1

Lecture 3: Supply

Advanced Micro TheoryMSc.EnviNatResEcon.

1/2005Charit Tingsabadh

2

Outline

• Supply concept

• Production function

• Cost function

• Empirical examples

3

Supply concept

• Supply: offer of goods at a price

• Goods are produced-output

• Using inputs-- as factors of production—in combination

• Factors include: land, labour, capital, energy, materials, etc.

• Technology of production

4

Supply concept

• Scale effect: constant, increasing, decreasing return to scale

• Relation between output and input at different levels of output

• Division of labour as an example:

5

Supply concept

• The short run and the long run• Short run: all factors fixed except one• Usually capital/technology are fixed, only

labour variable. Capacity utilization index.• Long run: all factors variable, new

technology• Let’s have some case examples: IT,

automation etc.

6

Representation

• Production function

• Relation between output Q and factors of production – labour, capital, materials, energy, nature etc.

• Various functional forms

• Cobb-Douglas, CES, Translog etc.

7

Production function

• Example: Q=f(K,L)

• Cobb-Douglas:

• Q=aKL (1-)

• Other forms

• Total, average, marginal product

• Factor substitution as part of technology option-may be possible, may be not.

8

Cost function

• Dual of production function• Factors have prices, so can calculate cost of

production• C = wL + rK,• So, what is the production problem?• What combination of factors (what

technology) to choose to produce the output?

9

Supply concept

• So far, assume fixed output

• But decision is about how much to produce, with what combination of factors, so need to account for the output side as well

• So, cost expressed in terms of output.

• Total, average, marginal cost, with respect to output.

10

Supply concept

• Types of costs

• Fixed cost and variable cost

• Varies with output

11

Supply concept

• Demand for factors of production-labour, capital

• As derived demand• Demand determined by marginal product of

factor • Consider case of labour, when to employ

new worker? • And capital, when to invest?

12

Dynamic perspectives

• Technology on the move, innovations• Types of innovation: product, process• Stable vs. disruptive• Types of technical progress: Hicks-neutral,

capital/labour saving;Harrod-neutral; vintage-embodied/disembodied technical progress

• Measurement of technical progress: growth accounting

13

14

Empirical functions

• Search and destroy mission:

• Find your own production/cost function and write a critique of the study.

15

Production function - Wikipedia, the free encyclopedia.htm

16

The Cost Function.htm

17

18

Homework

• Using the internet, obtain data on bananas: quantities, prices, etc.

• Develop 1 demand function and 1 supply function for your bananas and

• Estimate the price and income elasticities for your bananas, using the equation that you have developed.

• Enjoy!