Supply side of the market
Why firms exist. Production and cost relationships. Model of perfect competition. Model of monopoly. Regulation
Later: Monopolistic competition, oligopoly, game theory, factor markets, general equilibrium
Why do firms exist?
They combine resources to produce goods and services.
Why not use markets?
Transaction costs are high.
Role of managers - monitor workers to minimize shirking. Chinese barge-pullers.
Firm’s objective: maximize profitmaximize profit
Costs & Profits All costs are “opportunity costs.” Costs may be explicit or implicit. Total cost = TC = all relevant
costs. (Economic) Profit = TR-TC
– If positive, firms will enter.– If negative, firms will exit.– If zero, the market is stable.
Accounting profit may/will not equal Economic Profit.
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Short Run vs. Long Run
We are interested in the short run: At least one input is fixed
Fixed - capital; variable – labor
In the Long Run, all factors are variable.
Next - Production & Next - Production & Cost relationshipsCost relationships
Production Relationships
From 0 to L1 there are “increasing returns.” From L1 onwards, there are “diminishing
marginal returns.” After L3 additional workers lower output. Why?
L1L3
Labor
Output
Total Product = TP (=Q)
Production Relationships
L1L3
Labor
Output
TP (=Q)
Marginal Product = MP
L2
Average Product = AP
Average Product = AP = TP/L;this shows how much the average worker adds to output.
Marginal Product = MP = ΔTP/ΔL;this shows how much the last worker (unit) adds to output.
Cost Relationships As noted, TC = TFC + TVC
TFC is fixed, by definition.TVC can be written as w*L, where
w is the (constant) wage rate. Average Fixed Cost, AFC = TFC/Q Average Variable Cost,
AVC = TVC/Q . . . or, = wL/Q = w/APAs AP rises, AVC falls . . .
Average Total Cost, ATC = TC/Q = AFC + AVC
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Cost Relationships Marginal Cost, MC = ΔTC/ΔQ or, can
be written as = ΔTVC/ΔQ (Why?)
… = Δ(wL)/ΔQ = w(ΔL)/ΔQ = w/MP
AFCquantity (TP)
AVC
ATCMC$
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Key FormulasMP = ΔTP/ΔLAP = TP/LTC = TFC + TVCTVC = w*L
AFC = TFC/QAVC = TVC/Q = wL/Q = w/APATC = TC/Q = AFC + AVCMC = ΔTC/ΔQ = ΔTVC/ΔQ = Δ(wL)/ΔQ = w(ΔL)/ΔQ = w/MP
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