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

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Introduction to Microeconomics Lecture 9 Firms, Production and Costs Simon Cowan

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Outline Production Functions and Isoquants Returns to Scale; Isocosts and Isoquants Total, Average and Marginal Costs Short and Long Run Costs Opportunity Cost
Firms Firms are productive organisations They take inputs, transform them into an output or outputs, and pass on the output(s) The transfer of outputs and inputs usually involves some form of market transaction The overall purpose is usually to make money for the owners - generally called profit maximisation

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Input Output FEASIBLE NOT FEASIBLE Production Function Output = F (Input) Q = F(L) Production Set: Combination of inputs and outputs that are technically feasible The boundary is called the production possibilities frontier, or the production function
Production: a Two–Input Example Labour Machinery FEASIBLE NOT FEASIBLE 10-Isoquant of the Production Function Output = F (Labour, Machinery) Q = F(L, M)) Q = 10

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Machinery Labour Q 1 Q 3 Q 2 ISOQUANTS
Red Peppers Olives U 1 U 3 U 2 ISOQUANTS Indifference Curves

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Machinery Labour Q 2 SUBSTITUTABILITY MRTS MRTS Note Convexity implies Diminishing MRTS MRTS = Marginal Rate of Technical Substitution
Machinery Labour DIFFERENT DEGREES OF SUBSTITUTABILITY 1. No Substitutability: “Constant Coefficients” or “Leontief” technology Q 1 Q 2 Q 3

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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

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Machinery Labour DIFFERENT DEGREES OF SUBSTITUTABILITY 4. Perfect Substitutability: Q 1 Q 2 Q 3
Machinery Labour 100 300 200 RETURNS TO SCALE 10 30 20 15 10 5 1. Constant returns to scale Homogeneous of degree 1: f ( λ x , λ y ) = λ f ( x , y ) for λ > 0

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L9Costs - Introduction to Microeconomics Lecture 9 Firms...

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