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Economics for CED. Noémi Giszpenc Spring 2004 Lecture 3: Micro: Supply February 24, 2004. First, a little expansion of Demand From Lecture 2: The proximate causes of demand. Tastes:. A. Effective Demand. Prices:. B. From Lecture 2: longer causal chains. Tastes:. A 1 A 2 A 3.

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economics for ced

Economics for CED

Noémi GiszpencSpring 2004Lecture 3: Micro: Supply

February 24, 2004

first a little expansion of demand from lecture 2 the proximate causes of demand
First, a little expansion of Demand From Lecture 2:The proximate causes of demand

Tastes:

A

Effective Demand

Prices:

B

Economics for CED: Lecture 3, Noémi Giszpenc

from lecture 2 longer causal chains
From Lecture 2: longer causal chains

Tastes:

A1 A2 A3

Effective Demand

Prices:

B1 B2 B3

Other: (e.g.laws)

C1 C2 C3

Economics for CED: Lecture 3, Noémi Giszpenc

a bigger picture
A bigger picture

Commercial persuaders

Wants and desires

Effective demands

Prices

Marketers’ perspective

Economics for CED: Lecture 3, Noémi Giszpenc

an even bigger picture
An even bigger picture

Nature, Law, Culture, Home & School, other persuaders

Commercial persuaders

Wants and desires

Effective demands

Provident or improvident uses of the environment

Prices

Environmentalists’ perspective

Economics for CED: Lecture 3, Noémi Giszpenc

an even bigger picture1

Deprivation, anxiety, unhappiness, bad behavior

An even bigger picture

Nature, Law, Culture, Home & School, other persuaders

Unsatisfied desires

Commercial persuaders

Wants and desires

Effective demands=satisfied desires

Fit or misfit between wants generated and wants satisfied

Prices

Sociologists’, social psychologists’ perspective

Economics for CED: Lecture 3, Noémi Giszpenc

an even bigger picture2

Deprivation, anxiety, unhappiness, bad behavior

An even bigger picture

Few households own capital

Unsatisfied desires

Commercial persuaders

Wants and desires

Bargaining strengths

Effective demands

Incomes

HH rewards =firms’ costs of production

Prices

Many households contribute labor

Left economists’ perspective

Economics for CED: Lecture 3, Noémi Giszpenc

slide8

Nature, Law, Culture, Home & School, other persuaders

Deprivation, anxiety, unhappiness, bad behavior

Few households own capital

Unsatisfied desires

Commercial persuaders

Fit or misfit between wants generated and wants satisfied

Wants and desires

Bargaining strengths

Effective demands

Incomes

HH rewards =firms’ costs of production

Prices

Provident or improvident uses of the environment

Many households contribute labor

Broad economists’ perspective

Economics for CED: Lecture 3, Noémi Giszpenc

can even that picture be broadened
Can even that picture be broadened?

“Sixto Roxas, a Filipino economist, argues that the main problem with conventional economics is that it focuses its analysis on the interests of the individual and the firm rather than those of the family and the community. ‘Neo-classical economics is not just a mathematical framework or analytical guideline to facilitate the understanding of reality: it is a full-fledged ideology and design for remaking the world,’ he says… People are reduced to flesh-and-blood machines that earn wages and salaries and generate profits but whose non-economic existence is not recognized.” [emphasis added]

Economics for CED: Lecture 3, Noémi Giszpenc

now on to supply
Now, on to supply
  • Who produces for the market? Firms.
    • Households and Government are also producers, but not for the market
  • Relations between producers:
    • Organized relations (within-firm)
    • Market relations (beyond firm)
      • Ex: Restaurant owner organizes menu, shoppers, cooks, and waiters
      • But goes to market for meat, vegetables supplied by farmers, truckers, and shopkeepers

Economics for CED: Lecture 3, Noémi Giszpenc

firms purposes 1
Firms’ purposes (1)
  • Maximize profit, silly
  • Remember, profits = revenue - costs
  • Or π = PxQ - C(Q)
  • Assume firm’s Q has no effect on P (for now)
  • So main focus is effect of Q on C

Economics for CED: Lecture 3, Noémi Giszpenc

another way to see profit
Another way to see profit

Rev=3Q

Cost=5+Q2/4

And π=Rev-Cost

At what point is profit maximized? What is the slope of the cost curve?

Economics for CED: Lecture 3, Noémi Giszpenc

firms costs
Firms’ costs
  • (Do not include all costs--i.e., external)
  • In the “short run” means during the time that you cannot replace existing fixed K
    • What is the most economical way to use existing fixed K (capital): or, how to produce goods at least cost?
      • A dual problem: productivity (subject to diminishing marginal returns) and costs

Economics for CED: Lecture 3, Noémi Giszpenc

first costs a few simple definitions
First, costs: a few simple definitions
  • Total costs
    • All the accrued costs of producing
  • Average cost
    • Total cost divided by number of units produced
  • Marginal cost
    • Additional cost of producing the last unit

Economics for CED: Lecture 3, Noémi Giszpenc

let s produce some widgets
Let’s produce some widgets!
  • Typical good produced in economics classes.
  • Nobody knows what they are, really.
  • At left, a drawing of a widget by Leonardo da Vinci.

Economics for CED: Lecture 3, Noémi Giszpenc

a numerical example
A numerical example

Economics for CED: Lecture 3, Noémi Giszpenc

the example graphed
The example graphed

Economics for CED: Lecture 3, Noémi Giszpenc

marginal cost drives tc and ac
Marginal cost drives TC and AC
  • Marginal cost is always positive: total cost is always rising
  • If marginal cost < average cost, then marginal cost is pulling average cost down
  • If marginal cost > average cost, then marginal cost is pulling average cost up

Economics for CED: Lecture 3, Noémi Giszpenc

what happens to profits
What happens to profits?
  • Assume the price for output sold is $6

Economics for CED: Lecture 3, Noémi Giszpenc

information from costs
Information from Costs
  • All three cost measures show that biggest total profit comes from producing 4 units.
  • Only marginal cost shows when firm is actually losing, and how much.
  • Rule: Produce until MC = price
    • This will give us the supply curve

Economics for CED: Lecture 3, Noémi Giszpenc

types of costs
Types of costs
  • Fixed: can’t be altered at short notice
    • Factory, equipment, salaried staff
    • Also called sunk costs, overheads
    • Predictable economies of scale
      • average fixed cost per unit output declines w/ Q
  • Variable: can vary w/ Q of output
    • Raw materials, fuel, temp workers
    • May not vary evenly

Economics for CED: Lecture 3, Noémi Giszpenc

costs fixed variable
Costs = Fixed + Variable
  • Total Costs: C(Q) = F + V(Q)
  • Average Costs: AC = (F + V(Q) ) ÷ Q
    • Average Fixed costs = F ÷ Q
    • Average Variable costs = V(Q) ÷ Q
  • Marginal Costs: MC = d(F+V(Q))/dQ
    • Fixed costs have no effect on MC

Economics for CED: Lecture 3, Noémi Giszpenc

some cost curves
Some cost curves

TC

TC

VC

AC

MC=AC=1

MC=AVC

AFC

F = 0, V(Q) = Q

F = 1, V(Q) = Q

Economics for CED: Lecture 3, Noémi Giszpenc

another cost curve u shaped
Another cost curve: “U-shaped”

V(Q)=(Q/3-2)2

Economics for CED: Lecture 3, Noémi Giszpenc

yet another cost curve very high fixed costs low mc
Yet another cost curve: very high fixed costs, low MC

TC

F=100V(Q)=Q/100

MC

Economics for CED: Lecture 3, Noémi Giszpenc

a counter intuitive result
A counter-intuitive result
  • If a firm has fixed costs, and if it can keep meeting its variable costs, it should keep producing regardless of whether it is making a loss.
    • Making a little toward meeting fixed costs is better than making nothing at all
    • Explains success of early railroads despite lack of profitability--they just kept chugging!

Economics for CED: Lecture 3, Noémi Giszpenc

now productivity diminishing returns
Now, productivity: diminishing returns
  • Holding other factor(s) of production fixed, increasing a factor eventually adds less and less output
    • Not all producers encounter rising costs and diminishing returns as output increases
      • Some producers don’t get demand for that level of volume
      • Some factors of production have fixed capacity
        • Beyond limit, no production at all
      • Some factors of production are variable (can vary in proportion to each other)

Economics for CED: Lecture 3, Noémi Giszpenc

production function
Production Function
  • In general, Production is the transformation of inputs into outputs.
    • Inputs are the factors of production -- land, labor, and capital -- plus raw materials and business services.
  • A production function -- f(L,K, etc.)=q -- describes how combinations of inputs produce output (given a certain technology)
    • We saw a production function in first class

Economics for CED: Lecture 3, Noémi Giszpenc

average and marginal productivity
Average and marginal productivity
  • Productivity is ratio of output to input
  • Average productivity is total output divided by total input
  • Marginal productivity is increase in output with addition of last unit of input
    • With all other inputs held steady (cet. par.)

Economics for CED: Lecture 3, Noémi Giszpenc

a numerical example farmer ted
A numerical example: farmer Ted

Economics for CED: Lecture 3, Noémi Giszpenc

output diagram
Output Diagram
  • As the variable input increases, output increases at a decreasing rate.
  • This is the Law of Diminishing Marginal Productivity

Economics for CED: Lecture 3, Noémi Giszpenc

average and marginal productivity1
Average and marginal productivity
  • Marginal productivity is decreasing and pulling average productivity down.

Economics for CED: Lecture 3, Noémi Giszpenc

what happens to profits1
What happens to profits?
  • Assume:
    • cost of variable input fixed (wage rate of farmer=opportunity cost of working elsewhere), and
    • price of good produced fixed (price of wheat determined by world markets)
  • Profits ≈ revenue - costs = PxQ - C(Q) =Pxf(L,K) - C(L,K) for given L,K

Economics for CED: Lecture 3, Noémi Giszpenc

the relationship will look like this
The relationship will look like this
  • As labor input increases, output does not increase as fast.
  • Cost of labor input goes up steadily but return, or value of marginal product slows down

Economics for CED: Lecture 3, Noémi Giszpenc

how to maximize profit
How to maximize Profit
  • What does one additional labor unit add to cost? w = wage
  • What does one additional labor unit add to revenue? p*MP = value of marginal product
  • Profit is max’ed when p*MP = w

Economics for CED: Lecture 3, Noémi Giszpenc

costs and types of firms
Costs and types of firms
  • Natural monopolies
    • Ex: power & gas, water & sewerage, canals & RR
  • Continually increasing returns to scale
    • Big firms out-compete small firms
    • Ex: steel, machine-making, petro-chemicals
  • U-shaped costs
    • Medium-sized firms
    • Ex: house-building, furniture-making, textiles

Economics for CED: Lecture 3, Noémi Giszpenc

costs and types of firms1
Costs and types of firms
  • Constant unit costs
    • Can be big or small
    • Ex: book publishing, brewing, wineries
  • Diseconomies of scale
    • Small firms have lower unit costs than big
    • Ex: tailoring, repair, individual arts, some farming
  • Each type of industry has different temptations and remedies

Economics for CED: Lecture 3, Noémi Giszpenc

firms purposes 2
Firms’ purposes (2)
  • Working and managing for owners
    • When firms were mostly sole propietorships
    • Maximizing profit or return on equity
  • Directors’ purposes
    • In 20th C., more separation of ownership and control
    • Adolf A. Berle and Gardner C. Means, The modern corporation and private property (1932)
    • What are the directors going to do?

Economics for CED: Lecture 3, Noémi Giszpenc

berle and means 3 alternatives
Berle and Means: 3 alternatives
  • Directors maximize owners’ π
    • but own π motive weakened
  • Manage for their own benefit
    • Just enough π paid out to comply with law, attract K
    • Keeps π motive but leads to corp. plunder
  • Manage for good of all society
    • Purely neutral technocracy

Economics for CED: Lecture 3, Noémi Giszpenc

slide40

“The state seeks in some aspects to regulate the corporation, while the corporation, steadily becoming more powerful, makes every effort to avoid such regulation.”

Berle and Means (1932)

Economics for CED: Lecture 3, Noémi Giszpenc

firms are responsible to
Firms are responsible to…
    • (Can’t survive without any of the below)
  • Owners
  • Creditors
  • Employees
  • Customers
  • Community
  • Local & National government

Economics for CED: Lecture 3, Noémi Giszpenc

firms policy choices
Firms’ policy choices
  • Profit: maximize, moderate, or (for tax purposes) minimize?
  • Short, medium, or long-term profit?
  • How to divide profit between dividends and reinvestment in growth?
  • Aim for big revenue, market share, profit, profit/sales, profit/equity?
  • Stability or growth? Safety or risk?
  • Working conditions? Neighborliness?
  • Sketchiness: offshore taxes, unsavory partners, bribery?

Economics for CED: Lecture 3, Noémi Giszpenc