Scribd
Upload
74 views49 pages

Session 6 - Production and Producer's Equilibrium

This document outlines the key concepts of production, costs, and profit maximization for firms. It discusses [1] the law of supply and how firms respond to price changes, [2] the various types of costs including fixed, variable, and average costs, and [3] the relationship between costs and output using production functions and cost curves. Specifically, it explains that profit maximization occurs where marginal revenue equals marginal cost, which determines the profit-maximizing quantity of output for the firm.

Uploaded by

Anushkaa Datta
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PDF, TXT or read online on Scribd
74 views49 pages

Session 6 - Production and Producer's Equilibrium

This document outlines the key concepts of production, costs, and profit maximization for firms. It discusses [1] the law of supply and how firms respond to price changes, [2] the various types of costs including fixed, variable, and average costs, and [3] the relationship between costs and output using production functions and cost curves. Specifically, it explains that profit maximization occurs where marginal revenue equals marginal cost, which determines the profit-maximizing quantity of output for the firm.

Uploaded by

Anushkaa Datta
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PDF, TXT or read online on Scribd
You are on page 1/ 49

Production and Producer’s

Equilibrium
By
Saswat Kishore Mishra
PhD (Economics)
Assistant Professor

Administrative Staff College of India


Bella Vista, Raj Bhavan Road
1
Hyderabad – 500082, INDIA
OUTLINE

1) Recall:The Law of Supply


2) What are Costs?
3) Production and Costs
4) Measures of Costs
5) Costs in the Short-run and Long-run
6) Profit Maximization: Production
Decision Rule
2
1. Recall: Supply and the Law of Supply

o An economy made up of thousands of


firms that produce good and services
o Some firms employ thousands of
workers and have thousands of
stockholders
o Others are small, with few workers and
largely owned by single person or
family
3
Cont.

Law of Supply
o … firms are willing to produce and
sell a greater quantity of a good
when the price of the good is higher
o … this response leads to a supply
curve that slopes upward

4
Cont.

Here
o … will have a better understanding of
the decisions behind the supply curve
o … addresses a question – How does
the number of firms affect the prices
in a market and the efficiency of the
market outcome?
5
2. What are Costs?

The Firm’s Objective


o … The Economic Goal of the Firm is
to Maximize Profits

6
Cont.

What is a Firm’s Profit?


o Profit = Total Revenue – Total Cost
o Total Revenue (TR) is the amount
that the firm receives from the sale of
its output
o Total Cost (TC) is the amount that the
firm pays to buy inputs
7
Cont.

How to measure Total Revenue and


Total Cost ???
o Measurement of –
▪ Total Revenue – straightforward
▪ Total Cost – very subtle

8
Cont.

Costs as Opportunity Costs


o A firm’s cost of production
includes all the opportunity costs
of making its output of goods and
services

9
Cont.

Explicit and Implicit Costs


o A firm’s cost of production include
explicit costs and implicit costs
• Explicit costs are input costs that require
a direct outlay of money by the firm
• Implicit costs are input costs that do not
require an outlay of money by the firm

10
Cont.

Economic Profit versus Accounting Profit


o Economists measure a firm’s economic
profit as total revenue minus total cost,
including both explicit and implicit
costs
o Accountants measure the accounting
profit as the firm’s total revenue minus
only the firm’s explicit costs
11
Cont.

Economic Profit versus Accounting Profit


o When total revenue exceeds both
explicit and implicit costs, the firm
earns economic profit
• Economic profit is smaller than
accounting profit

12
Economists versus Accountants

13
3. Production and Costs

The Production Function


o … shows the relationship between
quantity of inputs used to make a
good and the quantity of output of
that good

14
Cont.

Marginal Product
o The marginal product of any input
in the production process is the
increase in output that arises from
an additional unit of that input

15
A Production Function and Total Cost

16
Cont.

Diminishing Marginal Product


o … property whereby the marginal
product of an input declines as the
quantity of the input increases
• Ex: As more and more workers are hired at
a firm, each additional worker contributes
less and less to production because the firm
has a limited amount of equipment
17
Production Function

18
Cont.

Diminishing Marginal Product


o The slope of the production function
measures the marginal product of an
input, such as a worker
o When the marginal product declines,
the production function becomes
flatter
19
Cont.

From the Production Function to


the Total-Cost Curve
o The relationship between the
quantity a firm can produce and its
costs determines pricing decisions
o The total-cost curve shows this
relationship graphically
20
A Production Function and Total Cost

21
Total Cost Curve

22
4. Various Measures of Costs

Costs of Production may be divided


into Fixed Costs andVariable Costs
o Fixed costs are those costs that do not
vary with the quantity of output
produced
o Variable costs are those costs that do
vary with the quantity of output
produced
23
Cont.

Total Costs
o Total Fixed Costs (TFC)
o TotalVariable Costs (TVC)
o Total Costs (TC)
TC = TFC + TVC

24
The Various Measures of Cost

25
Cont.

As an owner, you must decide


how much to produce?
o How much does it cost to make the
typical cup of coffee?
o How much does it cost to increase
production of coffee by 1 cup?

26
Cont.

Average Costs
o Average costs can be determined
by dividing the firm’s costs by the
quantity of output it produces
o The average cost is the cost of each
typical unit of product

27
Cont.

Average Costs
o Average Fixed Costs (AFC)
o AverageVariable Costs (AVC)
o Average Total Costs (ATC)
ATC = AFC + AVC

28
Average Costs
Fixed cost FC
AFC = =
Quantity Q

Variable cost VC
AVC = =
Quantity Q

Total cost TC
ATC = =
Quantity Q
29
The Various Measures of Cost

30
Marginal Costs (MC)
o … measures the increase in total cost
that arises from an extra unit of
production
o … helps answer the following question:
• How much does it cost to produce an
additional unit of output?
(change in total cost) TC
MC = =
(change in quantity) Q
31
Total Cost Curve

32
Average Cost and Marginal Cost

33
Cont.

Cost Curves and their Shapes


o Marginal cost rises with the
amount of output produced
o This reflects the property of
diminishing marginal product

34
Marginal Cost (MC) Curve

35
Cont.

The Average Total-Cost (ATC) Curve is


U-shaped
o At very low levels of output ATC is high
because fixed cost is spread over only a
few units
o ATC declines as output increases
o ATC starts rising because AVC rises
substantially
36
Cont.

The Average Total-Cost (ATC) Curve is


U-shaped
o The bottom of the U-shaped ATC
curve occurs at the quantity that
minimizes average total cost
o This quantity is sometimes called the
efficient scale of the firm
37
Average Total Cost (ATC) Curve

38
Cont.

Relationship between Marginal Cost


and Average Total Cost
1) Whenever marginal cost is less than
average total cost, average total cost is
falling
2) Whenever marginal cost is greater than
average total cost, average total cost is
rising
39
Cont.

Relationship between Marginal Cost


and Average Total Cost
3) The marginal-cost curve crosses the
average-total-cost curve at the
efficient scale
o Efficient scale is the quantity that
minimizes average total cost
40
ATC and MC Curves

41
5. Costs in the Short Run and in
the Long Run
o For many firms, the division of total
costs between fixed and variable costs
depends on the time horizon being
considered
• In the short run, some costs are fixed
• In the long run, fixed costs become
variable costs

42
Cont.

o Because many costs are fixed in the


short run but variable in the long
run, a firm’s long-run cost curves
differ from its short-run cost curves

43
ATC in the Short and Long Run

44
Economies and Diseconomies of Scale

45
6. Profit Maximization: Production
Decision Rule
Average Revenue (AR) = revenue earned per
unit of output
=> AR = TR/Q = P = price per unit of
output = demand
 AR curve is the demand curve
Marginal Revenue (MR) = ΔTR/ΔQ
= change in TR due to a unit change in
output
46
Cont.

47
Profit maximization occurs when MR = MC

48
49

You might also like