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Chapter 6

01:220:102 Chapter Notes - Chapter 6: Production Function, Economic Equilibrium, Fixed Cost

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Chapter 6: Sellers and Incentives
Key Ideas:
- The seller’s problem has three parts: production, costs, and revenues
- An optimizing seller makes decisions at the margin
- The supply curve reflects a willingness to sell a good or service at various price levels
- Producer surplus is the difference between the market price and the marginal cost curve
- Sellers enter and exit markets based on profit opportunities
6.1 Sellers in a Perfectly Competitive Market
- In a perfectly competitive market:
- No buyer or seller is big enough to influence the market price
- Sellers in the market produce identical goods
- There is free entry and exit in the market
- First and second are important because they ensure that agents are price-takers
- Sell/buy as much as they want at market price
6.2 The Seller’s Problem
- How do sellers decide what and how much to produce
- Three elements of seller’s problem
1. Making the goods
2. The cost of doing business
3. The rewards of doing business
Making the Goods: How Inputs Are Turned into Outputs
- Firm: business entity that produces and sells goods or services
- Production: process by which the transformation of inputs to outputs occur
- Relationship between quantity of inputs used and quantity of outputs produced is called
production function
- A firm relies on two inputs: packing cheese into boxes and physical capital

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- Physical capital: nay good, including machines and buildings used for production
- Short run: a period of time when only some of a firm’s inputs can be varied
- Labor
- Long run: a period of time when all of a firm’s inputs can be varied
- Fixed factor of production: input cannot be changed in short run
- Physical capital
- Variable factor of production: input that can be changed in the short run
- Labor (could fire and hire)
- Marginal product: the change in total output associated with using one more unit of input
- Only change in short run is to change the number of workers

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- Three
1. Marginal product increases with the first few workers
a. Specialization: workers developing a certain skill set in order to increase total productivity
i. Each worker has a specific job which completes the whole job
2. Marginal product eventually decreases with successive additions of workers
a. Law of diminishing returns: successive increases in inputs eventually leads to less additional
i. Idle time
3. Adding too many workers can actually decrease overall production
The Cost of Doing Business: Introducing Cost Curves
- Cost of production: what a firm must pay for its inputs
Total Cost = Variable cost + Fixed Cost
- Variable cost: cost of variable factors of production, which change along with a firm’s output
- Costs associated with workers and change the level of production
- Fixed cost: cost of fixed factors of production, which a firm must pay even if it produces zero output
- Structures and equipment
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