Lecture 06 - ECO100

# Lecture 06 - ECO100 - ECO ECO 100Y Introduction to...

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ECO 100Y Introduction to Economics Lecture 6: Production and Cost in e Long e Long- un the Long the Long Run Run © Gustavo Indart Slide 1

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ong ong- un Conditions Long Long Run Conditions Run Conditions ± All factors of production are variable ± Firms can substitute one factor for another ± Firms will choose a technically efficient combination of K and L ± Production function considers combinations ± There are several combination of K and L to produce any given level of output © Gustavo Indart Slide 2
rofit Maximization Profit Maximization ± irms try to maximize profits Firms try to maximize profits ± rofit- aximization implies Profit maximization implies costminimization ± Method of production must be economically p y efficient (and not only technically efficient ) © Gustavo Indart Slide 3

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Economically Efficient Combinations of K and L hen the last dollar spent on d creases total ± When the last dollar spent on K and L increases total output by the same amount MP K MP L ± = P P K L MP L P L ± = MP K P K © Gustavo Indart Slide 4
actor Substitution Factor Substitution ± Suppose that at certain combination of K and L the following relationship holds: MP K MP L > P K P L ± What should be done to achieve economic efficiency? nce, beyond the point of diminishing marginal productivity, the Since, beyond the point of diminishing marginal productivity, the marginal product of a factor of production decreases as more of that factor is being used in production, increasing the quantity of K will reduce MP K and decreasing the quantity of L will increase © Gustavo Indart Slide 5 MP L . Therefore, the firm should substitute capital for labour.

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oquants Isoquants ± Different combinations of K and L can produce a given output in a technically efficient way ± For instance, let’s say that Q = 5 can be produced with either (K, L) = (2, 4) or (K, L) = (3, 3) ± An isoquant is the locus of all the technically efficient ombinations of and L that can produced a cb s d cp d c d given level of output © Gustavo Indart Slide 6
An Isoquant (Q = 5) q( Q 5 ) K L 12 10 1 8 10 ay 72 6 Capital/d a 53 2 4 44 5 0 12345 b /d © Gustavo Indart Slide 7 3.5 5 Labour/day

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onditions for an oquant Conditions for an Conditions for an Isoquant Isoquant ± In the general case, isoquants satisfy three important conditions: K ¾ They are downward- sloping ¾ They are convex to the origin Q 1 ¾ They cannot intersect L © Gustavo Indart Slide 8
An Isoquant Map K The farther away an isoquant curve is from the origin, the greater the level of output it represents. If we keep L constant at L 1 while creasing the quantity of K from C K 2 increasing the quantity of K from K 1 to K 2 , then output must increase from Q 1 to Q 2 . A B K 1 Q 3 If we keep K constant at K 1 while creasing the Q 1 Q 0 Q 2 increasing the quantity of L from L 1 to L 2 , then output must increase from © Gustavo Indart Slide 9 L L 1 L 2 Q 1 to Q 2 .

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Marginal Rate of Technical Substitution ± s we move from one point on an isoquant to another, we are
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