EDU ECO2003 Brief summary Revision.pptx

# So we choose a value for q say q and plot our graph

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So, we choose a value for Q, say Q 0 , and plot our graph in L-K space. Does this remind you of something? Maybe how we represent 3D utility functions with indifference curves .

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Marginal Rate of Technical Substitution In consumer theory, we asked ourselves “how much of x would we substitute for y to remain at the same level of utility?” In the world of the firm, why don’t we ask: “How much labour could we substitute for capital in order to continue producing the level of output we were before?” The answer to this question is the Marginal Rate of Technical Substitution (MRTS)
Marginal Rate of Technical Substitution The MRTS effectively tells us how a firm is willing to substitute between inputs (for the purposes of this course, between K and L) Note that if you have a lot of a particular input, you would be willing to give up a lot of it for a little bit of the other one. Note how this supports the diminishing marginal returns assumption from earlier.

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Costs Where are we going? The topics we will look at are: Costs in the short run (Graphically and Algebraically) How to optimally allocate production Costs in the long run (Graphically and Algebraically) Market structures and how they link to cost curve structures Recall that we developed a theory of production which included two inputs: labour and capital. In reality, people don’t work for free, and machines don’t just appear in your factory for free. We normally talk about the cost of labour being wages (w) , and the cost of capital being rental (r) . Also remember that in the short run , we assumed capital to be fixed. So we can divide our costs into a portion of fixed costs (relating to our fixed input) and variable costs (relating to our variable input) Costs in the Short Run
Total Costs When you look at Total Costs, you need to think about Fixed inputs as well as Variable inputs TC = TFC + TVC TC = r.K + w.L VC is the upward sloping curve – this makes sense because more output means we need more labour. FC is horizontal, because it costs the same no matter how much we produce. The TC curve is exactly the VC curve translated up by the magnitude of our FC.

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Average Costs Lets kick it up a notch Focus on costs per unit We look at Average Total Cost, Average Fixed Cost, Average Variable Costs How do we define these? It is basically the relevant cost curve, divided by the Q (output produced) Average Fixed Costs AFC = TFC/Q Average Variable Costs AVC = TVC/Q Average Total Costs ATC = AFC + AVC = TFC/Q + TVC/Q Marginal costs are another important cost we are going to deal with Marginal cost is the cost of producing one extra unit Geometrically, it is the slop of TC curve (it’s also the slope of VC curve) We can also find Marginal Cost by taking the derivative of a cost function with respect to Q Marginal cost MC = dTC/dQ Marginal Cost
Remember the important relationship between Marginal and Average? MC cuts AVC and ATC at minimum points.

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• Spring '15
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