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Chapter 13

Chapter 13.docx

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David Gray

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Chapter 13- The Costs of Production - New unit of the course called the theory of the firm (go to duolingo to learn a game) - Related to the supply side of the market Some definitions: - Profits = total revenue – total costs = P*Q – total costs - Costs composed of payments to the factors of production - Explicit costs are out-of-pocket, ‘forkit-over’ costs - payroll, rent, capital costs, taxes, utilities - Implicit costs are opportunity costs associated with a firm’s inputs that do not require an outlay of money - Value of the firm’s inputs in alternative uses opportunity cost of the entrepreneur’s time - The going rate of return on capital, which could have been earned had the firm’s capital been invested elsewhere - what the land could have earned in another use - Accounting Profits versus economic profits - They involve different notions of COST … The basic idea: The bottom line for an economist is NOT the bottom line for an accountant ... accounting profits = TR - explicit costs - economic profits = total revenue – explicit costs - implicit costs - In other words, for economic profits, one takes account of the value of the firm’s resources in alternative uses - economic profit < accounting profit - the fundamental notion from an economic point of view is not the size of the ‘bottom line’, but rather resource allocation. - How do the activities of this firm stack up against alternative uses for its inputs? - In other words, all choices are relative to some benchmark - if economic profits > 0, resources are being used such that the return exceeds that of other uses - if economic profits < 0, resources are being used such that the return is lower than that in other uses - It is possible that the firm is still solvent - if economic profits = 0, the return on inputs is the same as it would be in other uses - We assume that the firm’s objective is to maximize profits, which (theoretically) go to the stockholders - These days well-known firms are laying off workers not because they are facing bankruptcy, but rather to boost ‘shareholder value’ - Is that what firms SHOULD do? Should they downsize and outsource? o A normative question o Some say YES - that yields the superior economic outcome. “Survival of the fittest!” Page 1 of 6 o Some say NO - a firm must exemplify “corporate responsibility” and avoid causing economic dislocation wherever and whenever possible Production function: start with the technology of production - Output = f (land, labour, capital) o also called total product (TP) - like the PPF of chapter 3 - As the production level increases (decreases), the utilization of a variable factor increases (decreases) - energy, raw materials, labour (mostly) - As the production level increases or decreases, the utilization of a fixed factor does not change o insurance services, plant building - Simplify the TP function so that only one variable factor is considered. o TP = Q = f (labour) - The positive slope in figure 13.2 means that as the amount of labour applied increases, so does output - A greater number of hours means more output and vice versa - (Production function…. figure 13.2)  middle of page 3 Marginal product of labour: - marginal product = MP (labour) = Δ TP / Δ labour input. - It’s the increment to total output obtained by hiring one more unit of labour. - In continuous terms, MP = d (TP) / dL, the derivative of the TP function with respect to labour input - the contribution of the last worker hired - it usually varies with the amount of labour inputted (usually not constant) Diminishing Marginal Product (DMP): - As successive increments of a variable factor are applied to a fixed factor, the MP (> 0) of the variable factor declines o says nothing about negative MP - Prof. Larry Blume would leave students more confused than he found them, and was worse than useless - zero MP would be no contribution at all o coach McNertney was a bum - In figures 13-2, this is reflected in the slope of the production function, which is becoming flatter and flatter as labour input rises - Example of DMP: - suppose that we have three secretaries and three work stations Page 2 of 6 - Suppose that we start hiring more staff. Assume that they all have equal ability. o 4 people will work with 3 work stations. The fourth person will help… o 5 people will work with 3 work stations. The fifth person will not be much of a help, and will contribute less to the total output than the fourth worker did, and so forth - In long run, more work stations can be added, and then DMP no longer applies - DMP applies in the short run only. We need a fixed factor, and in the long run all factors are variable. - These two product functions - the total product and the marginal product of labor, deal with the physical productivity o input related to output. - They are then used to derive the costs of production. Ultimate goal is to derive the S curve: Based primarily on the costs of production, which have 2 components: - the physical productivity of the production process (inputs related to output) - the prices for the input factors (land, labour, capital), which we have not covered yet. Transition from productivity to costs: - Distinction between the fixed costs and the variable costs of production o variable costs increase with the level of production o fixed costs remain constant with the level of production - In order to make the transition from the physical productivity to the costs of production, consider the following numerical illustration: - Suppose that the going wage for labour (the one variable factor) is $10 / hour - Suppose that the schedule for the marginal product of labour is: first worker = 10 units/hour; second worker = 10; third worker = 8; fourth worker = 7 - Given these figures, one can derive the costs of production, which are crucial to any business manager - The first worker hired produces 10 units per hour and costs the firm $10 to employ, so the labour cost PER UNIT OF OUTPUT = $10 / 10 = $1 - The second worker hired p
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