L06 - ECO ECO 100Y Introduction Introduction to Economics...

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ECO 100Y Introduction to Economics Lecture 6: Production and Cost in the Long the Long-Run Run the Long Run Run © Gustavo Indart Slide 1
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Long Long-Run Condition Run Condition 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
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Profit Maximization ! Firms try to maximize profits ! 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 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 K MP L ! = P K P L MP L P L ! = MP P K K © Gustavo Indart Slide 4
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Factor Substitution ! Suppose that at certain combination of K and L the 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 " Q = F(K, L) " 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 combinations of K and L that can produced a given level of © Gustavo Indart Slide 6 output
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An Isoquant (Q = 5) K L 12 10 1 8 10 y 72 6 Capital/d a 53 2 4 Units o f 44 0 1 2 3 4 5 U i fLb /d © Gustavo Indart Slide 7 3.5 5 Units of Labour/day
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Conditions for an Conditions for an Isoquan Isoquan Conditions for an Conditions for an Isoquant Isoquant ! In the general case, isoquants satisfy three important conditions: K " They are downward- sloping " They are convex to the origin Q 1 " They cannot intersect L © Gustavo Indart Slide 8
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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 increasing 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 .
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