Ch 6 Production and Costs

1. Production and Costs in the Short Run

1. 2. 1. 2. 1. 2. 3. 4. Production: TPL, MPL, APL Costs: TC(=TFC+TVC), ATC(=AFC+AVC), MC Isoquant, MRTS Isocost, PL/PK From Isoquant to SRTC From Isoquant to LRTC SRTC vs LRTC SRAC vs LRAC

2. Production and Costs in the Long Run

3. Relations Between the S- Run and the L- Run

the output for the production function: Q = 3KL

Labor Capital
1 2 3 4 5 6 1 2 3 4 5 6

the output for the production function: Q = 3KL

Labor Capital
1 2 3 4 5 6 1 3 6 9 12 15 18 2 6 12 18 24 30 36 3 9 18 27 36 45 54 4 12 24 36 48 60 72 5 15 30 45 60 75 90 6 18 36 54 72 90 108

1. Basic Short Run Model

the output for the production function: Q = 3KL
Labor Capital
1 2 3 4 5 6 9 18 27 36 45 54 1 2 3 4 5 6

Swanky Desks Inc.

selling handmade desks Production Schedule L 0 1 2 3 4 5 6 7 8 TPL 0 1 2.4 4.2 6.4 7.8 8.6 9 9 0.4 0 2.2 1.4 1.56 1.433333 1.285714 1.125 1 1.4 1.4 MPL APL 0 1

Swanky Desks Inc.

selling handmade desks Total, Marginal, and Average Products in the Short Run L 0 1 2 3 4 5 6 7 8 TPL 0 1 2.4 4.2 6.4 7.8 8.6 9 9 1 1.4 1.8 2.2 1.4 0.8 0.4 0 MPL APL 0 1 1.2 1.4 1.6 1.56 1.433333 1.285714 1.125

The Stages of Production (TPL)

The Stages of Production (MPL,APL)

TPL, MPL, APL

TP or Q

MPL=Q/L APL=Q/L

Q1
Q1 L

L1

L1

L2

L3

L4

L5

MPL & APL

APL MPL

AP when MP>AP

AP when MP<AP

MPL APL

L1

L2

L3

L4

L5

Typos on P138 (or 141) of the textbook (MPL,APL)

2nd stage E TP, Q 1 stage F DMR D IMR C

st

La

Lb 1st stage

Lc

Ld 2nd stage

Le

Lf

MPL, APL
MPL

IMR

Begin at same point b/c MPL =APL when L and L are both 1

DMR
APL

La

Lb

Lc

Ld

Le

Lf

When will the APL = MPL? and Why does the APL continue to rise even though the MPL is falling? Semester Marginal Grades (average for one semester) Cumulative GPA (average of each semesters averages)

2.0

2.0

2
3 4

2.5
3.0 3.0

2.25
2.5 2.625

5
6

2.8
2.0

2.66
2.55

Production to Cost
Q L Q L Q

Production Cost Curve (Q#4)

Labor

7 6 5 4 3 2 1

2.4

4.2

6.4

7.8

8.6 9

TP or Q

TP and TVC

Swanky Desks Inc.

selling handmade desks Total, Marginal, and Average Products in the Short Run L 0 1 2 3 4 5 6 7 8 TPL 0 1 2.4 4.2 6.4 7.8 8.6 9 9 TPL 0 1 2 3 4 5 6 7 8 1 1.8 2.4 2.9 3.3 3.85 4.5 5.25 L

Swanky Desks Inc.

selling handmade desks Cost Schedule (PL=$40 per day & PK=$100 per day)
TP 0 1 2 3 4 5 6 7 8 9 L 1 1.8 2.4 2.9 3.3 3.85 4.5 5.25 7 TFC $100 $100 $100 $100 $100 $100 $100 $100 TVC $0 $40 $72 $116 $132 $180 $210 $280 TC $100 $140 $196 $232 $254 $310 $380 MC $40 $24 $16 $26 $30 $70 $16.67 $14.29 $12.50 $11.11 AFC $100.00 $50.00 $33.33 AVC $40.00 $36.00 $32.00 $26.40 $25.67 $25.71 $31.11 ATC $140.00 $86.00 $54.00 $46.40 $42.33 $38.75 $42.22

Swanky Desks Inc.

selling handmade desks Cost Schedule (PL=$40 per day & PK=$100 per day)
TP 0 1 2 3 4 5 6 7 8 9 L 1 1.8 2.4 2.9 3.3 3.85 4.5 5.25 7 TFC $100 $100 $100 $100 $100 $100 $100 $100 $100 $100 TVC $0 $40 $72 $96 $116 $132 $154 $180 $210 $280 TC $100 $140 $172 $196 $216 $232 $254 $280 $310 $380 MC $40 $32 $24 $20 $16 $22 $26 $30 $70 AFC $100.00 $50.00 $33.33 $25.00 $20.00 $16.67 $14.29 $12.50 $11.11 AVC $40.00 $36.00 $32.00 $29.00 $26.40 $25.67 $25.71 $26.25 $31.11 ATC $140.00 $86.00 $65.33 $54.00 $46.40 $42.33 $40.00 $38.75 $42.22

Total Cost and Total Variable Cost

Marginal and Average Cost

Why MC falls when MPL rises?

(and vice versa)

L 7 8 9 10

TP 40 45 48 50

MPL 8 5 3 2

PL=$120 To increase production from 45 to 48 requires a 9th worker. The 9th worker has a MPL of 3 The marginal cost of each of the three units, 46, 47, 48, would be $40 MC = PL/MPL

Mathematical Example (costs as a function of Q only)

Q 3KL
Where, if K = 10: Q 30L L = Q2/30

TVC=PL*L TFC=PK*K TC=TVC+TFC

TVC = PL *Q2/30 TFC = PK*10 TC = PLQ2/30 + PK10

Then ATC = (PLQ2)/(30Q) + (PK10)/Q AVC = (PLQ2)/(30Q) AFC = (PK10)/Q MC = dTC/dQ = PLQ/15 ATC = (100Q2)/(30Q) + (2000)/Q AVC = (100Q2)/(30Q) AFC = (2000)/Q MC = dTC/dQ = 100Q/15

And if PL = 100 and PK = 200; TVC=(100Q2)/30 TFC=2000 TC= (100Q2)/30 + 2000

2. Production and Costs in the Long-run Isoquant Curves

Isoquants: An isoquant demonstrates all the combinations of inputs that produce the same level of output if production is technically efficient. Not only are isoquants downward sloping, but they bow toward the origin. 1. slope downward (with more of both inputs, we could always produce more (similar to more-is-better assumption)) 2. never cross (transitivity and downward slope) 3. fill the plane (completeness, no matter what combination of inputs used, there will be some level of output) 4. convex (balanced bundles produce more than bundles with lots of one input and little of the other)

 Marginal Rate of Technical Substitution of labor for capital (MRTSLK): the slope of the isoquant if L in on the horizontal axis. How much capital must be hired to maintain the same level of output if one unit of labor is removed from production.
MRTS: Holding output constant, how capital changes when labor changes by one unit. MPK: Holding labor constant, how output changes when capital is increased by one unit. MPL: Holding capital constant, how output changes when labor is increased by one unit.

K*MPK + L*MPL = 0 K*MPK = -L*MPL -K/L = MPL/MPK MRTS = K/L, so MRTS = MPL/MPK

2. Production and Costs in the Long-run Isocost Curves

Isocosts: An isocost curve is a lot like a budget constraint, it reflects all the combinations of inputs that cost the same amount. PL *L + PK * K = TC
K TC/PK

Slope = PL/PK

TC/PL

2. Production and Costs in the Long-run Cost Minimization

To minimize cost of producing a specific level of Q, we can keep reducing the TC until we can no longer cut cost without producing less than Q.
K

PL = 10 PK = 20 PL/PK = 1/2

L MRTS = .5/1 .2/1 .1/1

2. Production and Costs in the Long-run the Equimarginal Principle

Start at a point where MRTS < PL/PK. the benefit of reducing the amount of L used is PL and the cost is MRTS*PK. Setting the MB = MC results in a level of K and L such that MRTS*PK = PL. MRTS = PL/PKMPL/MPK=PL/PKMPL/PL=MPK/PK Expansion Path :As production increases, the locus of tangencies is called the expansion path. It reflects the lowest possible cost of producing any given level of output

2. Production and Costs in the Long-run Long Run Cost Curves

Information needed
Production function or isoquants Input prices LRTC: long run total cost the cost of producing a level of output if production is on the expansion path. LRAC: long run average cost = LRTC/Q LRMC: long run marginal cost = LRTC/Q

EXHIBIT 6.11 Deriving Long-Run Total Cost

PK=$10 PL=$15 At Q=33, LRTC=?

Landsburg, Price Theory and Applications, 7th edition

EXHIBIT 6.12 Long-Run Total, Marginal, and Average Costs

Landsburg, Price Theory and Applications, 7th edition

Returns to Scale
When all input quantities are increased by 1%, does output go up by
more than 1%
Increasing returns to scale Occurs at low levels of output Long-run average cost curve is decreasing Caused by either further specialization of resources or technology interacted with size.

exactly 1%
Constant returns to scale What a firm can do one, it can do twice Long-run average cost curve is flat

less than 1%
Decreasing returns to scale Occurs at sufficiently high levels of output Long-run average cost curve is increasing Theory Cuased Landsburg, Price and by bureaucratic intertia.
Applications, 7th edition

2. Production and Costs in the Long-run Returns to Scale vs. Economies of Scale.
as Q increases production always exhibits first IRS, then CRS and DRS,

the LRTC looks like this:

the LRAC looks like this:

LRTC LRTC

LRAC LRTC

Q
Q

3. Relationship between the SR and LR

ATC LRAC ATCk=1 ATCk=2 ATCk=3 LRAC

EXHIBIT 6.13a Short-Run and Long-Run Total Cost Curves

Landsburg, Price Theory and Applications, 7th edition

EXHIBIT 6.13b Short-Run and Long-Run Total Cost Curves continued

Landsburg, Price Theory and Applications, 7th edition

EXHIBIT 6.15 Many Short-Run Average Cost Curves

Landsburg, Price Theory and Applications, 7th edition

3. Relationship between the SR and LR

PK=200, PL=20
K
TC1 =8000+5500=13,500 TC2SR=8000+6420=14,420 TC2LR=8400+5740=14,140

K2=42 K1=40

Q = 140 Q = 135

L 1 2LR LL L =287 1=275 LR

L 2SR L SR=321

3. Relationship between the SR and LR

is LRMC higher or lower than MC?
SRTCK=40
14,420

SRTCK=42

14,140

13,500

8400
8000

135
MC is 920/5 = 184 LRMC = 640/5 = 128

140

3. Relationship between the SR and LR

is LRMC higher or lower than MC?

LRTC TC 14,420 14,140 13,500

103 101 100

135 140

135 140

MC is 920/5 = 184 LRMC = 640/5 = 128

3. Relationship between the SR and LR

is LRMC higher or lower than MC?
LRTC K = 50 K = 40 K = 30

LRTC

3. Relationship between the SR and LR

is LRMC higher or lower than MC?
ATC & LRAC

LRMC LRAC