Session 2 Cost Analysis and Supply Managerial Economics Professor Changqi Wu.
1 SM1.21 Managerial Economics Welcome to session 5 Production and Cost Analysis.
21
1 SM1.21 Managerial Economics Welcome to session 5 Production and Cost Analysis
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Transcript of 1 SM1.21 Managerial Economics Welcome to session 5 Production and Cost Analysis.
1
SM1.21 Managerial Economics
Welcome to session 5
Production and Cost Analysis
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Objectives
To understand the economics of production of the firm and the conditions for an efficient production
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The Production Function
The production function is the relationship between the maximum amount of output that can be produced and the inputs required to make that output
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Inputs
Inputs = resources Land (natural) Labor Capital Variable Inputs Fixed Inputs
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Fixed and variable Costs
The fixed cost do not vary with the firms output
The variable cost increase with the output
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Production function with 2 inputsCapi 6 10 24 31 36 40 39tal 5 12 28 36 40 42 40
4 12 28 36 40 40 363 10 23 33 36 36 332 7 18 28 30 30 281 3 8 12 14 14 12
1 2 3 4 5 6Labor
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Total and Marginal Cost
The firm’s total cost is the sum off all variable and fixed costs
The firm’s marginal cost is the per unit change in total cost that results from a change in total product
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The Law of diminishing returns As a firm uses more and more of a variable
input with the same amount of fixed input, it gets less returns from the variable input after a certain point
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Returns to scale
The degree by which output changes as a result of a given change in the quantity of all inputs used in production
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Optimal use of variable input
The marginal revenue product
The marginal resource cost
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Two variable inputs
Isoquants Isoquant’s slope is called
Marginal Rate of Technical Substitution
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Optimal Combination
Minimizing cost for given output Maximizing output for given input Profit maximization
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Change of input prices
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Product innovation
Product innovation
Process Innovation
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The Marginal Product
The marginal product of an input is the extra product or output added by one extra unit of that input while other inputs are held constant
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Total and Marginal Product
Total Product
0
1000
2000
3000
4000
5000
1 2 3 4 5
Labor input
Tota
l Pro
duct
Series1
Marginal Product
0
500
1000
1500
2000
2500
1 2 3 4 5
LaborM
arg
inal
pro
du
ct p
r u
nit
la
bo
r
Series1
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The Cobb-Douglas Function
Q=AKaLb
a= output elasticity of capital
b= output elasticity of labor
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Summary Production
Production refers to the transformation of inputs or resources into output of goods and services. Inputs can be fixed or variable. In the long run they are considered as variable.
The production function (3D) shows the maximum output that a firm can produce with different sets of one input, while keeping other inputs fixed.
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Summary Production
2. Total Product-Marginal Product-Average Product
The Total product is the output produced by using different quantities of inputs.
The marginal product is the change of the total product per unit change in the variable input used.
The average product is the total product divided by the quantity of the variable input used
Three stages of production: Stage 1: Increasing average productStage 2: Maximum AP to 0Stage 3: Negative marginal product
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Summary Production
Marginal Revenue productThe optimal use of the variable inputs occurs when MRP(Marginal Revenue Product)=MRC (Marginal resource cost)
IsoquantsThe various combinations of inputs to produce the same output are shown by isoquants
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Summary Production
5. Isocost lines
Once we know the wage rate and the rental price of capital and the total costs of the firm we can draw the isocost lines that shows the various combinations of Labor and Capital a firm can hire. To minimize production cost or maximize output, a firm must produce where an isocost line is tangent to the isoquant.
