Title: Introduction to Production and Resource Use
1Introduction toProduction and Resource Use
2Topics 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
3Conditions for Perfect Competition
- Homogeneous products
- No barriers to entry or exit
- Large number of sellers
- Perfect information
Page 109
4Classification 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
5Production Function
Output f(labor capital, land,
and management)
Start with one variable input
Page 112
6Production Function
Output f(labor capital, land,
and management)
Start with one variable input
assume all other inputs fixed at their
current levels
Page 112
7Coordinates of input and output on the TPP curve
Page 112
8Total Physical Product (TPP) Curve
Variable input
Page 113
9Law 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
10Other 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
11Other 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
12Change in output as you increase inputs
Page 112
13Total Physical Product (TPP) Curve
Marginal physical product is .45 as labor is
increased from 16 to 20
?output
?input
Page 113
14Output per unit input use
Page 112
15Total Physical Product (TPP) Curve
Average physical product is .31 if labor use is
26
output
input
Page 113
16Plotting the MPP curve
Change in output associated with a change in
inputs
Page 114
17Marginal Physcial Product
Change from point A to point B on the production
function is an MPP of 0.33
Page 114
18Plotting the APP Curve
Level of output divided by the level of input use
Page 114
19Average Physical Product
Output divided by labor use is equal to 0.19
Page 114
20Three Stages of Production
Average physical product (yield) is increasing in
Stage I
Page 114
21Three Stages of Production
Marginal physical product falls below the average
physical product in Stage II
Page 114
22Three Stages of Production
MPP goes negative as shown on Page 112
Page 114
23Three Stages of Production
Why are Stage I and Stage III irrational?
Page 114
24Three Stages of Production
Productivity rising so why stop???
Output falling
Page 114
25Three Stages of Production
The question therefore is where should I operate
in Stage II?
Page 114
26Economic Dimension
- We need to account for the price of the product
- We also need to account for the cost of the inputs
27Key Cost Relationships
The following cost derivations play a key role in
decision-making Marginal cost ? total cost
? output
Page 117-120
28Key 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
29Key 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
30From TPP curve on page 113
Page 118
31Fixed costs are 100 no matter the level
of production
Page 118
32Column (2) divided by column (1)
Page 118
33Costs that vary with level of production
Page 118
34Column (4) divided by column (1)
Page 118
35Column (2) plus column (4)
Page 118
36Change in column (6) associated with a change in
column (1)
Page 118
37Column (6) divided by column (1) or
Page 118
38or column (3) plus column (5)
Page 118
39Lets graph the cost series in this table
40Plotted cost relationships from table 6.3 on page
118
Plotting costs for levels of output
Page 119
41Now lets assume this firm can sell its product
for 45/unit
42Key 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
43Lets see this in graphical form
4445
PMRAR
Profit maximizing level of output, where MRMC
11.2
Page 123
45Average Profit 17, or AR ATC
PMRAR
45-28
28
Page 123
46Grey area represents total economic profit if the
price is 45
PMRAR
11.2 ? (45 - 28) 190.40
Page 123
47PMRAR
Zero economic profit if price falls to PBE. Firm
would only produce output OBE . AR-ATC0
Page 123
48PMRAR
Economic losses if price falls to PSD. Firm would
shut down below output OSD
Page 123
49Where is the firms supply curve?
PMRAR
Page 123
50Marginal cost curve above AVC curve?
PMRAR
Page 123
51Key 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
52Doing the math.
Produce 11.2 units of output (OMAX on p.
123) Price of product 45.00 Total revenue
11.2 45 504.00
53Doing 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
54Doing 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
55Profit 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
56Profit 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
57Price 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
58Price 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
59Price 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
60Profit 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
61Price 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
62Price 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
63Price 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
64Profit 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
65Price 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
66Price 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
67Price 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 !!!!!
68Profit 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
69The Firms Supply Curve
MC
45
ATC
28
AVC
18
P10
Q
11.2
10.3
8.6
7.0
70Now lets look at the demand for a single input
Labor
71Key Input Relationships
The following input-related derivations also play
a key role in decision-making Marginal
value marginal physical product price
product
Page 124
72Key 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
74Use 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
76MVP MPP 45
Page 125
77Profit maximized where MVP MIC or where MVP 5
and MIC 5
Page 125
78Marginal net benefit in column (5) is equal to
MVP in column (3) minus MIC of labor in column (4)
Page 125
79The cumulative net benefit in column (6) is
equal to the sum of successive marginal net
benefit in column (5)
Page 125
80For example 25.10 9.85 15.25 58.35
25.10 33.25
Page 125
81Cumulative 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
84A 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)
85In 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
86Chapter 7 focuses on the choice of inputs to use
and products to produce.