Lecture 06 - ECO100

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

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ECO 100Y Introduction to i Economics Lecture 6: P d i d C i Production and Cost in the Long the Long-Run Run Run © Gustavo Indart Slide 1

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Long Long-Run Conditions Run Conditions Long 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 technically efficient combinations There are several technically efficient combination of K and L to produce any given level of output © Gustavo Indart Slide 2
Profit Maximization Firms try to maximize profits Profit-maximization implies cost-minimization Profit maximization implies cost minimization Method of production must be economically efficient (and not only technically efficient ) © Gustavo Indart Slide 3

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Economically Efficient C bi i f K d L Combinations of K and L When the last dollar spent on K and L increases total When the last dollar spent on and increases total output by the same amount MP MP K L = P K P L MP L P L = MP P K K © Gustavo Indart Slide 4
Factor Substitution Suppose that at certain combination of K and L the f ll i l i hi h ld following relationship holds: MP K MP L > P K P L Wh t h ld b d t hi i ffi i ? What should be done to achieve economic efficiency? Since, 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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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) = (5, 3) or (K, L) = (4, 4) We obtain this information from the production function ¾ Q = F(K, L) ¾ For Q = 5 , then 5 = F(K, L) will indicate all the different combinations of K and L that will produce 5 units of output An isoquant is the locus of all the technically efficient combinations of K and L that can produced a given level of © Gustavo Indart Slide 6 output
An Isoquant (Q = 5) K L 12 10 1 8 10 ay 7 2 4 6 Capital/da 5 3 2 Units of 4 4 3 5 5 0 1 2 3 4 5 U i f L b /d © Gustavo Indart Slide 7 3.5 Units of Labour/day

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Conditions for an Conditions for an Isoquant Isoquant Conditions for an 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 l l f i level of output it represents.

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