Unit one.pptx - Unit one the theory of the firm...

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Unit one; the theory of the firm
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Neoclassical theory of the firm A firm is defined by a set of feasible production plans completely described by a production function The production function maps bundles of inputs on output The firm determines how, what and how much to produce The objective is profit maximisation or cost minimisation
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Neoclassical theory of the firm The cost function gives the minimum cost to produce Q units of the output. It incorporates technological efficiency and opportunity cost of inputs. Technological efficiency means that the firm uses no more than it requires to produce Q. For all those input bundles that can produce q, the firm choses the one that has minimum opportunity cost.
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Neoclassical theory of the firm Average cost is the minimum cost per unit of output produced. Marginal cost is change in cost with respect to output.
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Neoclassical theory of the firm If MC is below AC, the costs are falling and if MC is above AC the cots are rising. At the minimum cost AC=MC
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Cont’d
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Cost concepts Opportunity cost; is the value of the factor in its next best alternative use. The cost of the firm using another unit of an input it does not own is the price or rent charged. Economic cost of durable inputs;if the firm owns durable capital or inputs that provide productive services for more than one period- opportunity cost is computed in two parts;
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1. economic depreciation; this is the reduction in the resale value of the input for using it that period. This involves physical depreciation which is the loss in productive capabilities from wear and tear when using the asset 2. the rate of return that could have been earned if the durable input was sold at the beginning of the period.
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Cost concepts Opportunity cost of durable input is
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Cost concepts Avoidable costs and sunk expenditures; avoidable cost are cost than can be avoided when you stop producing, however, sunk expenditures are cost that can be avoided by not producing. Sunk expenditure arise because productive activities require specialised assets that cant be used in other productive activities.e.g airlines
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Cost concepts Short and long run. Short run is the period where on factor is fixed while long run is the period in which all factors are varied. In reality all factors are varied to some extent. But constrained by sunk cost and time.
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Cost concepts Variable vs fixed costs
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Advantages of being large Large firm can have lower per unit cost than smaller ones. We look at the advantages of being large at product level (economies of scale), at plant level (economies of scope) and at the level of the firm (multiplant economies of scope)
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Economies of scale Economies of scale exists if long run average cost is falling as output increases.
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