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Chapter 13

Chapter 13 Notes

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Ryerson University
ECN 104
Tsogbadral Galaabaatar

ECN104 – Chapter 13 Notes Chapter 13 Notes • Questions o What is a production function? What is marginal product? How are they related? o What are the various costs, and how are they related to each other and to output? o How are costs different in the short run vs. the long run? o What are the “economics of scale”? • Total Revenue, Total Cost, Profit o We assume that the firm’s goal is to maximize profit. o Profit = Total Revenue (the amount a firm receives from the sale of its output) – total cost (the market value of the inputs a firm uses in production) • Costs: Explicit vs. Implicit o Explicit costs: require an outlay of money  E.g., paying wages to workers o Implicit costs: do not require a cash outlay  E.g., the opportunity cost of the owner’s time o Remember one of the Ten Principles:  The cost of something is what you give up to get it o This is true whether the costs are implicit or explicit. Both matter for firms’ decisions o Example:  You need $100,000 to start your business  Interest rate is 5%  Case 1: • Borrow $100,000 • Explicit cost = $5000 interest on loan  Case 2: • Use $40,000 of your savings, borrow the other $60,000 • Explicit cost = $3000 (5%) interest on the loan • Implicit cost = $2000 (5%) foregone interest you could have earned on your $40,000  In both cases, total (explicit + implicit) costs equal $5000 • Economic Profit vs. Accounting Profit o Accounting profit = total revenue – total explicit costs o Economic profit = total revenue – total costs (including explicit and implicit costs) o Accounting profit ignores implicit costs, so its higher than economic profit • The Production Function o Shows the relationship between the quantity of inputs used to produce a good and the quantity of output of that good o It can be represented by a table, equation, or graph o Example:  Farmer Jack grows wheat  He has 5 acres of land  He can hire as many workers as he wants • Marginal Product o If Jack hires one more worker, his output rises by the marginal produce of labour o The marginal product of any input is the increase in output arising from an additional unit of that input, holding all other inputs constant o Marginal product of labour (MPL) = (Change in output) / (Change in labour) • Why MPL is Important o Recall one of the Ten Principles:  Rational people think at the margin. o When Farmer Jack hires an extra worker,  His costs rise by the wage he pays the worker  His output rises by MPL o Comparing them helps Jack decide whether he would benefit from hiring the worker • Why MPL diminishes o Farmer Jack’s output rises by a smaller and smaller amount for each additional worker. Why? o As Jack adds workers, the average worker has less land to work with and will be less productive o In general, MPL diminishes as Labour rises whether the fixed input is land or capital (equipment, machines, etc.) o Diminishing Marginal Product: the marginal product of an input declines as the quantity of the input increases (other things equal) • Example 1: Farmer Jack’s Costs o Farmer Jack must pay $1000 per month for the land, regardless of how much wheat he grows o The market wage for a farm worker is $2000 per month o So Farmer Jack’s costs are related to how much wheat he produces • Marginal Cost o Increase in Total Cost from producing one more unit o MC = (Change in Total Cost) / (Change in Output) • Why MC is Important o Farmer Jack is rational and wants to maximize his profit. To increase profit, should he produce more or less wheat? o To find the answer
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