Econ 4001.01 1st Edition Lecture 12Outline of Last Lecture II. Nimbus Broom Example to Open Cost of ProductionIII. Relationship between Marginal Cost and Marginal RevenueIV. Average vs. Marginal Relationship ReturnsV. Costs with 2 Inputs: Labor and Capitala. Short Runb. Long RunVI. Determining the Cost of Capitala. Isocost GraphsVII. Summary of Production OptimizationOutline of Current Lecture VIII. Input Substitution and Marginal ProductsIX. Cost Minimizing Input Combination as Output ChangesX. Short-Run vs. Long-Run Cost CurvesXI. Non-Linear Cost Curves: Economies of Scalea. Diseconomies of ScaleXII. Sale Economies and Output ElasticityXIII. Economies of ScopeXIV. Elements of Perfectly Competitive MarketsXV. Objectives of FirmsCurrent LectureCost of Production, Profit Maximization and Competitive Supply- Input Substitution and Marginal Productso Tangency of isocost line and isoquant line is where the two slopes are equal to each othero The last dollar spent on either input will have the same impact on output- Cost Minimizing Input Mix as Output Changeso With the appropriate data (relative values of w and r and production function) we can construct a series of isoquants with an isocost line tangent at the cost curveo Note that this expansion path has evenly spaced isoquants which indicates constant returns to scale- this does not have to be the caseThese notes represent a detailed interpretation of the professor’s lecture. GradeBuddy is best used as a supplement to your own notes, not as a substitute.- Isoquant/Isocost exampleso In the short run, if capital were fixed, what is low cost mix to make output of 140 units?o This is not a low cost: isoquant, isocost are not tangent- Short-run vs Long-run Cost Curveso Note that the isoquant is not tangent to the isocost line at point P-capital as fixedcosts makes lowest cost possible- Non-Linear Total Cost Curve: Economies of Scaleo At low levels of output, average costs may be declining, indicating economies of scale Specialization of labor Flexibility in matching people to machinery/process Lower cost input procurement-bulk orderso At high levels of output, average costs are likely to be rising, indicating diseconomies of scale Crowding and material flow may become more difficult Supervision inefficiencies as work force increases Material costs increase due to demand pressures- Scale Economies and Output Elasticityo Economies of scale: output can be increased with less than proportionate increase in costo Diseconomies of scale: increases in output are accompanied by more than proportionate cost increaseo If MC>AC, and AC is increasing then it is diseconomies of scaleo If MC<AC and AC is decreasing then it is economies of scale- Economies of Scopeo Theoretically, a firm that makes two products may be able to operate at lower costs due to efficiencies A common set of managers could oversee both products Equipment or raw materials could be shared Info systems, logistics, warehousing, could be sharedo This situation is called economies of scope A transformation curve between the two products would be bowed out due to these efficiencies- Changes in Cost from Cumulative Productiono If workers become more efficient as they make more units of output, they can cut average and marginal costo This phenomenon is called the Learning Curveo Reasons: Workers complete tasks in less time as they gain experience Machinery can be operated at higher speeds over time Quality control improves as the process is better understood; fewer rejectso Learning Curves vs. Economies of Scale- Elements of Perfectly Competitive Marketso Many Sellers: each firm is small relative ot market, so it has no influence on market price Firms behave as Price-Takerso Homogeneous products- each firm produces output that is identical to that of other firms Firms share a common demand curveo Free entry and exit: so profits lead to entry of new competitors, losses cause firms to leave market- Objectives for Firmso Revenue growth or growth rateo Cost minimizationo Generation of free cash flowo Manager’s potential goals: Maximize their salaries and benefits Make the firm a great place to work Keep problems and ownership far awayo Profit Maximization- Profit Maximization and Relationship to Costso Profit: difference between total revenue and total costo In equation form: pi(q)=TR(q)-TC(q)o If we used calculus, we would see that profit (pi) is maximized when MR(q)=MC(q)o Consider the output level at which MR(q)=MC(q) If MR>MC, then increasing production will raise profits If MR<MC, decreasing production will raise profits If MR=MC, then any change in production will lower profits- Demand and Marginal Revenue for Price Takerso Demand curve seen by firm in perfect competition is horizontal, it cannot changeprice, even though the overall market demand is downward slopingo Price=AR=MR on the horizontal demand curveo Therefore the profit maximization requires P=MC(q)o Firm chooses quantity at which P=MCo Price is independent of quantity produced for a perfectly competitive