Production and Costs

Document Sample
Production and Costs Powered By Docstoc
					A traffic jam is a collision between free enterprise and socialism. Free enterprise produces automobiles
               faster than socialism can build roads and road capacity. Andrew Galambos

                                 Factor Markets: Production Costs

CIRCULAR FLOW                                 IMPLICIT COSTS
MONEY                                         EXPLICIT COSTS
MARGINAL REVENUE                              NET WORTH
MARGINAL COST                                 PSYCHIC PROFIT
MRP = MRC                                     CONSUMER SOVEREIGNTY
MARGINAL PRODUCT                              P = MC = MIN ATC
DERIVED DEMAND                                ASSETS
LOWER ORDER GOODS                             BALANCE SHEET
HIGHER ORDER GOODS                            ENTREPRENEUR
TOTAL REVENUE                                 ENTREPRENEURIAL
MONOPSONISTIC                                 EQUITY
LIABILITIES                                   SPECULATION
TAYLOR RULE                                   ECONOMY OF SCALE
CLOSED SHOP                                   DISECONOMY OF SCALE
COLLECTIVE BARGAINING                         FIRM
DISUTILITY OF LABOR                           INDUSTRY
EMPLOYEE                                      PRISONER’S DILEMMA
EMPLOYER                                      LABOR (TRADE) UNION
LABOR                                         MARGINAL WORKER
INCREASING RETURNS (I)                        MINIMUM WAGE
MARKET ECONOMY                                STRIKE
LRAC                                          UNION SHOP
SRAC                                          WAGE, WAGE RATES
ATC                                           YELLOW-DOG CONTRACT
AFC                                           VARIABLE COSTS
AVC                                           FIXED COSTS
TC = TR                                       TOTAL COSTS
MC = MR                                       MARGINAL COSTS
LONG RUN                                      AVERAGE PRODUCTIVITY
SHORT RUN                                     ECONOMIC RENT
ECONOMIC LOSS                                 MONOPOLIST
Review Circular Flow Models

Money as a medium of exchange

Diminishing Marginal Returns

Derived Demand

Efficiency: allocative, productive, distributive

How are Wages determined?
      Collective bargaining
      MRP = Wage rate
      Perfectly competitive job markets
      Monopsonistic Job Markets
      Minimum Wage rates

What is MC=MR?

How is Rent determined?
       Pure Rent

            The Demand for a Resource: Perfect
            Competition in the Sale of the Product

      Unit 4 : Microeconomics                      Visual 4.2
      National Council on Economic Education
     The Demand for a Resource: Imperfect
     Competition in the Sale of the Product

Unit 4 : Microeconomics                  Visual 4.3
National Council on Economic Education

   The Supply of and Demand for Labor in a
         Competitive Labor Market

Unit 4 : Microeconomics                        Visual 4.4
National Council on Economic Education
  The Wage Rate and Level of Employment
     In a Monopsonistic Labor Market

Unit 4 : Microeconomics                            Visual 4.5
National Council on Economic Education   

           Prices in a Purely Competitive Market
        The Perfectly Competitive Firm and
        Industry in Short-Run Equilibrium

Unit 3: Microeconomics                   Visual 3.5
National Council on Economic Education
          The Perfectly Competitive Firm in
               Long-Run Equilibrium

Unit 3: Microeconomics                   Visual 3.7
National Council on Economic Education
  How an Increase in Demand Changes
  Equilibrium for the Firm and Industry

     How a Decrease in Demand Changes Long-
Unit 3: Microeconomics                 Run Visual 3.8
National Council on Economic Education
          Equilibrium for the Firm and Industry

   Unit 3: Microeconomics                     Visual 3.9
   National Council on Economic Education
Prices in a Monopolistically Competitive Market

                      Short-Run and Long-Run Equilibrium
                         for a Monopolistic Competitor
 Short-Run Profits                                                        Short-Run Losses

                                      Long-Run Equilibrium

    Unit 3: Microeconomics                               Visual 3.13
    National Council on Economic Education     
Prices in a Monopoly
           Price and Marginal Revenue for a

Unit 3: Microeconomics                   Visual 3.10
National Council on Economic Education
                      The Profit-Maximizing Position of a

                                                       Production and Costs
              Unit 3: Microeconomics                              Visual 3.11
              National Council on Economic Education    
Costs vs. Profits
Firm: profit motive
Market: equilibrium

Explicit Costs: wages, rent, and utilities.
Implicit Costs: salary working for someone else (Opportunity costs)

Economic profit: total revenue - (explicit + implicit costs)

Fixed input
Variable input

Marginal product
Law of Diminishing Marginal Returns

                 Number of Workers                               Total Output

                                     1                                                          10
                                     2                                                          25
                                     3                                                          42
                                     4                                                          48
                                     5                                                          55

Labor Productivity
How much a typical worker can produce (output) per hour of work.

There are three factors that influence labor productivity

       Physical capital

       Human capital


                   Big Ideas about Factor, or Resource, Markets

      1. The economic concepts are similar to those for product markets.
      2. The demand for a factor of production is derived from the demand for the good or service
      produced from this resource.
      3. A firm tries to hire additional units of a resource up to the point where the resource’s marginal
      revenue product (MRP) is equal to its marginal resource cost (MRC).
      4. In hiring labor, a perfectly competitive firm will do best if it hires up to the point where MRP =
      the wage rate.Wages are the marginal resource cost of labor.
      5. If you want a high wage:
      (A) Make something people will pay a lot for.
      (B) Work for a highly productive firm.
      (C) Be in relatively short supply.
      (D) Invest in your human capital.
      6. Real wages depend on productivity.
      7. Productivity depends on real or physical capital, human capital, labor quality and technology.

        Unit 4 : Microeconomics                                       Visual 4.1
        National Council on Economic Education              

Figuring out the Cost of Operating Your Business
Total Fixed Costs
Total Variable Costs
Total Costs                TC = TFC + TVC
Average variable cost      AVC = TVC/Q
Average total cost         ATC = TC/Q

The table below shows the various short run costs for a firm producing shoes.
Quantity/day       0         1         2         3          4     5      6            7           8     9     10    11
Total Cost         $200 $300 $363 $400 $433 $458 $480 $500 $538 $600 $700 $900
AFC                          $200 $100 $67                  $50   $40    $33          $29         $25   $22   $20   $18
AVC                          $100 $82            $67        $58   $52    $47          $43         $42   $44   $50   $64
ATC                          $300 $182 $134 $108 $92                     $80          $72         $67   $66   $70   $82

             Production Choices and Costs in the Long Run
             Long Run Average Cost Curve

             Different Scales of Production
             Economies of scale
             Diseconomies of scale

             Different time Periods

             Immediate: already produced
             Short-run: change variables
             Long-run: no fixed

                         Total Fixed, Total Variable, and Total

                   Unit 3: Microeconomics                               Visual 3.3
                   National Council on Economic Education     

             Relationships between totals, averages, and marginals:
Note that the average of something is total/units, and marginal is the change in totals. For

   1. average profit is: (total profit)/(total output)
   2. marginal profit is: [(total profit, output=x)-(total profit, output=(x-i))]/i

From the example in the table given above, we can plot total, average, and marginal
profits in Figure 2.b below:

Marginal Analysis and Profit Maximization

Marginal revenue equals marginal cost.

      Marginal revenue = (change in total revenue)/(1 unit change in Q)
      Marginal cost = (change in total cost)/(1 unit change in Q)

Profits are maximized when MR = MC. If we increase Q beyond that point, then MR is
less than MC, and so costs go up by more than revenues go up on that unit sold. If we
decrease Q, then MR is greater than MC, and we can usually increase profit by increasing
Q. Thus profit cannot be increased when:

               MR = MC

The breakeven point occurs when total profit = 0. (TC=TR)
The long-run average cost curve (LRAC) It just never happens!!!!

The marginal cost curve (MC)
Combining cost curves

Prisoner’s Dilemma

In economics

Advertising is sometimes cited as a real life example of the prisoner’s dilemma. When
cigarette advertising was legal in the United States, competing cigarette manufacturers
had to decide how much money to spend on advertising. The effectiveness of Firm A’s
advertising was partially determined by the advertising conducted by Firm B. Likewise,
the profit derived from advertising for Firm B is affected by the advertising conducted by
Firm A. If both Firm A and Firm B chose to advertise during a given period the
advertising cancels out, receipts remain constant, and expenses increase due to the cost of
advertising. Both firms would benefit from a reduction in advertising. However, should
Firm B choose not to advertise, Firm A could benefit greatly by advertising.
Nevertheless, the optimal amount of advertising by one firm depends on how much
advertising the other undertakes. As the best strategy is dependent on what the other firm
chooses there is no dominant strategy and this is not a prisoner's dilemma but rather is an
example of a stag hunt. The outcome is similar, though, in that both firms would be better
off were they to advertise less than in the equilibrium. Sometimes cooperative behaviors
do emerge in business situations. For instance, cigarette manufacturers endorsed the
creation of laws banning cigarette advertising, understanding that this would reduce costs
and increase profits across the industry. This analysis is likely to be pertinent in many
other business situations involving advertising.

Without enforceable agreements, members of a cartel are also involved in a (multi-
player) prisoners' dilemma. 'Cooperating' typically means keeping prices at a pre-agreed
minimum level. 'Defecting' means selling under this minimum level, instantly stealing
business (and profits) from other cartel members. Anti-trust authorities want potential
cartel members to mutually defect, ensuring the lowest possible prices for consumers.

Strategy for the classical prisoner's dilemma
The classical prisoner's dilemma can be summarized thus:
                        Prisoner B Stays Silent Prisoner B Betrays
                                                Prisoner A: 10 years
Prisoner A Stays Silent Each serves 6 months
                                                Prisoner B: goes free
                        Prisoner A: goes free
  Prisoner A Betrays                            Each serves 5 years
                        Prisoner B: 10 years

In this game, regardless of what the opponent chooses, each player always receives a
higher payoff (lesser sentence) by betraying; that is to say that betraying is the strictly
dominant strategy. For instance, Prisoner A can accurately say, "No matter what Prisoner
B does, I personally am better off betraying than staying silent. Therefore, for my own
sake, I should betray." However, if the other player acts similarly, then they both betray
and both get a lower payoff than they would get by staying silent. Rational self-interested
decisions result in each prisoner being worse off than if each chose to lessen the sentence
of the accomplice at the cost of staying a little longer in jail himself (hence the seeming
dilemma). In game theory, this demonstrates very elegantly that in a non-zero-sum game
a Nash equilibrium need not be a Pareto optimum.

Generalized form
We can expose the skeleton of the game by stripping it of the prisoner framing device.
The generalized form of the game has been used frequently in experimental economics.
The following rules give a typical realization of the game.

       There are two players and a banker. Each player holds a set of two cards, one
       printed with the word "Cooperate", the other printed with "Defect" (the standard
       terminology for the game). Each player puts one card face-down in front of the
       banker. By laying them face down, the possibility of a player knowing the other
       player's selection in advance is eliminated (although revealing one's move does
       not affect the dominance analysis[1]). At the end of the turn, the banker turns over
       both cards and gives out the payments accordingly.

Given two players, "red" and "blue": if the red player defects and the blue player
cooperates, the red player gets the Temptation to Defect payoff of 5 points while the blue
player receives the Sucker's payoff of 0 points. If both cooperate they get the Reward for
Mutual Cooperation payoff of 3 points each, while if they both defect they get the
Punishment for Mutual Defection payoff of 1 point. The checker board payoff matrix
showing the payoffs is given below.

 Example PD payoff matrix
          Cooperate Defect
Cooperate 3, 3      0, 5
 Defect 5, 0        1, 1

In "win-lose" terminology the table looks like this:
            Cooperate             Defect
Cooperate    win-win       lose much-win much
 Defect win much-lose much       lose-lose

These point assignments are given arbitrarily for illustration. It is possible to generalize
them, as follows:

 Canonical PD payoff matrix
           Cooperate Defect
Cooperate R, R       S, T
  Defect T, S        P, P

Where T stands for Temptation to defect, R for Reward for mutual cooperation, P for
Punishment for mutual defection and S for Sucker's payoff. To be defined as prisoner's
dilemma, the following inequalities must hold:


This condition ensures that the equilibrium outcome is defection, but that cooperation
Pareto dominates equilibrium play. In addition to the above condition, if the game is
repeatedly played by two players, the following condition should be added.[2]


If that condition does not hold, then full cooperation is not necessarily Pareto optimal, as
the players are collectively better off by having each player alternate between Cooperate
and Defect.

These rules were established by cognitive scientist Douglas Hofstadter and form the
formal canonical description of a typical game of prisoner's dilemma.

A simple special case occurs when the advantage of defection over cooperation is
independent of what the co-player does and cost of the co-player's defection is
independent of one's own action, i.e. T+S = P+R.

A concept invented 1951 by John F. Nash Jr., Nobel laureate and hero of the 2001 film A
Beautiful Mind. The strategies of the players in a game are in Nash equilibrium if no
player would gain by a unilateral change of strategy. Unfortunately, some games, such as
Prisoners' Dilemma, have Nash equilibria with unsatisfactory properties. In Prisoners'
Dilemma, it is a Nash equilibrium for both (all) players to defect even though it is
common knowledge that it is better for one and all that each should cooperate.

JA Chapter 9-10, 13
Immigrants, Superstars and Poverty, EPI
Collective Bargaining Wrong in Principle, John W. Scoville
Jobs for All, Percy L.Greaves, Jr.
Chapter 7 Economic Reasoning
$750,000 Steelworkers, EPI
Effects of the Minimum Wage, EPI
How are Wages Determined? Percy Greaves

Movies:      Waterworld
             Along Came Polly
             About a Boy

Shared By: