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McGill University
Economics (Arts)
ECON 208
Wendy Dickinson

Chapter 7Producers in the Short Run10192011 14300 PM 71 What are Firms Single Proprietorshiphas one owner manager who is personally responsible for all aspects of the business including its debtOrdinary Partnershiphas 2 joint owners each of whom is personally responsible for all partnerships debtsLimited Partnershiptake no part in running of business and liability is limited to amount they investo Less common Corporationfirm regarded in law as having an identity of its ownowners are not personally responsible for anything done in firms nameState Owned Enterpriseowned by gov but usually under direction of a more or less independent state appointed boardNon Profit Organizationprovide goods or services to customers but having any profits that are generated remain with org and not claimed by individs Financing of FirmsEquityfunds provided by owners of the firmDebtfunds borrowed from creditors outside firm Goals of firms2 assumptions o Firms want to maximize profitIf not someone else will buy the firm out o Each firm is assumed to be a single consistent decisionmaking unitNo worries for internal company politics 72 Production costs and profitsProduction o 4 types in inputs for productionIntermediate productsie steel girders Inputs provided directly by natureie landInputs provided directly by peopleie labor servicesInputs provided by the services of physical capital ie machines o Production Function relates inputs to outputsDescribes technological relationship between inputs that firm uses and output it producesOutputfLKLinput of laborK input of capitalProduction is a flow number of units per period of timeCost and Profits o Economic profit includes implicit and explicit costs o Economic profit includes the implicit opportunity cost of owners time and capital in the firms cost o So economic cost are less than accounting profits o If economic profit is positive then owners capital earning more than it could in its next best alternative useProfit Maximizing Output o Firms econ profits is equal to total revenue minus total costProfit piTR total revenueTC total costTime horizons for Decision Making o The short run is a length of time over which some of the firms factors of production are fixedTypically capital is fixed in the short run o The long run is the length of time over which all of the firms factors of production can be varied but its technology is fixed o The very long run is the length of time over which all of the firms factors of production and technology can be varied 73 Production in the Short RunTotal average and marginal products o Total product TP is total amount of output that is produced during a given period of time o Average product AP is the total product divided by the number of units of the variable factor used to produce it usually thought of as laborAPTPLabor o Marginal product MP of labor is MPTPLaborMP is slope of TP curveDiminishing Marginal Product o The law of diminishing returnAs workers are added to a production process each can specialize on one task and the workers marginal product initially risesBut if there is a fixed amount of physical capita eventually the marginal product is likely to fallTotal amount of workers is reachedThe AverageMarginal Relationship o If an additional workers output raises the AP MPAP o If marginal workers output reduces AP MPAP o Just as simple as it seems o AP curve slope is positive as long as MP curve is above itMP curve must intersect AP curve at its maximum point 74 Costs in the Short RunDefining Short Run costs o Total CostTotal fixed cost amount of capital machinerytotal variable cost like workersIf you divide by quantity you get average everything o Marginal Cost MC is increase in total cost resulting from increasing the output by one unitMCTCQ o Because fixed costs dont vary with output only part of TC that changes is Variable cost o Average Fixed cost declines steadily as output risesCalled spreading the overheadShape of ATC curve o Falling AFC average fixed cost tends to push down ATC o Rising MC and thus AVC tends to push up ATC
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