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Chapter 7

Chapter 7. Behind the Supply Curve:. Recall: Optimal Consumer Behavior. Consumer Behavior (behind the demand curve): Consumption of G&S (Q) produces satisfaction Satisfaction measured as utility Budget as constraint. Optimal Consumer Behavior:. One product with no constraint

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Chapter 7

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  1. Chapter 7 Behind the Supply Curve:

  2. Recall: Optimal Consumer Behavior • Consumer Behavior • (behind the demand curve): • Consumption of G&S (Q) produces satisfaction • Satisfaction measured as utility • Budget as constraint

  3. Optimal Consumer Behavior: • One product with no constraint TU maximized when MU=0 • Two products, optimal consumption bundle MUx / Px = MUy / Py • Two products with budget constraintbudget line and indifference curves MUx / MUy = Px / Py = dY / dX

  4. Producer Behavior • Behind the supply curve: • Inputs produces outputs • Outputs measured as Q • Cost of inputs as constraint

  5. Optimal Producer Behavior: • One input with no constraint TP maximized when MP=0 • Two inputs, optimal input combination MPL / w = MPk / r • Two inputs with cost constraintIso-Cost lines and Iso-Quant Curves MPL / MPk = w / r = dK / dL

  6. K: was fixed and is variable--Long-Run: • The period of time in which all inputs are variable.

  7. Optimal Input Combination:Marginal Analysis • Given cost budget, buy L and K at MPL/w = MPK/r

  8. optimal choice with two variable inputs • Two inputs, both variable • Given input prices • Given cost • Iso-cost Line: a line that shows the various combinations of inputs that cost the same amount to purchase, given input prices.

  9. Characteristics of Iso-cost lines: • C=wL+rK • The slope of the Iso-cost curve is the negative of the relative input price ratio, -w/r. • A change in total cost will lead to a parallel shift of the Iso-cost curve. • A change in an input price will rotate the Iso-cost curve.

  10. Substitutability among Inputs • Variable Proportions Production: more than one combinations of inputs are possible (substitutions allowed) • Fixed proportions Production: only one combination of inputs is feasible (fixed ratio, no substitutions)

  11. Iso-quant: • a curve showing all possible combinations of inputs that would produce the same level of output.

  12. Characteristics of Iso-quant: • Downward sloping: to keep the same total product. • An infinite number of Iso-quants makes up an Iso-quant map. • The farther away from the origin, the higher the output level it represents.

  13. Characteristics of Iso-quant: (cont.) • No two curves can intersect: Completeness and Transitivity • Convex to origin: Diminishing marginal rate of technical substitution (MRTS)

  14. Marginal rate of Technical Substitution: MRTS • the rate at which one input is substituted for another along an Iso-quant • the slope of the Iso-quant • MRTS= - (dK/dL) • dQ=(MPL*dL)+(MPK*dK) since dQ=0, (MPL*dL)= - (MPK*dK) MPL/ MPK = - (dK / dL) MRTS= - (dK/dL) = MPL/MPK

  15. Optimization: Constrained Minimization • min C = wL + rK • s.t Q = f(L, K) by choosing L, K • Rule: cost of producing a certain level of output will be minimized when MRTS = - w/r

  16. Optimization (minimization):Marginal Product Approach • MRTS = MPL/MPK • cost is minimized when MRTS = - w/r • cost of producing a certain level of output will be minimized when MRTS=MPL/MPK=w/r, or (MPL/w)=(MPK/r)

  17. Optimization:Constrained Maximization • Max Q = f(L, K) • s.t. C = wL + rK by choosing L, K • Rule: MRTS = MPL/MPK = w/r or MPL/w = MPK/r

  18. Expansion Path: • A curve or locus of points that shows the cost-minimizing input combination for each level of output, holding input prices constant. • Each point on the path is both technically and economically efficient. • MRTS = w/r everywhere on the path.

  19. Return to Scale: Assume: Q = f(L, K) and zQ = f(cL, cK) • there is constant return to scale if z=c. • there is increasing return to scale if z>c. • there is decreasing return to scale if z<c.

  20. Long-run Costs • LTC = wL + rK • LAC = LTC/Q • LMC = ΔLTC/ΔQ

  21. LTC, LAC, & LMC

  22. LTC, LAC, & LMC LMC<LAC,LAC; LMC>LAC,LAC; LMC=LAC,LAC min. C LMC LAC Q

  23. (Internal) Economies of Scale • LAC decreases as output increases. --specialization and division of labor --technological factors

  24. (Internal) Diseconomies of Scale • LAC increases as output increases. --limitations to efficient management

  25. External Economy vs. External Diseconomy -industry development provides better transportation, information, and human resources. *competition causes higher costs

  26. Economies of Scope: • there is economies of scope if C(X, Y) < C(x) + C(Y), otherwise, there is diseconomies of scope. • SC = (C(X) + C(Y) - C(X, Y))/C(X, Y) if SC>0, there exits economies of scope if SC<0, there exits diseconomies of scope.

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