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Chapter 6 Supply

The Cost Side of the Market

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Market: Demand meets Supply

Demand: – Consumer– buy to consume

Supply: – Producer– produce to sell

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Recall: demandwillingness vs. ability to consume

Willingness: satisfaction (total utility)

Ability: budget

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similarly: supplywillingness vs. ability to produce

Willingness: produce to sell for profit– Profit = total revenue – total cost

= PxQ - TC– total production (Q) when P and C are

given Ability: cost

（ to pay for production factors ）

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Recall: Consumer Decision-Making

The goal: to maximize Total Utility (willingness)

by choosing:– the Optimal Quantities of goods and

services to consume subject to: (ability)

– limited income– market prices of the goods and services

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similarly: Producer Decision-Making

The goal: to maximize Profit (willingness)

by choosing:– the Optimal Quantities of goods and

services to produce subject to: production cost (ability)

– inputs– prices of inputs

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The goal for producers

Maximize profit Profit = price of output x quantity produced

- production cost Price of output:

– determined by market (not affected by single producer in perfectly competitive market)

Production cost: determined by – quantity of input based on quantity of output

produced and technology applied– Input prices

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The Production Function

the relationship between the quantity of inputs a firm uses and the quantity of output it produces.

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Inputs (Production Factors)

Resources used in the production process labor (L) capital (K) natural resources (N) entrepreneurship (E)

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Inputs: Fixed vs. Variable

Fixed input: – the level of its usage cannot be readily changed

(the level of its usage does not change along with level of output)

– An input whose quantity cannot be altered in the short run

Variable input: – the level of its usage may be readily changed (the

level of its usage changes along with the level of output)

– An input whose quantity can be altered in the short run

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Short-run vs. Long-run

Short-run: – the period of time in which at least one

input is fixed.– A period of time sufficiently short that at

least some of the firm’s factors of production are fixed

Long-run: – the period of time in which all inputs are

variable.

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Production Function

Q = f (L, K, N, E) A relationship between inputs and

outputs, assuming technical efficiency.

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Technical Efficiency

The maximum level of output is obtained from a given combination of inputs

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Economic Efficiency

A given amount of output is produced using the combination of inputs that costs the least (at minimum cost)

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Short-Run Production:some inputs are fixed

Total Product: Q = f (L, K, N, E)

Usually assume N and E given Total Product of Labor:

Q = f (L) (K, N, E fixed)

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TP Curve: Total Product

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Recall: Sarah’s Total Utility from Ice Cream Consumption

Figure 5.2, p.130

Based on table 5.1, p.129

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Recall: Diminishing Marginal Utility for Sarah from ice-cream

Figure 5.3, p. 131

Based on Table 5.2, p.130

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MP: Marginal Product

The marginal product of an input is the additional quantity of output that is produced by using one more unit of that input.

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TP Curve: Total Product

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Marginal Product of Labor Curve

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Diminishing Returns to an Input (diminishing marginal product)

diminishing returns to an input: an increase in the quantity of an input leads to a decline in the marginal product of that input, holding the levels of all other inputs fixed

Other things held constant, as more of a variable input is used in production, its marginal productivity will decline after a certain point.

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Recall: Key Points for Sarah’s example

TU first increases then max out and starts to decrease

TU increases at a slower pace TU is maximized when MU=0 MU is decreasing but positive when TU is

increasing MU is decreasing and negative when TU is

decreasing MU = 0 when TU is maximized

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similarly:

TP first increases then max out and starts to decrease

TP increases at a slower pace TP is maximized when MP=0 MP is decreasing but positive when TP is

increasing MP is decreasing and negative when TP is

decreasing MP = 0 when TP is maximized

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Total Product, Marginal Product, and the Fixed Input

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Short-Run Production:some inputs are fixed

Total Product: Q = f (L, K, N, E) Total Product of Labor: Q = f (L) (K, N, E fixed) Marginal Product of Labor:

MPL= dQ / dL Average Product of labor: APL=Q/L

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Short-Run Production:Q, AP, MP, and shift in Q

L \ K 1 2 3 4 5 1 25 52 74 90 100 2 55 112 162 198 224 3 83 170 247 303 342 4 108 220 325 400 453 5 125 258 390 478 543 6 137 286 425 523 598

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K=1

L TP=Q MP AP

1 25 25 25

2 55 30 22.5

3 83 28 27.7

4 108 25 27

5 125 17 25

6 137 12 22.8

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Production: one input

TP = Q = f(L,K,N,E) When K,N,E fixed: SR TP(L) = f (L) AP(L) = TP(L) / L MP(L) = dTP(L) /dL MP is the slope of TP TP maximized when MP = 0

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Short-Run Production: Summary

L=0 leads to Q=0 when MP is increasing, Q is increasing

at an increasing rate when MP is decreasing, Q may still

increase but at a decreasing rate When MP=0, Q stop increasing and

start decreasing (Q is maximized). AP reaches its maximum when AP=MP

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Q

L0

TP

AP

MP

E

A B

Ⅰ Ⅱ ⅢF

MP>APAP

MP<APAP

MP<0TP

MP=APAP Max

MP=0TP Max