ECO100Y1b.doc
Page 1 of 14
Lecture #9 – Monday, November 10, 2003
THEORY OF THE FIRM
• Firms want to maximize profits.
•
(
)
LKqq ,=.
Time Periods
• Very short run: both factors fixed. •
(
)
LKqq ,=
• Short run: one factor fixed. •
(
)
LKqq ,=
• Long run: two inputs vary. •
(
)
LKqq ,=
• Very long run: technology varies – the
function itself varies.
•
(
)
LKqq ,
ˆ
=
Relate to Costs of Production
•
(
)
LpKpqTCLK⋅+⋅=.
• In the short run, TVCTFCCost Variable TotalCost Fixed Total+=+=⋅+⋅=LpKpTCLKSR.
Short Run Productivity Curves
•
(
)
Labour ofProduct Total,== LKqq
SR
.
•
MP
AP
=
where AP is maximum.
• When AP is rising, MP is above it.
• When AP is falling, MP is below it.
L
APL
MPL
AP
MP
q
p
S
Firm Output
Input
(Production Function)
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ECO100Y1b.doc
Page 2 of 14
Lecture #10 – Monday, November 17, 2003
•
(
)
LKqTP
L
,=
•
L
TP
AP =
•
L
TP
MP∆
∆
=
COST CURVES
• TVCTFCLPKPTC
LKSR
+=⋅+⋅=
Example
LTC100$1500$ +×=
• U-shaped cost curves – Law of Diminishing (Marginal) Return
• q
TFC
AFC=
• q
TVC
AVC=
• AVCAFCSAC
q
TVC
q
TFC
q
TCSR+=⇔+=
SAC
MC
AC
MC
AVC
AFC
q
TP
AP
MP
L
L
AP
MP
TP
SAC
MC
AC
MC
L
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ECO100Y1b.doc
Page 3 of 14
PROFITS
• TCTR
−
=
π
Nature of Costs: Accounting Costs vs. Economic Costs
• Manager’s salary
• TR = $500000
• TC = $450000 – including $25000 manager’s salary.
• “Profits” = $50000
• Adjust: $25000
• Economic π: $25000
• Interest imputation adjustment
• Adjust $10000
• Economic π: $15000
• TCTR
−
=
π
– TC where every input paid its opportunity cost
• 0
=
π
– business making its proper return (normal rate of return)
• 0
>
π
– attractive, should go into business
• 0
<
π
– economic loss
PROFIT MAXIMIZATION
Produce or Not? Loss Minimization
QTVCTRProfits
0-$ -$ 100.00-$
1 2.00$ 10.00$ 92.00-$
2 4.00$ 20.00$ 84.00-$
3 6.00$ 30.00$ 76.00-$
•
As you produce more, you reduce the loss –
produce positive quantity.
QTVCTRProfits
0-$ -$ 100.00-$
1 20.00$ 10.00$ 110.00-$
2 40.00$ 20.00$ 120.00-$
3 60.00$ 30.00$ 130.00-$
•
As you produce more, you increase the loss –
produce nothing.
•
Produce when TVCTR
>
.
•
Rule #1: Produce when AVCp
q
TVC
q
TR>⇔>.
Profit Maximizing Quantity
•
Rule #2: For πmax, MCMR
=
INDUSTRY STRUCTURES
Monopoly: one firm Duopoly: two firms Oligopoly Monopolistic Competition Perfect Competition:
large number of firms
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