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Lecture 4 Production and Cost under Perfect Competition

Lecture 4 Production and Cost under Perfect Competition -...

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Lecture 4 Production and Cost under Perfect Competition EC1101E Introduction to Economic Analysis 1
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Lecture Outline 1. Cost concepts and time period of production/ 2. The law of diminishing returns and the product curves. 3. Short-run cost curves. 4. Long-run costs and shape of the long-run average cost curve. 5. Economies of scale, minimum efficient scale, and diseconomies of scale. 6.Profit maximization under perfect competition. 7.Increasing, constant, and decreasing cost industry and the long-run supply curve. 2
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Cost Concepts and Definitions Explicit costs A firm's actual cash payments for its inputs. It is the firm’s total accounting cost. Implicit Costs Opportunity costs of non-purchased inputs such as the entrepreneur's time and money. Economic Cost The sum of explicit and implicit costs. 3
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Definition of Time Periods Short run A period of time over which at least one input to production is fixed. Long run A planning horizon over which a firm is perfectly flexible in its choice of inputs. 4
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Time Period Decisions Short run : How much output to produce? The key principle for short-run decision- making is the principle of diminishing returns. Long run : What combination of inputs to use? What type of production facility to build? Short-run costs are associated with production in the short run with a fixed input. Long-run costs are incurred by firm when it is free to vary all of its inputs . 5
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Short-run Production and Diminishing Returns A production function shows the relationship between the amount of inputs used and the amount of output generated per period of time. The Total product (TP) curve shows the relationship between the quantity of labor and the quantity of output produced in a give time period. 6
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Marginal and Average Product Marginal product (MP) is the increase in total product resulting from a one-unit increase in the amount of the variable factor (labor) employed. Marginal product = change in total product change in the quantity of the variable input. Average product (AP) is total product per unit of the variable input (labor) employed. Average product = total product total variable input employed 7
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Law of Diminishing Returns The shapes of the product curves explained by diminishing returns. The Law of Diminishing Returns: As a firm uses more of a variable input, with the quantity of fixed inputs held fixed, output eventually increases at a decreasing rate or the marginal product of the variable input eventually diminishes. 8
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Production in the Short Run 9
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10 Short-Run Production and Diminishing Returns 10 Maximum slope of ray from origin c When TP is increasing at an increasing rate, MP is rising When TP is increasing at a decreasing rate, MP is falling 12 ― 10 ― 8 ― 6 ― 2 ― 4 ― 1 2 3 4 5 6 7 Numbers of workers Quantity of paddles 8 0 Total product (TP) Average product (AP) Marginal product (MP) MP =0 d' d Maximum TP: Slope of TP = 0 b
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