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Introduction to Production and Resource Use

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Title: Introduction to Production and Resource Use


1
Introduction toProduction and Resource Use
  • Chapter 6

2
Topics of Discussion
  • Conditions of perfect competition
  • Classification of inputs
  • Important production relationships (assume one
    variable input in this chapter)
  • Assessing short run business costs
  • Economics of short run decisions

3
Conditions for Perfect Competition
  • Homogeneous products
  • No barriers to entry or exit
  • Large number of sellers
  • Perfect information

Page 109
4
Classification of Inputs
  • Land includes renewable (forests) and
    non-renewable (minerals) resources
  • Labor all owner and hired labor services,
    excluding management
  • Capital manufactured goods such as fuel,
    chemicals, tractors and buildings
  • Management production decisions designed to
    achieve specific economic goal

Page 110
5
Production Function
Output f(labor capital, land,
and management)
Start with one variable input
Page 112
6
Production Function
Output f(labor capital, land,
and management)
Start with one variable input
assume all other inputs fixed at their
current levels
Page 112
7
Coordinates of input and output on the TPP curve
Page 112
8
Total Physical Product (TPP) Curve
Variable input
Page 113
9
Law of DiminishingMarginal Returns
As successive units of a variable input are
added to a production process with the other
inputs held constant, the marginal
physical product (MPP) eventually declines
Page 113
10
Other Physical Relationships
The following derivations of the TPP curve
play An important role in decision-making Margin
al Physical ? Output ? Input Product
Pages 114-115
11
Other Physical Relationships
The following derivations of the TPP curve
play An important role in decision-making Margin
al Physical ? Output ? Input Product
Average Physical Output
Input Product
Pages 114-115
12
Change in output as you increase inputs
Page 112
13
Total Physical Product (TPP) Curve
Marginal physical product is .45 as labor is
increased from 16 to 20
?output
?input
Page 113
14
Output per unit input use
Page 112
15
Total Physical Product (TPP) Curve
Average physical product is .31 if labor use is
26
output
input
Page 113
16
Plotting the MPP curve
Change in output associated with a change in
inputs
Page 114
17
Marginal Physcial Product
Change from point A to point B on the production
function is an MPP of 0.33
Page 114
18
Plotting the APP Curve
Level of output divided by the level of input use
Page 114
19
Average Physical Product
Output divided by labor use is equal to 0.19
Page 114
20
Three Stages of Production
Average physical product (yield) is increasing in
Stage I
Page 114
21
Three Stages of Production
Marginal physical product falls below the average
physical product in Stage II
Page 114
22
Three Stages of Production
MPP goes negative as shown on Page 112
Page 114
23
Three Stages of Production
Why are Stage I and Stage III irrational?
Page 114
24
Three Stages of Production
Productivity rising so why stop???
Output falling
Page 114
25
Three Stages of Production
The question therefore is where should I operate
in Stage II?
Page 114
26
Economic Dimension
  • We need to account for the price of the product
  • We also need to account for the cost of the inputs

27
Key Cost Relationships
The following cost derivations play a key role in
decision-making Marginal cost ? total cost
? output
Page 117-120
28
Key Cost Relationships
The following cost derivations play a key role in
decision-making Marginal cost ? total cost
? output Average variable total variable
cost output cost
Page 117-120
29
Key Cost Relationships
The following cost derivations play a key role in
decision-making Marginal cost ? total cost
? output Average variable total variable
cost output cost Average total
total cost output cost
Page 117-120
30
From TPP curve on page 113
Page 118
31
Fixed costs are 100 no matter the level
of production
Page 118
32
Column (2) divided by column (1)
Page 118
33
Costs that vary with level of production
Page 118
34
Column (4) divided by column (1)
Page 118
35
Column (2) plus column (4)
Page 118
36
Change in column (6) associated with a change in
column (1)
Page 118
37
Column (6) divided by column (1) or
Page 118
38
or column (3) plus column (5)
Page 118
39
Lets graph the cost series in this table
40
Plotted cost relationships from table 6.3 on page
118
Plotting costs for levels of output
Page 119
41
Now lets assume this firm can sell its product
for 45/unit
42
Key Revenue Concepts
Notice the price in column (2) is identical to
marginal revenue in column (7). What about
average revenue, or AR? What do you see if you
divide total revenue in column (3) by output in
column (1)? Yes, 45. Thus, P MR AR under
perfect competition.
Page 122
43
Lets see this in graphical form
44
45
PMRAR
Profit maximizing level of output, where MRMC
11.2
Page 123
45
Average Profit 17, or AR ATC
PMRAR
45-28
28
Page 123
46
Grey area represents total economic profit if the
price is 45
PMRAR
11.2 ? (45 - 28) 190.40
Page 123
47
PMRAR
Zero economic profit if price falls to PBE. Firm
would only produce output OBE . AR-ATC0
Page 123
48
PMRAR
Economic losses if price falls to PSD. Firm would
shut down below output OSD
Page 123
49
Where is the firms supply curve?
PMRAR
Page 123
50
Marginal cost curve above AVC curve?
PMRAR
Page 123
51
Key Revenue Concepts
The previous graph indicated that profit is
maximized at 11.2 units of output, where MR (45)
equals MC (45). This occurs between lines G and
H on the table above, where at 11.2 units of
output profit would be 190.40. Lets do the
math.
Page 122
52
Doing the math.
Produce 11.2 units of output (OMAX on p.
123) Price of product 45.00 Total revenue
11.2 45 504.00
53
Doing the math.
Produce 11.2 units of output Price of product
45.00 Total revenue 11.2 45
504.00 Average total cost at 11.2 units of
output 28 Total costs 11.2 28
313.60 Profit 504.00 313.60 190.40
54
Doing the math.
Produce 11.2 units of output Price of product
45.00 Total revenue 11.2 45
504.00 Average total cost at 11.2 units of
output 28 Total costs 11.2 28
313.60 Profit 504.00 313.60
190.40 Average profit AR ATC 45 28
17 Profit 17 11.2 190.40
55
Profit at Price of 45?

Revenue 45 ? 11.2 504.00 Total cost 28 ?
11.2 313.60 Profit 504.00 313.60
190.40 Since P MR AR Average profit 45
28 17 Profit 17 ? 11.2 190.40
MC
P 45
ATC
28
AVC
Q
11.2
56
Profit at Price of 45?

Revenue 45 ? 11.2 504.00 Total cost 28 ?
11.2 313.60 Profit 504.00 313.60
190.40 Since P MR AR Average profit 45
28 17 Profit 17 ? 11.2 190.40
MC
P 45
190.40
ATC
28
AVC
Q
11.2
57
Price falls to 28.00.
Produce 10.3 units of output (OBE on p.
123) Price of product 28.00 Total revenue
10.3 28 288.40
58
Price falls to 28.00.
Produce 10.3 units of output Price of product
28.00 Total revenue 10.3 28
288.40 Average total cost at 10.3 units of
output 28 Total costs 10.3 28
288.40 Profit 288.40 288.40 0.00
59
Price falls to 28.00.
Produce 10.3 units of output Price of product
28.00 Total revenue 10.3 28
288.40 Average total cost at 10.3 units of
output 28 Total costs 10.3 28
288.40 Profit 288.40 288.40
0.00 Average profit AR ATC 28 28
0 Profit 0 10.3 0.00
60
Profit at Price of 28?

Revenue 28 ? 10.3 288.40 Total cost 28 ?
10.3 288.40 Profit 288.40 288.40
0 Since P MR AR Average profit 28 28
0 Profit 0 ? 10.3 0 (break even)
MC
45
ATC
P28
AVC
Q
11.2
10.3
61
Price falls to 18.00.
Produce 8.6 units of output (OSD on p. 123) Price
of product 18.00 Total revenue 8.6 18
154.80
62
Price falls to 18.00.
Produce 8.6 units of output Price of product
18.00 Total revenue 8.6 18
154.80 Average total cost at 8.6 units of
output 28 Total costs 8.6 28
240.80 Profit 154.80 240.80 86.00
63
Price falls to 18.00.
Produce 8.6 units of output Price of product
18.00 Total revenue 8.6 18
154.80 Average total cost at 8.6 units of
output 28 Total costs 8.6 28
240.80 Profit 154.80 240.80
86.00 Average profit AR ATC 18 28
10 Profit 10 8.6 86.00
64
Profit at Price of 18?

Revenue 18 ? 8.6 154.80 Total cost 28 ?
8.6 240.80 Profit 154.80 240.80
0 Since P MR AR Average profit 18 28
10 Profit 10 ? 8.6 86 (Loss)
MC
45
ATC
28
AVC
P18
Q
11.2
10.3
8.6
65
Price falls to 10.00.
Produce 7.0 units of output (below OSD on p.
123) Price of product 10.00 Total revenue
7.0 10 70.00
66
Price falls to 10.00.
Produce 7.0 units of output Price of product
10.00 Total revenue 7.0 10
70.00 Average total cost at 7.0 units of output
28 Total costs 7.0 28 196.00 Profit
70.00 196.00 126.00
67
Price falls to 10.00.
Produce 7.0 units of output Price of product
10.00 Total revenue 7.0 10
70.00 Average total cost at 7.0 units of output
30 Total costs 7.0 30 210.00 Profit
70.00 210.00 140.00 Average variable
costs 19 Total variable costs 19 7.0
133.00 Revenue variable costs 63.00 !!!!!
68
Profit at Price of 10?

Revenue 10 ? 7.0 70.00 Total cost 30 ?
7.0 210.00 Profit 70.00 210.00
140.00 Since P MR AR Average profit 10
30 20 Profit 20 ? 7.0 140 Average
variable cost 19 Variable costs 19 ? 7.0
133.00 Revenue variable costs 63 Not
covering variable costs!!!!!!
MC
45
ATC
28
AVC
18
P10
Q
11.2
10.3
8.6
7.0
69
The Firms Supply Curve

MC
45
ATC
28
AVC
18
P10
Q
11.2
10.3
8.6
7.0
70
Now lets look at the demand for a single input
Labor
71
Key Input Relationships
The following input-related derivations also play
a key role in decision-making Marginal
value marginal physical product price
product
Page 124
72
Key Input Relationships
The following input-related derivations also play
a key role in decision-making Marginal
value marginal physical product price
product Marginal input wage rate,
rental rate, etc. cost
Page 124
73
D
Wage rate represents the MIC for labor
C
E
B
F
G
5
I
H
J
Page 125
74
Use a variable input like labor up to the point
where the value received from the market equals
the cost of another unit of input, or MVPMIC
D
C
E
B
F
G
5
I
H
J
Page 125
75
D
The area below the green lined MVP curve and
above the green lined MIC curve
represents cumulative net benefit.
C
E
B
F
G
5
I
H
J
Page 125
76
MVP MPP 45
Page 125
77
Profit maximized where MVP MIC or where MVP 5
and MIC 5
Page 125
78


Marginal net benefit in column (5) is equal to
MVP in column (3) minus MIC of labor in column (4)
Page 125
79
The cumulative net benefit in column (6) is
equal to the sum of successive marginal net
benefit in column (5)
Page 125
80
For example 25.10 9.85 15.25 58.35
25.10 33.25
Page 125
81


Cumulative net benefit is maximized where MVPMIC
at 5
Page 125
82
D
If you stopped at point E on the MVP curve, for
example, you would be foregoing all of the
potential profit lying to the right of that point
up to where MVPMIC.
C
E
B
F
G
5
I
H
J
Page 125
83
D
If you went beyond the point where MVPMIC, you
begin incurring losses.
C
E
B
F
G
5
I
H
J
Page 125
84
A Final Thought
One final relationship needs to be made. The
level of profit-maximizing output (OMAX) in the
graph on page 123 where MR MC corresponds
directly with the variable input level (LMAX) in
the graph on page 125 where MVP MIC. Going
back to the production function on page 112, this
means that OMAX f(LMAX capital, land and
management)
85
In Summary
  • Features of perfect competition
  • Factors of production (Land, Labor, Capital and
    Management)
  • Key decision rule Profit maximized at output
    MRMC
  • Key decision rule Profit maximized where MVPMIC

86
Chapter 7 focuses on the choice of inputs to use
and products to produce.
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