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Firm definition and it's goal? |
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• Name given to describe any business. • Purpose of a business is to take inputs to produce output. • Goal: maximize profit |
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a period of time in which at least one input is fixed. The time period is too short for firms to be able to expand or contract their capacity (plant size) or to leave one market to enter another market. |
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a period of time in which all inputs can vary. The firm capacity is able to vary and firms are able to leave and enter markets. |
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• Total Revenue ‐ Total Cost |
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• Total Cost to an accountant is the explicit cost: direct outlays of money (payments to non‐owners of a firm for their resources). |
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forgone payments of money for self‐employed self‐owned resources. |
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• Total Cost to an economist is both the explicit cost plus the implicit cost • Total Cost to an economist is called the Economic Cost. – this is the total opportunity cost (explicit and implicit). IMPLICIT + EXPLICIT |
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Equal to TR ‐ Explicit Cost |
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• Earning as much in this business as the other choice. No more, no less. • Earning a normal rate of return: Normal Profit (Accounting Profit is almost always greater than zero when a firm is earning “Normal Profit”). |
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• Earning more in this business than the other choice. • Earning above a normal rate of return |
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Economic loss, normal profit, economic profit |
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• TR < Economic Cost: Economic Loss (Negative Economic Profit). • TR = Economic Cost: Normal Profit (Zero Economic Profit). • TR > Economic Cost: Economic Profit (Above Normal Profit). |
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Short Run: at least one input is constant (capital) • The short run for a business is when it is limited by its physical size. It takes time to expand in a current business or to move into a new business. In the meantime, the owner(s) needs to make decisions (short run decisions) concerning the employment of labor and the production amount. • Throughout this course, we will assume (for simplicity) that there is only one input (factor of production) that is variable. The input is labor. – A variable input is a factor of production that the business can change the amount employed from one day to another. |
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Total Product of Labor (TP) |
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Total maximum production (Q) when labor is added to the production process holding capital and technology constant. – TP = Q |
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on average the amount of output produced by each worker. – Productivity of Labor – AP = TP/L or Q/L |
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Marginal Product of Labor (MP) |
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the increase in TP when one more worker is added to production. – MP = ΔTP/ΔL or ΔQ/ΔL |
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Increasing Marginal Returns |
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• As more and more of a variable input (labor) is initially added to a production process, holding at least one other input constant (capital), the resulting increments of production (MP) will, many times, increase. – it is recognized when the MP is increasing – labor is the variable input where we see Increasing Marginal Returns • This happens when labor is being initially added to the production process. When more and more workers are being added, they can specialize more and more in particular types of tasks. |
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Law of Diminishing Marginal Returns |
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• The benefits of specialization will eventually end as more and more labor is added. – This is not due to differences between workers. It is due to the lack of additional equipment for the workforce. As more and more workers are added to production, eventually there will be less and less equipment (capital) to be used by the new employees. • As more and more of a variable input (labor) is added to a production process, holding at least one other input constant (capital), the resulting increments of production (MP), after some point, will diminish. – Due to additional workers having, after some point, less & less capital to work with. – Once the MP starts to decline, we are experiencing Diminishing Marginal Returns. – Every business will come across Diminishing Marginal Returns if the business adds more and more of a variable input. |
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If MP is above AP, AP increases and if MP is below AP, AP decreases |
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at least one input is constant (plant capacity is fixed) |
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Costs that change with the level of output |
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labor, raw materials, fuel, etc. • In our simple world: labor |
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• Total Variable Costs (TVC): |
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combined total variable costs. Wage x Labor or (W x L) |
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Average Variable Cost (AVC) |
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): variable cost per unit of output. AVC = TVC/Q |
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Costs that do not vary with the level of output • As output increases the AFC always declines: |
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loans, insurance, capital construction, long term leases, salaried staff, etc. • In our simple world: capital |
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• Total Fixed Cost (TFC): |
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combined total of all fixed costs. |
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fixed cost per unit of output. AFC = TFC/Q. • As output expands, AFC declines. • TFC = $1,000,000 (1 million dollars) • If Q = 1, AFC = $1,000,000/1 = $1,000,000 • If Q = 10, AFC = $1,000,000/10 = $100,000 • If Q = 100, AFC = $1,000,000/100 = $10,000 • If Q = 1,000, AFC = $1,000,000/1,000 = $1,000 • If Q = 1 million, AFC = $1,000,000/1,000,000 = $1 |
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on average the dollar amount each unit of output cost to make. • ATC = TC/Q • ATC = AVC + AFC |
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• MC tells the firm the change in TC due to a unit increase in production (what it costs to make one more unit of output). • MC = ΔTC/ΔQ |
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Relating Production with Cost Relationship Between AP & AVC |
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• AP = Q/L • AVC = TVC/Q – AVC = (W x L)/Q since TVC = W x L – AVC = W x (L/Q) – AVC = W x (1/AP) since 1/AP = L/Q – AVC = W/AP • If AP increases, AVC decreases. • If AP decreases, AVC increases. • Thus AP & AVC are inversely related. |
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Relationship Between MP & MC |
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• MP = ΔQ/ΔL • MC = ΔTVC/ΔQ as well as ΔTC/ΔQ – MC = Δ(W x L)/ΔQ since TVC = W x L – MC = W x ΔL/ΔQ W does not change – MC = W x (1/MP) since 1/MP = ΔL/ΔQ – MC = W/MP • If MP increases, MC decreases. • If MP decreases, MC increases. • Thus MP & MC are inversely related. |
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No fixed inputs • The Long Run is when a business (firm) has enough time to change the physical size of its business or to leave its current market and/or enter another market. • Capital is now a variable input, just like labor. • In the Long Run, the firm needs to decide what market(s) to be in and the size of the business in the market(s). |
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Long Run Average Total Cost Curve |
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• Cost curve that shows the lowest average cost of producing at each possible company size. Used in the long run. |
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gives all the long run positions (all the possibilities). |
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$ When the(LRATC)Cost curve is downward sloping this represents, what is known as, Economies of Scale. • Benefits of Large Scale Production: double your inputs you more than double your output. As a firm increases its size it can lower the average cost. Eventually, opportunities of economies of scale run out and the LRATC curve stops falling |
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Economies of Scale are due to: |
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• (1) Greater labor specialization: assembly line • (2) Greater management specialization • (3) Utilize more efficient capital: robotics |
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When the LRATC is sloping upward • Inefficiencies of Large Scale Production: double your inputs you less than double your output. As a firm increases its size its average cost increases. |
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Diseconomies of scales are due to: |
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• Coordination problems: as a business increases in size, it, after some point, will become increasingly more difficult to operate. |
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Constant Returns to Scale |
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• Duplicate the current production facilities. When there are not any Constant Returns, then Q the LRATC is U shaped. |
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