TJVB).
Tom and Jerry put €50,000 of their own money into the firm.
(They used this money to pay for equipment, labor, etc.)
They rented equipment for € 30,000;
They hired one employee to help them for an annual wage of
€ 20,000;
Tom gave up his previous job, at which he earned € 30,000,
and spent all his time working for TJVB;
Jerry kept his old job, which paid € 30 an hour, but gave up
10 hours of leisure each week (for 50 weeks) to work for
TJVB;
The prevailing interest rate was 10%
The cash cost of TJVB (for raw materials and like) were
€ 10,000 for the year.
Economic cost vs. Accounting
cost – an example
Explicit costs
30000+20000+10000 = 60000
Implicit costs
30000+10x50x30+10%x50000
=30000+15000+5000 = 50000
Accounting costs
60000 = explicit cost
Economic costs
60000+50000=110000
Implicit cost +explicit
cost
Economic and Accounting
Profit
Accounting profit =
TR – accounting cost
 Economic profit =
TR – economic cost
 Normal profit
= implicit cost
= the profit that might be earned elsewhere

Technological choice
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Technology – a way of putting
resources together
Efficient technology vs. inefficient
technology
Technological choice and
consumer choice
Consumer choice
MUa/Pa = MUb/Pb
The firm as a consumer:
MUL/PL = MUK/Pk
Technological choice
MPL/PL = MPK/Pk
Analysis of the production
function
Short run
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Short run
There is at least one fixed factor
Firm’s decisions are constrained by the
fixed factor
If the demand changes, the firm can
respond only by changing the quantity
of output, not the scale of production
short run
The Law of Diminishing Returns
total, average and marginal product
L
0
1
2
3
4
5
6
7
8
TPL
0
15
32
57
80
95
108
119
128
short run
The Law of Diminishing Returns
total, average and marginal product
L
0
1
2
3
4
5
6
7
TPL
0
15
32
57
80
95
108
119
MPL
APL
15
17
25
23
15
13
11
15
16
19
20
19
18
17
Analysis of the Production
Function
long run
Long run
 All factors are variable
 The firm can change its production
capacity – the scale of production
Short-Run vs. Long-Run Costs
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Short run – Diminishing marginal
returns results from adding successive
quantities of variable factors to a fixed
factor
Long run – Increases in capacity can
lead to increasing, decreasing or
constant returns to scale
Returns to Scale
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RS = % change in the output : % change in
production factors
Economies of Scale
RS > 1
Constant Returns to Scale
RS = 1
Diseconomies of Scale
RS < 1
Short Run Costs
In buying factor inputs, the firm will incur
costs
Short run costs are classified as:
 Fixed costs
 Variable costs
Short-Run Costs
Q
0
1
2
3
4
5
6
7
8
FC VC TC = FC+ VC
10 0
10
10 6
16
10 11
21
10 14
24
10 16
26
10 21
31
10 27
37
10 35
45
10 46
56
Short run – there is at least one fixed factor
Fixed cost – does not vary with the output
Variable cost – directly related to variations in output
The Law of diminishing marginal returns
Short-Run Costs
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Total Cost - the sum of all costs
incurred in production
 TC = FC + VC
Average Cost – the cost per unit of
output
 AC = TC/Output
Marginal Cost – the cost of one more
or one fewer units of production
 MC = TCn – TCn-1 units
Short Run Costs
Marginal Costs
Q
0
1
2
3
4
5
6
7
8
FC
10
10
10
10
10
10
10
10
10
VC TC = FC+ VC MC =
0
10
6
16
11
21
14
24
16
26
21
31
27
37
35
45
46
56
ΔTC/Δ Q
6
5
3
2
5
6
8
11
Marginal costs
МС –Extra cost
involved in the
production of an
extra unit of output
Short-Run Costs
Q
0
1
2
3
4
5
6
7
8
FC
10
10
10
10
10
10
10
10
10
VC TC = FC+ VC AFC = FC/Q AVC= VC/Q AC = TC/Q MC = TC/ΔQ
0
10
6
16
10
6
16
6
11
21
5
5,5
10,5
5
14
24
3,3
4,7
8
3
16
26
2,5
4
6,5
2
21
31
2
4,2
6,2
5
27
37
1,7
4,5
6,12
6
35
45
1,4
5
6,4
8
46
56
1,25
5,75
7
11
Short-Run Costs
Q
0
1
2
3
4
5
6
7
8
FC
10
10
10
10
10
10
10
10
10
VC TC = FC+ VC AFC = FC/QAVC= VC/Q AC = TC/Q
0
10
6
16
10
6
16
11
21
5
5,5
10,5
14
24
3,3
4,7
8
16
26
2,5
4
6,5
21
31
2
4,2
6,2
27
37
1,7
4,5
6,12
35
45
1,4
5
6,4
46
56
1,25
5,75
7
The Revenues of the Firm
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Total Revenue
TR = P x Q
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Average Revenue
AR = P
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Marginal Revenue
MR = Δ TR/Δ Q
Profit
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Profit = TR – TC
The reward for enterprise
Profits help in the process of directing
resources to alternative uses in free
markets
Relating price to costs helps a firm to
assess profitability in production
Profit
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Normal Profit – the profit that might be
earned elsewhere (the minimum amount
required to keep a firm in its current line of
production)
Economic (Abnormal or Supernormal)
profit – profit made over and above normal
profit
The Profit of the Firm
Short Run
Long Run
Maximum Profit
Maximum Profit
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MC = MR
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P > AC
Minimum Loss
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MC = MR
P > AVC
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MC = MR
P > AC