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UW-Madison ECON 101 - Production and Cost

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Production and Cost: Supply Side** Homework 4 is due next Thursday**Must learn all the abbreviations this weekendA. Vocabulary terms1. Profit (Pie sign)2. Total revenue3. Total cost4. Short run (SR)- time period in which at least 1 input is fixed5. Long run (LR)- time period in which all inputs are variable 6. L- labor7. K- capital8. Q- quantity produced9. VC- variable cost (Pl x L)10. FC- fixed cost (Pk x K)11. TC- fixed + variable costs. TC changes due to changes in VC, if Q=0 in SR, TC= FC12. AVC- average variable cost= VC/ Qa. AVC curve is u shaped 13. AFC- average fixed cost= FC/ Q14. ATC- average total cost= TC/ Q or (FC+VC)/ Qa. ATC curve is U shaped due to diminishing returns to labor 15. MC- marginal cost= Change in total cost/ change in Quantity, addition to TC from producing one more unit16. MU- marginal utility- change in total utility from consuming one more good17. MPl- marginal production of labor- change in total product from hiring an additional unit of labor18. MPk- same as labor but with capitalB. Goal of the firm is to maximize profit1. Profit= Total revenue- total cost2. Total revenue- p times q3. Total costa. we need to know the # of units of inputs we need in order to produce a particular level of output and this level of inputs depends on the technological relationship b/w inputs and outputs- production functionb. We need to know the price of each input so that we can calculate our costs= cost Function c. Cost of production= f( quantities of inputs) and prices of inputsd. Production function- describes how various kinds of inputs can be combined to produce one or more productsC. Marginal production of labor1. MPl= change in quantity/ change in labor= change in total product/ change in labora. the addition to total product for hiring an additional unit of labor2. MPk= ?= change in quantity/ change in k3. Law of diminishing returns- as additional units of the variable input are added to the fixed input output initially increases but at some point output increases at a diminishing ratea. Fixed input is a short run phenomena because at least 1 input is fixedD. Calculation revenue1. Inputs2. Inputs + price of inputs= cost of production3. Price of output and quantities demanded at those prices= revenuesE. Costs1. Use opportunity cost concept to measure input costs2. Comparison of accounting profits vs Economic profitsa. Accounting profit= total revenue - explicit costsb. Economic profits= Total revenue - (explicit + implicit costs)1. Implicit costs- value of owner's time, value of the owner's funds3. If MC= ATC at a certain quantity then ATC stays the same4. if MC < ATC at a certain quantity then ATC decreases5. IF MC > ATC at a particular quantity, than ATC increasesa. MC intersects ATC & AVC at their minimum points F. Long Run curves1. What happens to output if we increase all inputs proportionately? a. 3 possibilities1. Double all your inputs= double outputa. constant returns to scale (CRTS)b. Double inputs= 2TCc. Double output= 2Qd. ATC= 2TC/ 2Q= TC/ Q= ATC **in this case, ATC stays the same= as Q increases, ATC is constant2.Double all inputs= more than double our outputa. Increasing returns to scale (IRTS)b. ATC(prime)= 2TC/ 3Q then ATC` < ATCc. advantage to getting bigger: ATC decreases as Q increases3.Double all inputs= less than double your outputsa. Decreasing returns to scale (DRTS)b. Initially: ATC= TC/Qc. ATC`= 2TC/ 1.5Qd. ATC` > ATCe. advantage to staying small= as size of plant increases, costs/ unit increases= ATC increases as Q increases2. Long run costsa. IRTS1. Technical factors= more efficient use of lumpy inputs2. Division of labor and specialization of labor of equipmentb. DRTS1. Limits to decision- make up of communications c. Summing up1. we've looked at technology and input prices and that:a. allows us to construct ATC, AVC, AFC, MCb. allows us to compare cost per unit to price per unitc. can compare the addition to TR from selling one more unit (MR- marginal revenue) to the addition to TC from producing one more


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