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Chapter 6 Supply

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  1. Chapter 6 Supply The Cost Side of the Market

  2. Market: Demand meets Supply • Demand: • Consumer • buy to consume • Supply: • Producer • produce to sell

  3. Recall: demandwillingness vs. ability to consume • Willingness: satisfaction (total utility) • Ability: budget

  4. similarly: supplywillingness vs. ability to produce • Willingness: produce to sell for profit • Profit = total revenue – total cost = PxQ - TC • total production (Q) when P and C are given • Ability: cost (to pay for production factors)

  5. Recall: Consumer Decision-Making • The goal: to maximize Total Utility (willingness) by choosing: • the Optimal Quantities of goods and services to consume • subject to: (ability) • limited income • market prices of the goods and services


  6. similarly: Producer Decision-Making • The goal: to maximize Profit (willingness) • by choosing: • the Optimal Quantities of goods and services to produce • subject to: production cost (ability) • inputs • prices of inputs

  7. The goal for producers • Maximize profit • Profit = price of output x quantity produced - production cost • Price of output: • determined by market (not affected by single producer in perfectly competitive market) • Production cost: determined by • quantity of input based on quantity of output produced and technology applied • Input prices

  8. The Production Function • the relationship between the quantity of inputs a firm uses and the quantity of output it produces.

  9. Inputs (Production Factors) Resources used in the production process • labor (L) • capital (K) • natural resources (N) • entrepreneurship (E)

  10. Inputs: Fixed vs. Variable • Fixed input: • the level of its usage cannot be readily changed (the level of its usage does not change along with level of output) • An input whose quantity cannot be altered in the short run • Variable input: • the level of its usage may be readily changed (the level of its usage changes along withthe level of output) • An input whose quantity can be altered in the short run

  11. Short-run vs. Long-run • Short-run: • the period of time in which at least one input is fixed. • A period of time sufficiently short that at least some of the firm’s factors of production are fixed • Long-run: • the period of time in which all inputs are variable.

  12. Production Function • Q = f (L, K, N, E) • A relationship between inputs and outputs, assuming technical efficiency.

  13. Technical Efficiency • The maximum level of output is obtained from a given combination of inputs

  14. Economic Efficiency • A given amount of output is produced using the combination of inputs that costs the least (at minimum cost)

  15. Short-Run Production: some inputs are fixed • Total Product: Q = f (L, K, N, E) • Usually assume N and E given • Total Product of Labor: Q = f (L) (K, N, E fixed)

  16. TP Curve: Total Product

  17. Recall: Sarah’s Total Utility from Ice Cream Consumption Figure 5.2, p.130 Based on table 5.1, p.129

  18. Recall: Diminishing Marginal Utility for Sarah from ice-cream Figure 5.3, p. 131 Based on Table 5.2, p.130

  19. MP: Marginal Product • The marginal product of an input is the additional quantity of output that is produced by using one more unit of that input.

  20. TP Curve: Total Product

  21. Marginal Product of Labor Curve

  22. Diminishing Returns to an Input (diminishing marginal product) • diminishing returns to an input: an increase in the quantity of an input leads to a decline in the marginal product of that input, holding the levels of all other inputs fixed • Other things held constant, as more of a variable input is used in production, its marginal productivity will decline after a certain point.

  23. Recall: Key Points for Sarah’s example • TU first increases then max out and starts to decrease • TU increases at a slower pace • TU is maximized when MU=0 • MU is decreasing but positive when TU is increasing • MU is decreasing and negative when TU is decreasing • MU = 0 when TU is maximized

  24. similarly: • TP first increases then max out and starts to decrease • TP increases at a slower pace • TP is maximized when MP=0 • MP is decreasing but positive when TP is increasing • MP is decreasing and negative when TP is decreasing • MP = 0 when TP is maximized

  25. Total Product, Marginal Product, and the Fixed Input

  26. Short-Run Production: some inputs are fixed • Total Product: Q = f (L, K, N, E) • Total Product of Labor: Q = f (L) (K, N, E fixed) • Marginal Product of Labor: MPL= dQ / dL • Average Product of labor: APL=Q/L

  27. Short-Run Production:Q, AP, MP, and shift in Q

  28. K=1

  29. Production: one input • TP = Q = f(L,K,N,E) • When K,N,E fixed: SR • TP(L) = f (L) • AP(L) = TP(L) / L • MP(L) = dTP(L) /dL • MP is the slope of TP • TP maximized when MP = 0

  30. Short-Run Production: Summary • L=0 leads to Q=0 • when MP is increasing, Q is increasing at an increasing rate • when MP is decreasing, Q may still increase but at a decreasing rate • When MP=0, Q stop increasing and start decreasing (Q is maximized). • AP reaches its maximum when AP=MP

  31. Q MP>AP AP MP<AP AP MP<0 TP F MP=0 TP Max TP Ⅱ Ⅲ Ⅰ MP=AP AP Max E AP L 0 A B MP