# L9Costs - Introduction to Microeconomics Lecture 9 Firms...

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1 Introduction to Microeconomics Lecture 9 Firms, Production and Costs Simon Cowan Outline z Production Functions and Isoquants z Returns to Scale; Isocosts and Isoquants z Total, Average and Marginal Costs z Short and Long Run Costs z Opportunity Cost Firms z Firms are productive organisations z They take inputs, transform them into an output or outputs, and pass on the output(s output(s) z The transfer of outputs and inputs usually involves some form of market transaction z The overall purpose is usually to make money for the owners - generally called profit maximisation Production Set: Combination of inputs and outputs that are technically feasible The boundary is called the production possibilities frontier, or the production function Input Output FEASIBLE NOT FEASIBLE Production Function Output = F (Input) Q = F(L) Production: a Two–Input Example Labour 10-Isoquant of the Production Function Output = F (Labour, Machinery) Machinery FEASIBLE NOT FEASIBLE Q = F(L, M)) Q = 10 Labour Q 1 Q 3 Q 2 ISOQUANTS Machinery

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2 Olives U 1 U 3 U 2 ISOQUANTS Indifference Curves Red Peppers Labour Q 2 SUBSTITUTABILITY MRTS Note Convexity implies Diminishing MRTS MRTS = Marginal Rate of Technical Substitution Machinery MRTS Labour DIFFERENT DEGREES OF SUBSTITUTABILITY 1. No Substitutability: “Constant Coefficients” or “Leontief” technology Q 1 Q 2 Q 3 Machinery Labour DIFFERENT DEGREES OF SUBSTITUTABILITY 2. Low Substitutability: Q 1 Q 2 Q 3 Machinery Labour DIFFERENT DEGREES OF SUBSTITUTABILITY 3. High Substitutability: Q 1 Q 2 Q 3 Machinery Labour DIFFERENT DEGREES OF SUBSTITUTABILITY 4. Perfect Substitutability: Q 2 Q 3 Machinery Q 1
3 Labour 100 300 200 RETURNS TO SCALE 15 1. Constant returns to scale Machinery 10 30 20 10 5 Homogeneous of degree 1: f ( λ x , λ y ) = λ f ( x , y ) for λ > 0

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## This note was uploaded on 04/12/2010 for the course ECON DEAM taught by Professor Vines during the Spring '10 term at Oxford University.

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L9Costs - Introduction to Microeconomics Lecture 9 Firms...

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