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What questions are fundamental to understanding how supply responds to changing market conditions?
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-How do firms decide whether and how much to produce?
-How do firms choose between inputs such as capital and labor?
-How does the timeframe analysis affect firm decisions?
-How do firms choose between inputs such as capital and labor?
-How does the timeframe analysis affect firm decisions?
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Production
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describes the process by which an entity turns raw inputs into a good or service
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Final goods
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purchased by consumers (bread)
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Intermediate goods
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used as inputs in other production process (wheat used to make bread)
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Production function
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mathematical relationships between amount of output and various combinations of inputs
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Assumptions about firms' prod. behavior: The produces a _____________
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single good
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Assumptions about firms' prod. behavior: The firm has __________________________ what product to produce
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already chosen
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Assumptions about firms' prod. behavior: Firms ____________ costs associated with every level of production; necessary condition for product maximization
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minimize
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Assumptions about firms' prod. behavior: Only two inputs are used in production:
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capital and labor
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capital
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the buildings, equipment, etc
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labor
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all human resources
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Assumptions about firms' prod. behavior: In the short-run, what is chosen and what is fixed?
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the amount of labor employed is chosen, but capital is assumed to be fixed in total supply
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Short run
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period in time in which one more inputs used in production cannot be changed
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fixed inputs
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inputs that cannot be changed in the short run
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Variable inputs
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Inputs that can be changed in the short run
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long run
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period of time when all inputs in production can be changed
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Assumptions about firms' prod. behavior: What increases with inputs?
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output
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Assumptions about firms' prod. behavior: inputs are characterized by _________
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diminishing returns; if the amount of capital is held constant, each additional worker produces less incremental output than the last and vice versa
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Assumptions about firms' prod. behavior: The firm can employ _________ capital and labor at fixed prices.
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unlimited
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Assumptions about firms' prod. behavior: ______________ markets are well functioning; the firm is not budget constrained
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capital
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marginal product
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the additional output that a firm can produce using an additional unit of an input
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What can firms change in the long run?
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both labor and capital
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What are the benefits of firms being able to change both labor and capital in the long run?
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-Firms can lessen the effects of diminishing marginal product
-firms can substitute between capital and labor
-firms can substitute between capital and labor
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In the long run, firms are able to change both labor and capital. One benefit of this is firms can lessen the effects of diminishing marginal product. What does this mean?
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-adding more and more baristas to a coffee shop with one espresso machine does not increase the shop's productivity very much
-adding one more barista and another espresso machine, however, could make the coffee shop much more productive
-adding one more barista and another espresso machine, however, could make the coffee shop much more productive
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In the long run, firms are able to change both labor and capital. One benefit of this is firms can substitute capital and labor. What does this mean?
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-having more flexibility allows firms to better minimize costs as prices change
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The long run production function is a bunch of
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short run functions
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Cost minimization
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refers to the firms' goal of producing a specific quantity of output at a minimum cost
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What is required for the cost minimization model?
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-isoquants
-isocost lines
-isocost lines
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Isoquant
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a curve representing combinations of inputs that allow a firm to make a particular quantity of output
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What does the slope of the isoquant describe?
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how inputs may be substituted to produce a fixed level of output
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Marginal Rate of Technical Substitution
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the rate the firm can trade input L for input K, holding output constant
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Mathematically, the MRTSlk is equal to what?
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the negative of the slope of the isoquant
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As you move down the isoquant, what happens to the amount of capital?
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it declines
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MRTSlk describes...
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the rate at which labor must be substituted for capital to hold the quantity produced constant
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What happens to the slope of the isoquant as you move down it? What does this mean?
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slope gets smaller; the firm has less capital and each unit is relatively more productive
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What does the shape of the isoquant reveal?
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information about the relationship between inputs to production
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Relatively straight isoquants imply
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inputs are relatively substitutable; MRTSlk does NOT vary much along the curve
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Relatively curved isoquants imply
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inputs are relatively complementary; MRTSlk varies greatly along the curve
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Isocost maps
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show how quantities of inputs are related to output produced
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Isocost line
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shows all of the input combinations that yield the same cost
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returns to scale
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the change in output when all inputs are increased in the same proportion
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constant returns to scale
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double input --> output doubles
quadruple inputs --> output quadruples
quadruple inputs --> output quadruples
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Increasing returns to scale
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describes production for which is changing all inputs by the same proportion changes output more than proportionally
double inputs --> output quadruples
double inputs --> output quadruples
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Decreasing returns to scale
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describes production for which changing all inputs by the same proportion changes output less than proportionally
-double inputs --> output increases by less than double
-quadruple inputs --> output only doubles
-double inputs --> output increases by less than double
-quadruple inputs --> output only doubles
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Why might a firm experience increasing returns to scale?
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-fixed costs do not vary with output
-learning by doing may occur, whereby a firm develops more efficient processes as it expands or produces more output
-learning by doing may occur, whereby a firm develops more efficient processes as it expands or produces more output
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Generally, firms should not experience decreasing returns to scale. Why is this?
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When decreasing returns to scale is observed in data, it often results from not accounting for all inputs
-for instance, second manager may not be as competent as the first
-for instance, second manager may not be as competent as the first
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Expansion path
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a curve that illustrates how the optimal mix of input varies with total output
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What does the expansion path allow us to construct?
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total cost curve
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total cost curve
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shows a firm's cost of producing particular quantities
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