PPA 723: Managerial Economics Study Guide: Production, Cost, and Supply

PPA 723: Managerial Economics

Study Guide:

Production, Cost, and Supply

Managerial Economics, Study Guide

Topics

Short-run product curves Short-run cost curves Short-run firm supply Short-run market supply Input mix decision Long-run product curves Long-run cost curves Long-run firm supply Long-run market supply


Short-Run Product CurvesQuestion:

If some inputs (usually capital) are fixed (i.e. in the short run), how much output can a firm produce from different quantities of a variable input (usually labor)?

Analytical Tools: Total product curve Average product curve Marginal product curve

Key Concepts/Results Law of diminishing marginal product (MPL eventually slopes downward) MPL = APL at minimum of APL curve


Short-Run Cost Curves Question:

If some inputs (usually capital) are fixed (i.e. in the short run), how much does it cost to produce various levels of output by varying a variable input (usually labor)?

Analytical Tools: Average fixed cost curve Average variable cost curve Average total cost curve Marginal cost curve

Key Concepts/Results Law of diminishing marginal productivity leads to upward sloping MC curve after

some point U-shaped AVC (usually) and U-shaped ATC (always) MC = AVC at minimum of AVC MC = ATC at minimum of ATC


Short-Run Firm SupplyQuestion:

If some inputs (usually capital) are fixed (i.e. in the short run), what is the most profitable level of output for the firm to produce?

Analytical Tools: Average variable cost curve Marginal cost curve In a competitive market, marginal revenue = market price = P

Key Concepts/Results The firm shuts down (supply = 0) if P < minimum of AVC curve. If P > minimum of AVC curve, the firm sets P = MC, which

implies that the MC curve is the supply curve.


Short-Run Market SupplyQuestion:

What does the market supply curve look like in the short run?

Analytical Tools: SR firm supply curve Number of firms

Key Concepts/Results The SR market supply curve is the horizontal summation of the

firm supply curves for the firms in the market. The more firms in the market, the more elastic the SR market

supply curve.


Long-Run Product CurvesQuestion:

If all inputs are variable (i.e. in the long run), how much output can a firm produce from combinations of inputs?

Analytical Tools: Isoquant

Key Concepts/Results Isoquants have the same properties as indifference curves, i.e. higher

isoquants indicate more product, isoquants cannot slope upward, and isoquants cannot cross.

The slope of an isoquant is MPL/MPK (with L on the horizontal axis). Constant returns to scale exist if product doubles when inputs double. Economies [diseconomies] of scale exist if product more than doubles

[less than doubles] when inputs double.


The Input-Mix DecisionQuestion:

What is the least expensive input combination for producing a given output?

Analytical Tools: Isoquants Isocost lines

Key Concepts/Results: The least expensive input combination is at the tangency

between an isocost line and the relevant isoquant. The slope of an isocost line is the wage rate over the capital

rental rate = w/r (with labor on the horizontal axis). The least cost combination is where MPL/w = MPK/r, that is,

where each input has the same MP per dollar of cost.


Long-Run Cost CurvesQuestion:

If all inputs are variable (i.e. in the long run), how much does it cost to produce various levels of output?

Analytical Tools: Expansion path Long-run average cost curve Long-run marginal cost curve

Key Concepts/Results Expansion path (from input-mix diagram) indicates the cost of every

output at the optimal input mix, i.e. the long-run cost curve. LR MC = LR AC at minimum of LR AC SR cost LR cost


Long-Run Firm SupplyQuestion:

If all inputs are variable (i.e. in the long run), what is the most profitable level of output for the firm to produce?

Analytical Tools: LR AC curve LR MC curve In a competitive market, marginal revenue = market price = P

Key Concepts/Results The firm shuts down (supply = 0) if P < minimum of LR AC

curve. If P > minimum of LR AC curve, the firm sets P = LR MC, which

implies that the LR MC curve is the supply curve.


Long-Run Market SupplyQuestion:

What does the market supply curve look like in the long run?

Analytical Tools: LR firm supply curve Entry and exit

Key Concepts/Results Firms enter the market in response to economic profits and exit in

response to losses—thereby altering the market price. LR equilibrium exists when no firms have an incentive to enter or exit,

i.e. when economic profits equal zero. In LR equilibrium P = minimum LR AC With free entry and exist, the same costs for all firms, and constant input

prices, the LR supply curve is horizontal.

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PPA 723: Managerial Economics Study Guide: Production, Cost, and Supply