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# ch04 - Technology and Cost Chapter 4 Technology and Cost 1...

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Chapter 4: Technology and Cost 1 Technology and Cost

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Chapter 4: Technology and Cost 2 The Neoclassical View of the Firm Concentrate upon a neoclassical view of the firm the firm transforms inputs into outputs Inputs Outputs The Firm There is an alternative approach (Coase) What happens inside firms? How are firms structured? What determines size? How are individuals organized/motivated?
Chapter 4: Technology and Cost 3 The Single-Product Firm Profit-maximizing firm must solve a related problem minimize the cost of producing a given level of output combines two features of the firm production function : how inputs are transformed into output Assume that there are n inputs at levels x 1 for the first, x 2 for the second,…, x n for the nth. The production function, assuming a single output, is written: q = f(x 1 , x 2 , x 3 ,…,x n ) cost function : relationship between output choice and production costs. Derived by finding input combination that minimizes cost Minimize x i subject to f(x 1 , x 2 , x 3 ,…,x n ) = q 1 Σ w i x i i=1 n

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Chapter 4: Technology and Cost 4 This analysis has interesting implications different input mix across time: as capital becomes relatively cheaper space: difference in factor costs across countries Analysis gives formal definition of the cost function denoted C(Q): total cost of producing output Q average cost = AC(Q) = C(Q)/Q marginal cost: additional cost of producing one more unit of output. Slope of the total cost function formally: MC(Q) = dC(Q)/d(Q) Also consider sunk cost incurred on entry independent of output cannot be recovered on exit
Chapter 4: Technology and Cost 5 Cost curves: an illustration \$/unit Quantity AC MC Typical average and marginal cost curves Relationship between AC and MC If MC < AC then AC is falling If MC > AC then AC is rising MC = AC at the minimum of the AC curve

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Chapter 4: Technology and Cost 6 Cost and Output Decisions Firms maximizes profit where MR = MC provided output should be greater than zero implies that price is greater than average variable cost shut-down decision Enter if price is greater than average total cost must expect to cover sunk costs of entry
Chapter 4: Technology and Cost 7 Economies of scale Definition: average costs fall with an increase in output Represented by the scale economy index S = AC(Q) MC(Q) S > 1: economies of scale S < 1: diseconomies of scale S is the inverse of the elasticity of cost with respect to output η C = dC(Q) C(Q) dQ Q = dC(Q) dQ C(Q) Q = MC(Q) AC(Q) = 1 S

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Chapter 4: Technology and Cost 8 Economies of scale
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ch04 - Technology and Cost Chapter 4 Technology and Cost 1...

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