Welcome to Day 8. Principles of Microeconomics

Transcription

1 rinciples of Microeconomics Welcome to Day 8 Goals for Today 1) Short-run and long-run 2) Specialization of labor 3) Diminishing marginal returns 4) Graphing marginal cost and average total cost. Now we move into chapter 7 to talk about production and cost. We ve already seen in our elasticity of supply discussion that time matters for how much is produced. Two Time Frames Short-Run: Some inputs are fixed Long-Run: All inputs are variable Marginal roduct of Labor (ML) is the increase in total output gained by adding one more worker. / L N ML N ML Why would ML be rising? 1

2 Specialization of Labor 1) Take advantage of natural abilities. 2) More practice and training at specific jobs. 3) Less time lost walking between jobs. N ML Specialization of Labor Region N ML Specialization of Labor Region Why would ML be falling? Diminishing Marginal Returns As more variable factors are added to work with a fixed factor, eventually output rises at a diminishing rate. N ML Specialization of Labor Region Diminishing Marginal Returns Region roductivity of Labor Measured in ML Bushels of Wheat Spec. of Labor Reg. Dim. Mar. Ret. Reg Number of Workers 2

3 Now that we know what ML is, here is a new statistic for you. Average roduct of Labor (AL) = /N Average-Marginal Rule: When the marginal is above the average, the average rises; when the marginal is below the averge, the average fall. N ML AL Marginal and Average roduct of Labor on the same graph. Bushels of Wheat ML AL Number of Workers Marginal and Average roduct of Labor on the same graph. Bushels of Wheat S.o.L. Region AL ML D.M.R. Region Output ML AL Number of Workers Number Workers 3

4 Fixed Costs (don t change as production varies): Lease ayments Interest on Loans Some Insurance I told you the productivity story just so I can tell you the cost story. Variable Costs (do change as production varies): Labor Supply Electricity TFC TVC TC ATC If workers cost $ each, how many workers did the firm hire to build 1 radio? How about 2 radios? Why does it take 2 full workers to make the first radio, but only another 1.5 to make the second radio? The workers must be getting more productive. Why would that be? Why does it take 2 full workers to make the first radio, but only another 1.5 to make the second radio? The workers must be getting more productive. Why would that be? Specialization of Labor 4

5 Why does it take 4 workers to make radio 4, but 6 workers to make radio 5? Why does it take 4 workers to make radio 4, but 6 workers to make radio 5? Diminishing Marginal Returns TFC TVC TC ATC Above the green line is SoL. Below is DMR. Marginal Cost and Average Total Cost on the same graph. Cost in Dollars ATC Output Marginal Cost and Average Total Cost on the same graph. Dollars Fixed Cost Specialization of labor Diminishing Marginal Returns ATC Output What we learned today. 1) Short-run and long-run. 2) Marginal product of labor. 3)Specialization of labor and diminishing marginal returns. 4) Average-marginal rule. 5) How productivity affects cost. 6) How to graph marginal and average total cost. 5

6 rinciples of Microeconomics Welcome to Day 9 What we learned last class: 1) Short-run and long-run. 2) Marginal product of labor. 3)Specialization of labor and diminishing marginal returns. 4) Average-marginal rule. 5) How productivity affects cost. 6) How to graph marginal and average total cost. Goals for Today 1) Long-run average total cost. 2) Economies of scale, diseconomies of scale, and constant returns to scale. 3) Three properties of perfect competition. 4) Marginal revenue. 5) rofit maximizing for a firm in perfect competition. In the short-run, the size of the factory is fixed. In the long-run, the size of the factory can be varied. The LRATC is made up of segments of the various possible SRATC curves. Economies of Scale -LRATC is falling as you produce more in a larger factory. Constant returns to Scale -LRATC is staying the same as you produce more in a larger factory. Diseconomies of Scale -LRATC is rising as you produce more in a larger factory 6

7 Why Economies of Scale? 1) Specialization of Labor 2) Mass roduction Techniques Assembly Lines Why Diseconomies of Scale? 1) Leviathan roblems Would you always want to produce in constant returns to scale since that is the lowest cost of production area? 2) Law of Increasing Opportunity Cost roblems Would you always want to produce in constant returns to scale since that is the lowest cost of production area? No! How many customers you have and how much they are willing to pay matters also. Alright, so you learned all this about productivity and cost. What is the business actually going to do? For that, we have to bring in the customers. 7

8 Businesses operate in different environments, called market structures. There are 4 market structures. Each market structure is defined by: 1) How many firms sell in it. 2) How close the firms products are to each other. 3) How easy it is to get into or out of the market. The first market structure is erfect Competition 1) Many sellers and buyers. 2) Firms sell identical goods. 3) There is easy entry/exit. Because there are many firms selling identical products, the sales price is the same for all firms. These firms are called rice Takers. erfect Competition examples are: 1) Small farms. 2) Stockbrokers selling identical stock. 3) Miners. 4) Fishermen A small wheat farmer has a demand curve that looks like this: $5.98 Demand Curve 8

9 He s not worried that he will produce so much wheat he will drive the world price of wheat down. The world demand curve for wheat is still downward sloping, but he is too small to make any difference. Just like you buying potato chips. Marginal Revenue is the increase in total revenue gained with each additional sale. It is a before cost is taken out number. For firms in perfect competition, marginal revenue = price. A small wheat farmer has a marginal revenue curve that looks like this: $5.98 Demand Curve Marginal =Revenue Curve The farmer does not get to pick his price, but he does get to pick his quantity of wheat grown. He will do what makes him the most money. TR TC π rice=$ TR = x 1 0 π= rofit TR = Total Revenue TC = Total Cost 9

10 TR TC π MR To maximize profit, produce the wheat that has MR> and don t produce the wheat that has >MR. Don t sell any lemonade that costs more than cents to make. What We Learned Today: If you can produce fractions rather than just integers, then produce the level of output where MR=. This is called the Fundamental Rule of rofit Maximization. 1) Long-run average cost. 2) Economies of scale, diseconomies of scale, and constant returns to scale. 3) Three properties of perfect competition. 4) Marginal revenue. 5) rofit maximizing for a firm in perfect competition. rinciples of Microeconomics Welcome to Day What We Learned Last Class: 1) Long-run average cost. 2) Economies of scale, diseconomies of scale, and constant returns to scale. 3) Three properties of perfect competition. 4) Marginal revenue. 5) rofit maximizing for a firm in perfect competition.

11 Goals for Today 1) Graphing a firm in perfect competition. 2) When a firm losing money should shut-down. 3) The firm s supply curve in the shortrun and market equilibrium 4) Entry, Exit, and long-run equilibrium. 5) Increasing, constant, and decreasing cost industries. Just because you follow the fundamental rule of profit maximization doesn t mean you necessarily make a positive profit. Sometimes the best you can do is to lose the least. TR TC π MR Note that you can t avoid a loss by shutting down. If you shut down, you lose fixed cost. What should you do here? Is there a way to know if you are making a profit or losing money just using the price and the ATC of production? TR = x TC = ATC x TR = x TC = ATC x The s will be the same for both equations. So if >ATC, this firm is making money. If <ATC, this firm is losing money. 11

12 So how do you graph this all out? First, the fundamental rule of profit maxization: produce the quantity where MR = roduce at π to maximize profit. Cost in Dollars MR π Output π MR π Here, intersects MR twice. Always use the 2 nd point of interception. MR,, and are not enough to know if you are making a positive profit. As fixed costs rise, these numbers do not change, yet your profit is falling. You need to add ATC. π MR ATC π MR ATC π Here we have profit because >ATC. π Here we have a loss because ATC>. 12

13 When should a firm just give up and shut-down? When its loss from operating is greater than its fixed cost. Firm 1 Firm 2 TR $400 $400 TFC $0 $0 TVC $395 $405 TC $495 $505 rofit $-95 $-5 What should each firm do? Keep operating when TR>TVC. TR = x TVC = AVC x 1 Keep operating when >AVC Shutdown when <AVC = AVC is the shutdown price. How much will this firm produce at 1? MR MR2 MR1 MR3 1 What about at 2 and 3? We have marked 3 points on the firms supply curve. 13

14 2 1 3=S Supply Curve The market supply curve is all the individual supply curves added together. Individual firm supply curves Market Supply Curve The firm s marginal cost curve is its supply curve down to the Shutdown rice (S) Now we add the demand curve and we get where the market price comes from E S D The market price for wheat is the price such that each farm, in response to that price, wants to grow an amount of wheat which, when all the farms are added together, equals the amount of wheat that customers want to buy at that price. This is what chapter 3 said, also. Now let s talk about the long-run, so enough time goes by that new farms can enter the market. Before we do so, let s be a bit more exact about what we mean by cost and profit. Explicit Cost is actual money paid out. Implicit Cost is the value of resources used for which no money is paid. For example: time and already owned land. 14

15 Accounting profit is Total Revenue minus Explicit Cost. Economic rofit is Total Revenue minus both Explicit and Implicit Cost. The economic profit of a choice can also be understood as how much more you make doing this choice than the next best choice. You are offered $0 to work all day on project A and $60 to work all day on project B. What is your economic profit of choosing A? Suppose woman A and woman B want to start two similar businesses. Woman A has an $80,000 job she would have to quit to run her business, but woman B is unemployed and we count her time as having 0 value. How does this affect their accounting and economic profits? Woman A Woman B Total Revenue $0,000 $0,000 Explicit Cost $60,000 $60,000 Accounting rofit $40,000 $40,000 Implicit Cost $80,000 $0 Economic rofit -$40,000 $40,000 Economic profit is a better predictor of behavior. We would predict woman A will not start this business and woman B will. So now enough time goes by for new wheat farms to open up. When will new farms be started? When wheat farms are making money, that is, have a positive economic profit. 15

16 How long will the new farms keep coming in? Remember, entry is easy. Till profits go to zero. If profits are negative (in other words, losses), then farms will leave in the long-run until profits are zero. So no matter where you start, profits in the long-run go to zero because of easy entry/exit. So what does the long-run equilibrium look like? Let s think about how the long-run responds to an increase in demand. Start at a long-run equilibrium with profits for the typical wheat farm at $0. ATC 1 MR= How much will this firm produce at 1? Now there is an increase in market demand and the price rises to 2 in the short-run. S short-run 2 MR 1 = ATC MR 2 = 2 1 D1 D2 This firm is now making a profit. This attracts entry. 16

17 2 1 ATC MR 2 = 2 MR 1 = 1 There has to be a new equilibrium back at 1. For this to happen, the long-run supply curve has to be flat. S short-run 2 How far will the price have to fall until profit is back to zero? 1 = 3 D D S Long-run 2 1 = 3 ATC MR 2 = 2 MR 1 = 1 MR 3 = 3 But I fear we have proven too much. It looks like in the long-run, price always goes back to where it started, and I don t believe this. And profits are back to zero. BTW, this farm is back to producing where it started, so where is all the additional wheat coming from? 2 ATC MR 2 = ATC 2 ATC 1 MR 2 = 2 1 MR 1 = 1 1 MR 1 = 1 How can we get back to zero profits as new firms come in with the price ending up higher than 1? That s right. If ATC rises as new firms enter the market. 17

18 So now 3 will be higher than 1 when ATC rises as new firms enter. 2 3 S short-run 1 D 2 D S Long-run This case of rising ATC as new firms enter is called an Increasing Cost Industry. The first case where ATC stayed constant is called a Constant Cost Industry. Which case seems more likely? Could it even be possible that as more firms enter the market, the ATC falls? Think about what happens if wheat farms need tractors, and tractors are made with economies of scale. For this Decreasing Cost Industry, the long-run price 3 will be lower than the starting price 1 if there is an increase in demand. This means there must be a downward sloping long-run supply curve. Now 3 is less than 1. And increase in demand has lead to a lower price. S short-run Let s review and simplify. Increasing Cost Industry: Cost rises as more is made -LRS slopes up S Long-run 2 1 D 2 S Long-run D D D 1 18

19 Constant Cost Industry: Cost stays the same as more is made - LRS slopes straight across. Decreasing Cost Industry: Cost falls as more is made -LRS slopes down. 1 = 2 D 2 S Long-run D D D 2 S Long-run Where does all this leave the law of supply? It is still true that short-run supply curves always slope up. But now this is primarily because of diminishing marginal returns rather than the next worker getting worse. In the long-run, supply curves usually slope up as more resources are used and the workers get worse; but it is possible for the supply curve to slope down if significant inputs are made with economies of scale. As we add more complexity to the model, our previously simple answers grow more complex. What we learned today: 1) Graphing a firm in perfect competition. 2) When a firm losing money should shut-down. 3) The firm s supply curve in the shortrun and market equilibrium 4) Entry, Exit, and long-run equilibrium. 5) Increasing, constant, and decreasing cost industries. 19