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Lecture 05 - ECO100 - Introduction to Introduction to...

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ECO 100Y Introduction to Introduction to Economics Lecture 5: P d ti d C t Production and Costs in the Short in the Short-Run Run © Gustavo Indart Slide 1
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The Firm A firm is an institution that buys or hires factors of production and organizes these resources to produce and sell goods and services The most important decisions a firm has to make are: ¾ h d d i h i i what to produce and in what quantities ¾ what technology to use ¾ what quantities of each factor of production to use © Gustavo Indart Slide 2
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Production Theory In production theory, the underlying behavioural assumption is that firms try to maximize profits Profits are the difference between the value of sales (or Total Revenue ) and the Total Cost of producing the output sold ¾ π = TR – TC ¾ TR = P*Q The firm’s Total Cost is equal to the value of all the The firm s is equal to the value of all the inputs used in the production of the output P fi i i i i li i i i i © Gustavo Indart Slide 3 Profit-maximization implies cost-minimization
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Measurements of Costs Accountants measure historical cost, where historical cost values factors of production at the price actually paid for them Economists measure opportunity cost, where opportunity cost is the best alternative forgone opportunity cost For convenience, when analyzing the cost of the firm, we are going to talk about the dollar equivalent of opportunity cost © Gustavo Indart Slide 4
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Different Time Periods The short run is a time period in which technology and the quantities of some factors of production are fixed The long run is a time period in which all inputs may be varied but in which the basic technology of production cannot be changed The very long run is the period of time in which all The is the period of time in which all inputs and technologies may be varied Note that time periods do not correspond to any Note that time-periods do not correspond to any specific number of months or years ¾ It is a conceptual distinction and it varies depending © Gustavo Indart Slide 5 It is a conceptual distinction and it varies depending on the industry in question
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The Production Function In any of the periods just considered, the firm tries to produce an output combining the different inputs in the most efficient way The production function shows the maximum output that can be produced with any input combination ¾ It only shows technically efficient combinations of i p t inputs For instance, the production function Q = F(L, K) shows the maximum output ( Q ) that can be produced with any combination of labour ( L ) and capital ( K ) ¾ Q 2L + 3K Q 5 L ½ + K ½ © Gustavo Indart Slide 6 e.g., Q = 2L + 3K or Q = 5 L
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The Short The Short-Run Production Run Production Function For simplicity, we will assume that there are only two factors of production: capital ( K ) and labour ( L ) In the short run , K is assumed to be fixed ( K ) ¾ Therefore the level of output ( Q ) changes only as Therefore, the level of output ( ) changes only as L varies In the short run, the production function describes
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