Chapter 6 Supply The Cost Side of the Market
Market: Demand meets Supply • Demand: • Consumer • buy to consume • Supply: • Producer • produce to sell
Recall: demandwillingness vs. ability to consume • Willingness: satisfaction (total utility) • Ability: budget
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）
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
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
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
The Production Function • the relationship between the quantity of inputs a firm uses and the quantity of output it produces.
Inputs (Production Factors) Resources used in the production process • labor (L) • capital (K) • natural resources (N) • entrepreneurship (E)
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
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.
Production Function • Q = f (L, K, N, E) • A relationship between inputs and outputs, assuming technical efficiency.
Technical Efficiency • The maximum level of output is obtained from a given combination of inputs
Economic Efficiency • A given amount of output is produced using the combination of inputs that costs the least (at minimum cost)
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)
Recall: Sarah’s Total Utility from Ice Cream Consumption Figure 5.2, p.130 Based on table 5.1, p.129
Recall: Diminishing Marginal Utility for Sarah from ice-cream Figure 5.3, p. 131 Based on Table 5.2, p.130
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.
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.
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
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
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
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
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
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