Chapter 11ProductionIts what firms do.. they take inputs and make outputsFirms: inputs and outputsMcdonaldsSprintUniversity of KansasInputs:-- people, materials, machinery(capital)FixedYou don’t have to increase them to increase your outputRent as an exampleOr variableYou do have to increase them to increase your outputWages as an exampleLemonade standInputsStandSignPERSONAL pitcherLemons variableSugarVodkaProduction functionTells us the relationship between the maximum output that can be produced and different combination of inputs… general shape that curves and levels offMarginal product of laborThe additional output that a firm can produce when it hires one more unit of labor(Change in total output)/(change in input(labor))law of diminishing marginal productivity—when you hire more people the less will be produced per personlaw of diminishing returnswhen you add units of a variable input to a fixed inputa point will be reached where each additional unit of inputincreases total output by a smaller and smaller incrementsmarginal costthe change in your total cost divided by the change in your outputthe change in your total costs when you produce one more unit of outputmarginal product, average productAverage Variable CostMarginal CostAverage Total CostsFirms want to max their profitsWhat’s the right quantity of output to produce?What is the right number of inputs?TC=FC+VCATC=TC/QAVC=VC/QAFC=FC/QMC=DELTA TC/DELTA QATC*Q=TCAVC*Q=VCrelationshipRelationship between MC and AVC and MP and APIf labor is the variable input…MC= (w)/MPAVC=(w)/AP… where (w) Is the price of labor, the wagechanges in the fixed inputs shift the graphpunchline1.changing the fixed input shifts your cost curves2.changing the fixed input takes you out the short run and into the long runshort run v long runin the short run some input is fixedin the long run everything can varythe firm is not stuck with..diminishing marginal returns is a short run phenomenonlong run average cost curve: all of the possible size of kitchens and connecting the average cost curvesPage 368 and 372Look up economies of scale in the book: as the output increases, these set up costs are reduced on a per unit basisWhy does this matter so muchMarkets are determined by the long run average cost curveChapter 12Market structures and competitionMarket structuresPerfect competitionIn this market you have a very large number of sellersThey are basically all selling the same marketAll firms produce essentially the same productThere are so many substitutes that if a firm tried to charge a price higher than all other firms chargedThat firm would not sell any!!Example: Gas stationFlat horizontal line for demand curveMonopolyOnly one firm provides itNo close substitutesExample: local water company (toilets), patents (pharmaceutical companies)OligopolySmall number of firms provide this goodCompete with each otherSubstitutes for each otherPrice based on what the other firm is doingExample: overnight delivery service2-12 firmsMonopolistic competitionThey are substitutes for each otherThey compete with each otherExample: fast foodFirms in perfect competition have perfectly elastic demand curves so they are flatSo…If the firm has no control over the price, it only has one thing that it does controlAnd that is the quantity of the output (Q) it will produceShould it produce all that it can?No, remember average cost increase out put increases **missed restFinding the right amount of optimal outputNEW STUFFAverage fixed cost on the bottomAverage variable costThe one above the 2 is average total costMarginal cost goes up the fastestThe upward slope of the marginal cost curve is the supply curveKnow what changes demand and supplyNeed the marginal revenue and marginal cost curve along with demand curveDemand curve can be horizontalperfect competitionDownward slopingMonopolyOligopolyMonopolistic competitionMr=mc makes you most profitableP*q= total revenueAtc* q = total costProfits= p-atc*qWhen p=atc then there is zero profits then we are at long run equilibriumMarket power when you can charge a price above marginal costIf the demand curve is steep then the good is inelastic which gives them more market powerEconomies of scale, when the cost are decreasing as quantities increaseDiseconomies of scale is the oppositeAnd that’s how natural monopolies come inMonopolies aren’t always bad like pharmaceuticals having less incentive if they didn’t have patentsDwl= Price at monopoly - Price of marginal cost * the difference in quantity *.5SooFirm has no control over the priceOnly has one thing that it does controlAnd that is the quantity of output it will produceShould it produce all that it canNo average cost increase as output increasesIn perfectly competitive firmNo control over the priceCan only control the level of outputThe firm should increase output up to the point where price and marginal cost are equal or come closest…As long as price is greaterPrice=Marginal RevenueMarginal revenueMarginal revenue = (the change in total revenue) / (change in quantity)the change in total revenue from selling one more unit of product page 400price or Marginal Revenue= Marginal Cost page 402 On exam**the difference between p and ATC that distance is the difference between the 2 lines on the graph vertically and that is the profit per unit.You take the vertical difference times the horizontal amount that you are selling and that equals the total profitsProfit per unit * number of units = total profitsP comes closest to mcThis level of output maxes your profitsIt also minimizes your losesThere may be a reason why you want to continue to produce even at a lossWhat about the?(Tc-tc^0)/Q=AVCRememberAs long as the market price is >AVC you can cover all of your variable costs and some of your fixed costsBetter to stay in business than shut downIf market price is such that p<=avc then: shut downThe firms marginal cost curve is the firms supply curve—page 409If the price equals ATC then profits are 0 and no other firms will enter the marketProfits are 0?!?!In econ we assume the cost calculations contain a “reasonable” profitZero profits means zero “excess” profits… above the beyond this “reasonable” profitCompany has 1 million dollarsInvest in new productWhen calculating products costs and what is required to break even company includes inputs plus 4% it could have earned if it were investedInvest in government bondBond pays 4% return safe and