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Lecture 5

# Lecture notes week 5

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University of Toronto Scarborough

Economics for Management Studies

MGEA02H3

Gordon Cleveland

Fall

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ECMA04H Week 5 We will finish up Elasticity and Excess Burden of an Excise Tax and then move on to Production, Productivity and Costs Production, productivity and costs Basic objective.understand diminishing marginal productivity and the shapes of typical cost curves in short run. Why?: to understand the supply curve. Decisions by firms about how much to producesupply. We assume that the objective of firms is to maximize profits! They hire labour and purchase (or rent) capital equipment and other inputs. These inputs combine together to produce output. Output is sold to earn a profit (or loss.) A simple story to motivate what this week is all about: Imagine that you and 4 other friends are in a lawn mowing business. You have only one lawnmower (fixed amount of capital). The following is the production function 1 workers + 1 lawnmower = 5 lawns per day 2 workers + 1 lawnmower = 9 lawns per day 3 workers + 1 lawnmower = 12 lawns per day 4 workers + 1 lawnmower = 14 lawns per day 5 workers + 1 lawnmower = 15 lawns per day The marginal product of labour (additional output from the additional worker) is 5 lawns for the first worker, 4 more for the second, 3 more for the third, 2 more for the fourth, and 1 more for the final worker The average product of labour is 5 lawns per worker when there is 1 worker, 4.5 lawns per worker when there are 2 workers, 4 lawns per worker when there are 3 workers, 3.5 lawns per worker when there are 4 workers, and 3 lawns per worker when there are 5 workers If the rental on the lawnmower costs $30 per day (cost of capital equipment) (fixed cost) and the wage paid to each worker is $50 per day (variable cost), then the cost of cutting the first 5 lawns is $30 + $50 = $80. The cost of cutting 9 lawns per day is $30 + 2*$50 = $130. The cost of cutting 12 lawns is $30 + 3*$50 = $180. The cost of cutting 14 lawns is $30 + 4*$50 = $230. And the cost of cutting 15 lawns per day is $30 + 5*$50 = $280. We can calculate the average cost per lawn, and the marginal cost per lawn (change in costs as output changes). L K Q = TP MPL APL TC AC MC 0 1 0 0 0 $30 1 1 5 5 5 $80 $16 $10 2 1 9 4 4.5 $130 $14.44 $12.50 3 1 12 3 4 $180 $15 $16.67 4 1 14 2 3.5 $230 $16.43 $25 5 1 15 1 3 $280 $18.67 $50 L = labour K = fixed costs Q = output MPL = marginal product of labour APL = average product of labour TC = total costs AC = TC Q = average cost per unit of output MC = dTC dq = marginal cost Draw the average cost and marginal cost curves. As long as there are fixed inputs (e.g., capital equipment) in the short run, the AC and MC curves will have these shapes. www.notesolution.com

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