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lectureOutline07

# lectureOutline07 - Introduction to Economics Source LR12...

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ECO 100Y Introduction to Economics Topic 7: Theory of the Firm Source: LR12, LR11, LR10: Chapters 7 and 8 (exclude appendix to Ch. 8). For Ch. 8: Be guided by what is done in class. 1 Topic 7: Theory of the Firm ECO 100 W.G. Wolfson A Firm and Its Decisions A firm transforms inputs into outputs In ECO 100, the decisions a firm has to make are: What to produce and in what quantities What quantities of each factor of production to use These decisions are dependent on: The Production Function (“technical data”) The Cost of factors (“input prices”) The Revenues from output (leading to “profits”) ECO 100 W.G. Wolfson 2 Topic 7: Theory of the Firm 1 2

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The Production Function The Production Function (PF) shows the maximum output (q) that can be produced with any input combination q = q(X 1 , X 2 , X 3 , X 4 , …) X i , = Input i In Eco 100, we usually assume 2 inputs and 1 output “Traditional” inputs are K (Capital) and L (Labour) PF becomes q = q (K, L) Sample PFs: q = 2L + 4K or q = 3 L ½ + 5K ½ ECO 100 W.G. Wolfson 3 Topic 7: Theory of the Firm Classifying PFs By Time Period The Very Short Run Both inputs are fixed The Short Run One input is fixed (K) The Long Run Both inputs can vary The Very Long Run The PF itself shifts ECO 100 W.G. Wolfson 4 Topic 7: Theory of the Firm 3 4
The Short Run Productivity Curves We utilize the Short Run Production Function K is fixed and L can vary Aside: Technology is constant, of course! Output (q) varies in response to changes in L Short Run Production Relationships: Total Product of Labour = TP L = q(K fixed , L) Average Product of Labour = AP L = TP L / L Marginal Product of Labour = MP L = TP L / L ECO 100 W.G. Wolfson 5 Topic 7: Theory of the Firm “Law of Diminishing Returns” As more L is added to fixed K, we can predict that (eventually) the growth in output (q) will fall i.e., (eventually) MP L will fall Further, (eventually) AP L will fall “Eventually” means that they could rise initially This is the famous “ law of diminishing returns Sometimes called “law of diminishing marginal returns”

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