# supply

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Published on October 4, 2007

Author: Chyou

Source: authorstream.com

Slide1:  Background to Supply Background to Supply:  Background to Supply The Short-run Theory of Production SHORT-RUN THEORY OF PRODUCTION:  SHORT-RUN THEORY OF PRODUCTION Profits and the aims of the firm Long-run and short-run production: fixed and variable factors The law of diminishing returns The short-run production function: total physical product (TPP) average physical product (APP) APP = TPP/QV marginal physical product (MPP) MPP = TPP/QV Wheat production per year from a particular farm (tonnes):  Wheat production per year from a particular farm (tonnes) Wheat production per year from a particular farm (tonnes):  Wheat production per year from a particular farm (tonnes) Wheat production per year from a particular farm (tonnes):  Wheat production per year from a particular farm (tonnes) Wheat production per year from a particular farm (tonnes):  Wheat production per year from a particular farm (tonnes) SHORT-RUN THEORY OF PRODUCTION:  SHORT-RUN THEORY OF PRODUCTION Profits and the aims of the firm Long-run and short-run production: fixed and variable factors The law of diminishing returns The short-run production function: total physical product (TPP) average physical product (APP) APP = TPP/QV marginal physical product (MPP) MPP = TPP/QV graphical relationship between TPP, APP and MPP Wheat production per year from a particular farm:  Number of farm workers Wheat production per year from a particular farm Tonnes of wheat produced per year Number of workers 0 1 2 3 4 5 6 7 8 TPP 0 3 10 24 36 40 42 42 40 Wheat production per year from a particular farm:  Number of farm workers Wheat production per year from a particular farm Tonnes of wheat produced per year Number of workers 0 1 2 3 4 5 6 7 8 TPP 0 3 10 24 36 40 42 42 40 Wheat production per year from a particular farm:  Wheat production per year from a particular farm Number of farm workers Tonnes of wheat produced per year TPP b d Wheat production per year from a particular farm:  Wheat production per year from a particular farm Number of farm workers (L) Tonnes of wheat per year TPP Tonnes of wheat per year Number of farm workers (L) Wheat production per year from a particular farm:  Wheat production per year from a particular farm Tonnes of wheat per year TPP Tonnes of wheat per year MPP Number of farm workers (L) Number of farm workers (L) Wheat production per year from a particular farm:  Wheat production per year from a particular farm Tonnes of wheat per year TPP Tonnes of wheat per year APP MPP Number of farm workers (L) Number of farm workers (L) Wheat production per year from a particular farm:  Wheat production per year from a particular farm Tonnes of wheat per year TPP Tonnes of wheat per year APP MPP Number of farm workers (L) Number of farm workers (L) Wheat production per year from a particular farm:  Wheat production per year from a particular farm Tonnes of wheat per year TPP Tonnes of wheat per year APP MPP b Number of farm workers (L) Number of farm workers (L) b Wheat production per year from a particular farm:  Wheat production per year from a particular farm Tonnes of wheat per year TPP Tonnes of wheat per year APP MPP b b d d Number of farm workers (L) Number of farm workers (L) Background to Supply:  Background to Supply Short-run Costs SHORT-RUN COSTS:  SHORT-RUN COSTS Measuring costs of production: opportunity costs explicit costs implicit costs Fixed costs and variable costs Total costs total fixed cost (TFC) total variable cost (TVC) total cost (TC = TFC + TVC) Total costs for firm X:  Output (Q) 0 1 2 3 4 5 6 7 TFC (£) 12 12 12 12 12 12 12 12 Total costs for firm X Total costs for firm X:  TFC Output (Q) 0 1 2 3 4 5 6 7 TFC (£) 12 12 12 12 12 12 12 12 Total costs for firm X Total costs for firm X:  TFC Total costs for firm X Output (Q) 0 1 2 3 4 5 6 7 TFC (£) 12 12 12 12 12 12 12 12 TVC (£) 0 10 16 21 28 40 60 91 Total costs for firm X:  TVC Output (Q) 0 1 2 3 4 5 6 7 TFC (£) 12 12 12 12 12 12 12 12 TVC (£) 0 10 16 21 28 40 60 91 TFC Total costs for firm X Total costs for firm X:  TVC TFC Total costs for firm X Output (Q) 0 1 2 3 4 5 6 7 TFC (£) 12 12 12 12 12 12 12 12 TVC (£) 0 10 16 21 28 40 60 91 TC (£) 12 22 28 33 40 52 72 103 Total costs for firm X:  TC Output (Q) 0 1 2 3 4 5 6 7 TFC (£) 12 12 12 12 12 12 12 12 TVC (£) 0 10 16 21 28 40 60 91 TC (£) 12 22 28 33 40 52 72 103 TVC TFC Total costs for firm X Total costs for firm X:  TC TVC TFC Total costs for firm X SHORT-RUN COSTS:  Marginal cost marginal cost (MC) and the law of diminishing returns SHORT-RUN COSTS Average and marginal physical product:  Average and marginal physical product Output Quantity of the variable factor Average and marginal physical product:  Output Quantity of the variable factor MPP b APP Average and marginal physical product Marginal cost:  Output (Q) Costs (£) Marginal cost SHORT-RUN COSTS:  Marginal cost marginal cost (MC) and the law of diminishing returns the relationship between the marginal and total cost curves SHORT-RUN COSTS Total costs for firm X:  TC TVC TFC Total costs for firm X SHORT-RUN COSTS:  Marginal cost marginal cost (MC) and the law of diminishing returns the relationship between the marginal and total cost curves Average cost SHORT-RUN COSTS SHORT-RUN COSTS:  Marginal cost marginal cost (MC) and the law of diminishing returns the relationship between the marginal and total cost curves Average cost average fixed cost (AFC) SHORT-RUN COSTS SHORT-RUN COSTS:  Marginal cost marginal cost (MC) and the law of diminishing returns the relationship between the marginal and total cost curves Average cost average fixed cost (AFC) average variable cost (AVC) SHORT-RUN COSTS SHORT-RUN COSTS:  Marginal cost marginal cost (MC) and the law of diminishing returns the relationship between the marginal and total cost curves Average cost average fixed cost (AFC) average variable cost (AVC) average (total) cost (AC) SHORT-RUN COSTS SHORT-RUN COSTS:  Marginal cost marginal cost (MC) and the law of diminishing returns the relationship between the marginal and total cost curves Average cost average fixed cost (AFC) average variable cost (AVC) average (total) cost (AC) relationship between AC and MC SHORT-RUN COSTS Average and marginal costs:  Output (Q) Costs (£) Average and marginal costs Background to Supply:  Background to Supply The Long-run Theory of Production LONG-RUN THEORY OF PRODUCTION:  LONG-RUN THEORY OF PRODUCTION All factors variable in long run The scale of production: constant returns to scale increasing returns to scale decreasing returns to scale Slide41:  Short-run and long-run increases in output LONG-RUN THEORY OF PRODUCTION:  Economies of scale specialisation & division of labour indivisibilities container principle greater efficiency of large machines by-products multi-stage production organisational & administrative economies financial economies economies of scope LONG-RUN THEORY OF PRODUCTION LONG-RUN THEORY OF PRODUCTION:  Diseconomies of scale External economies and diseconomies of scale Optimum combination of factors MPPa/Pa = MPPb/Pb ... = MPPn/Pn LONG-RUN THEORY OF PRODUCTION Background to Supply:  Background to Supply Isoquant–Isocost Analysis ISOQUANT- ISOCOST ANALYSIS:  ISOQUANT- ISOCOST ANALYSIS Isoquants their shape An isoquant:  Units of K 40 20 10 6 4 Units of L 5 12 20 30 50 Point on diagram a b c d e Units of labour (L) Units of capital (K) An isoquant An isoquant:  Units of K 40 20 10 6 4 Units of L 5 12 20 30 50 Point on diagram a b c d e a Units of labour (L) Units of capital (K) An isoquant An isoquant:  Units of K 40 20 10 6 4 Units of L 5 12 20 30 50 Point on diagram a b c d e a b Units of labour (L) Units of capital (K) An isoquant An isoquant:  Units of K 40 20 10 6 4 Units of L 5 12 20 30 50 Point on diagram a b c d e a b c d e Units of labour (L) Units of capital (K) An isoquant ISOQUANT- ISOCOST ANALYSIS:  ISOQUANT- ISOCOST ANALYSIS Isoquants their shape diminishing marginal rate of substitution Diminishing marginal rate of factor substitution:  Units of capital (K) Units of labour (L) g h isoquant MRS = 2 Diminishing marginal rate of factor substitution Diminishing marginal rate of factor substitution:  Units of capital (K) Units of labour (L) g h j k DK = 2 DL = 1 isoquant MRS = 2 MRS = 1 MRS = DK / DL Diminishing marginal rate of factor substitution ISOQUANT- ISOCOST ANALYSIS:  ISOQUANT- ISOCOST ANALYSIS Isoquants their shape diminishing marginal rate of substitution an isoquant map An isoquant map:  Units of capital (K) Units of labour (L) An isoquant map ISOQUANT- ISOCOST ANALYSIS:  ISOQUANT- ISOCOST ANALYSIS Isoquants their shape diminishing marginal rate of substitution isoquants and returns to scale An isoquant map:  Units of capital (K) Units of labour (L) An isoquant map ISOQUANT- ISOCOST ANALYSIS:  ISOQUANT- ISOCOST ANALYSIS Isoquants their shape diminishing marginal rate of substitution isoquants and returns to scale isoquants and marginal returns Diminishing marginal rate of factor substitution:  Units of capital (K) Units of labour (L) g h j k DK = 2 DL = 1 isoquant MRS = 2 MRS = 1 MRS = DK / DL Diminishing marginal rate of factor substitution ISOQUANT- ISOCOST ANALYSIS:  ISOQUANT- ISOCOST ANALYSIS Isoquants their shape diminishing marginal rate of substitution isoquants and returns to scale isoquants and marginal returns Isocosts ISOQUANT- ISOCOST ANALYSIS:  ISOQUANT- ISOCOST ANALYSIS Isoquants their shape diminishing marginal rate of substitution isoquants and returns to scale isoquants and marginal returns Isocosts slope and position of the isocost An isocost:  Units of labour (L) Units of capital (K) Assumptions PK = £20 000 W = £10 000 TC = £300 000 An isocost An isocost:  Units of labour (L) Units of capital (K) TC = £300 000 a b c d Assumptions PK = £20 000 W = £10 000 TC = £300 000 An isocost ISOQUANT- ISOCOST ANALYSIS:  ISOQUANT- ISOCOST ANALYSIS Isoquants their shape diminishing marginal rate of substitution isoquants and returns to scale isoquants and marginal returns Isocosts slope and position of the isocost shifts in the isocost ISOQUANT- ISOCOST ANALYSIS:  Least-cost combination of factors for a given output point of tangency ISOQUANT- ISOCOST ANALYSIS Finding the least-cost method of production:  Units of labour (L) Units of capital (K) Finding the least-cost method of production Finding the least-cost method of production:  Units of labour (L) Units of capital (K) Finding the least-cost method of production ISOQUANT- ISOCOST ANALYSIS:  Least-cost combination of factors for a given output point of tangency comparison with marginal productivity approach ISOQUANT- ISOCOST ANALYSIS ISOQUANT- ISOCOST ANALYSIS:  Least-cost combination of factors for a given output point of tangency comparison with marginal productivity approach Highest output for a given cost of production ISOQUANT- ISOCOST ANALYSIS Finding the maximum output for a given total cost:  TPP2 TPP3 TPP4 TPP5 Units of capital (K) Units of labour (L) O TPP1 Finding the maximum output for a given total cost Finding the maximum output for a given total cost:  O Units of capital (K) Units of labour (L) TPP2 TPP3 TPP4 TPP5 TPP1 Finding the maximum output for a given total cost Finding the maximum output for a given total cost:  O Units of capital (K) Units of labour (L) TPP2 TPP3 TPP4 TPP5 TPP1 Finding the maximum output for a given total cost Finding the maximum output for a given total cost:  O K1 L1 Units of capital (K) Units of labour (L) TPP2 TPP3 TPP4 TPP5 r v s u TPP1 Finding the maximum output for a given total cost Background to Supply:  Background to Supply Long-run Costs LONG-RUN COSTS:  LONG-RUN COSTS Long-run average costs shape of the LRAC curve assumptions behind the curve Alternative long-run average cost curves:  Alternative long-run average cost curves Output O Costs Economies of Scale Alternative long-run average cost curves:  Output O Costs Alternative long-run average cost curves Diseconomies of Scale Alternative long-run average cost curves:  Output O Costs Alternative long-run average cost curves Constant costs A typical long-run average cost curve:  A typical long-run average cost curve Output O Costs A typical long-run average cost curve:  A typical long-run average cost curve Output O Costs Economies of scale Constant costs Diseconomies of scale LONG-RUN COSTS:  LONG-RUN COSTS Long-run average costs shape of the LRAC curve assumptions behind the curve Long-run marginal costs Long-run average and marginal costs:  Long-run average and marginal costs Output O Costs LRAC Economies of Scale Long-run average and marginal costs:  Output O Costs LRAC Long-run average and marginal costs Diseconomies of Scale Long-run average and marginal costs:  Output O Costs LRAC Long-run average and marginal costs = LRMC Constant costs Long-run average and marginal costs:  Output O Costs Long-run average and marginal costs LRAC Initial economies of scale, then diseconomies of scale LONG-RUN COSTS:  LONG-RUN COSTS Long-run average costs shape of the LRAC curve assumptions behind the curve Long-run marginal costs Relationship between long-run and short-run average costs LONG-RUN COSTS:  LONG-RUN COSTS Long-run average costs shape of the LRAC curve assumptions behind the curve Long-run marginal costs Relationship between long-run and short-run average costs the envelope curve Deriving long-run average cost curves: factories of fixed size:  Deriving long-run average cost curves: factories of fixed size Costs Output O 3 factories 2 factories 1 factory Deriving long-run average cost curves: factories of fixed size:  SRAC1 SRAC3 SRAC2 SRAC4 SRAC5 LRAC Costs Output O Deriving long-run average cost curves: factories of fixed size Deriving a long-run average cost curve: choice of factory size:  Deriving a long-run average cost curve: choice of factory size Costs Output O Examples of short-run average cost curves Deriving a long-run average cost curve: choice of factory size:  LRAC Costs Output O Deriving a long-run average cost curve: choice of factory size LONG-RUN COSTS:  LONG-RUN COSTS Long-run average costs shape of the LRAC curve assumptions behind the curve Long-run marginal costs Relationship between long-run and short-run average costs the envelope curve Long-run cost curves in practice LONG-RUN COSTS:  LONG-RUN COSTS Long-run average costs shape of the LRAC curve assumptions behind the curve Long-run marginal costs Relationship between long-run and short-run average costs the envelope curve Long-run cost curves in practice the evidence LONG-RUN COSTS:  LONG-RUN COSTS Long-run average costs shape of the LRAC curve assumptions behind the curve Long-run marginal costs Relationship between long-run and short-run average costs the envelope curve Long-run cost curves in practice the evidence minimum efficient plant size LONG-RUN COSTS:  Derivation of long-run costs from an isoquant map derivation of long-run costs LONG-RUN COSTS Slide95:  Units of capital (K) O Units of labour (L) Deriving an LRAC curve from an isoquant map Slide96:  Units of capital (K) O Units of labour (L) TC1 TC2 TC3 TC4 TC5 TC6 TC7 100 200 300 400 500 600 700 Deriving an LRAC curve from an isoquant map LONG-RUN COSTS:  Derivation of long-run costs from an isoquant map derivation of long-run costs the expansion path LONG-RUN COSTS Slide98:  Units of capital (K) O Units of labour (L) TC1 TC2 TC3 TC4 TC5 TC6 TC7 100 200 300 400 500 600 700 Expansion path Deriving an LRAC curve from an isoquant map Background to Supply:  Background to Supply Revenue REVENUE:  REVENUE Defining total, average and marginal revenue Revenue curves when firms are price takers (horizontal demand curve) average revenue (AR) marginal revenue (MR) Deriving a firm’s AR and MR: price-taking firm:  O O Price (£) AR, MR (£) Q (millions) Q (hundreds) S D (a) The market (b) The firm Deriving a firm’s AR and MR: price-taking firm Deriving a firm’s AR and MR: price-taking firm:  O O Price (£) AR, MR (£) Pe S D D = AR = MR Q (millions) Q (hundreds) (a) The market (b) The firm Deriving a firm’s AR and MR: price-taking firm REVENUE:  REVENUE Defining total, average and marginal revenue Revenue curves when firms are price takers (horizontal demand curve) average revenue (AR) marginal revenue (MR) total revenue (TR) Total revenue for a price-taking firm:  Total revenue for a price-taking firm TR (£) Quantity Quantity (units) 0 200 400 600 800 1000 1200 Price = AR = MR (£) 5 5 5 5 5 5 5 Total revenue for a price-taking firm:  TR (£) Quantity Quantity (units) 0 200 400 600 800 1000 1200 Price = AR = MR (£) 5 5 5 5 5 5 5 TR (£) 0 1000 2000 3000 4000 5000 6000 Total revenue for a price-taking firm Total revenue for a price-taking firm:  TR TR (£) Quantity Quantity (units) 0 200 400 600 800 1000 1200 Price = AR = MR (£) 5 5 5 5 5 5 5 TR (£) 0 1000 2000 3000 4000 5000 6000 Total revenue for a price-taking firm Total revenue for a price-taking firm:  TR TR (£) Quantity Total revenue for a price-taking firm REVENUE:  Revenue curves when price varies with output (downward-sloping demand curve) average revenue (AR) marginal revenue (MR) total revenue (TR) REVENUE Revenues for a firm facing a downward-sloping demand curve:  Revenues for a firm facing a downward-sloping demand curve Revenues for a firm facing a downward-sloping demand curve:  Revenues for a firm facing a downward-sloping demand curve Revenues for a firm facing a downward-sloping demand curve:  Revenues for a firm facing a downward-sloping demand curve AR and MR curves for a firm facing a downward-sloping D curve:  AR and MR curves for a firm facing a downward-sloping D curve Q (units) 1 2 3 4 5 6 7 P =AR (£) 8 7 6 5 4 3 2 AR AR, MR (£) Quantity AR and MR curves for a firm facing a downward-sloping D curve:  Q (units) 1 2 3 4 5 6 7 P =AR (£) 8 7 6 5 4 3 2 TR (£) 8 14 18 20 20 18 14 MR (£) 6 4 2 0 -2 -4 MR AR, MR (£) Quantity AR and MR curves for a firm facing a downward-sloping D curve AR REVENUE:  Revenue curves when price varies with output (downward-sloping demand curve) average revenue (AR) marginal revenue (MR) total revenue (TR) REVENUE TR curve for a firm facing a downward-sloping D curve:  TR curve for a firm facing a downward-sloping D curve Quantity TR (£) TR curve for a firm facing a downward-sloping D curve:  TR curve for a firm facing a downward-sloping D curve TR Quantity TR (£) Quantity (units) 1 2 3 4 5 6 7 P = AR (£) 8 7 6 5 4 3 2 TR (£) 8 14 18 20 20 18 14 REVENUE:  Revenue curves when price varies with output (downward-sloping demand curve) average revenue (AR) marginal revenue (MR) total revenue (TR) revenue curves and price elasticity of demand REVENUE TR curve for a firm facing a downward-sloping D curve:  TR curve for a firm facing a downward-sloping D curve TR Elastic Inelastic Quantity TR (£) AR and MR curves for a firm facing a downward-sloping D curve:  AR, MR (£) Quantity AR and MR curves for a firm facing a downward-sloping D curve MR AR REVENUE:  Revenue curves when price varies with output (downward-sloping demand curve) average revenue (AR) marginal revenue (MR) total revenue (TR) revenue curves and price elasticity of demand Shifts in revenue curves REVENUE Background to Supply:  Background to Supply Profit Maximisation PROFIT MAXIMISATION:  PROFIT MAXIMISATION Using total curves maximising difference between TR and TC Finding maximum profit using total curves:  TR, TC, TP (£) Quantity Finding maximum profit using total curves Finding maximum profit using total curves:  TR, TC, TP (£) TR Quantity Finding maximum profit using total curves Finding maximum profit using total curves:  TR, TC, TP (£) TR TC Quantity Finding maximum profit using total curves PROFIT MAXIMISATION:  PROFIT MAXIMISATION Using total curves maximising difference between TR and TC the total profit curve Finding maximum profit using total curves:  TR, TC, TP (£) TP TR TC Quantity Finding maximum profit using total curves Finding maximum profit using total curves:  TR, TC, TP (£) TP TR TC a b c d Quantity Finding maximum profit using total curves Finding maximum profit using total curves:  TR, TC, TP (£) TP TR TC Quantity Finding maximum profit using total curves PROFIT MAXIMISATION:  PROFIT MAXIMISATION Using total curves maximising difference between TR and TC the total profit curve Using marginal and average curves PROFIT MAXIMISATION:  PROFIT MAXIMISATION Using total curves maximising difference between TR and TC the total profit curve Using marginal and average curves stage 1: profit maximised where MR = MC Finding the profit-maximising output using marginal curves:  Quantity Costs and revenue (£) Finding the profit-maximising output using marginal curves Finding the profit-maximising output using marginal curves:  Quantity Costs and revenue (£) MC Finding the profit-maximising output using marginal curves Finding the profit-maximising output using marginal curves:  Quantity Costs and revenue (£) MR MC Finding the profit-maximising output using marginal curves PROFIT MAXIMISATION:  PROFIT MAXIMISATION Using total curves maximising difference between TR and TC the total profit curve Using marginal and average curves stage 1: profit maximised where MR = MC stage 2: using AR and AC curves to measure maximum profit Measuring the maximum profit using average curves:  Quantity Costs and revenue (£) Measuring the maximum profit using average curves MR MC Measuring the maximum profit using average curves:  Quantity Costs and revenue (£) MR MC AR Measuring the maximum profit using average curves Measuring the maximum profit using average curves:  T O T A L P R O F I T MR Quantity Costs and revenue (£) MC AC AR Total profit = £1.50 x 3 = £4.50 Measuring the maximum profit using average curves PROFIT MAXIMISATION:  Some qualifications long-run profit maximisation the meaning of profit What if a loss is made? loss minimising: still produce where MR = MC PROFIT MAXIMISATION Loss-minimising output:  O Costs and revenue (£) Quantity Loss-minimising output PROFIT MAXIMISATION:  Some qualifications long-run profit maximisation the meaning of profit What if a loss is made? loss minimising: still produce where MR = MC short-run shut-down point: P = AVC PROFIT MAXIMISATION The short-run shut-down point:  The short-run shut-down point O Costs and revenue (£) Quantity PROFIT MAXIMISATION:  Some qualifications long-run profit maximisation the meaning of profit What if a loss is made? loss minimising: still produce where MR = MC short-run shut-down point: P = AVC long-run shut-down point: P = LRAC PROFIT MAXIMISATION

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