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  • Producer Theory Overview

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    Economics Theory

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    © All Rights Reserved
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    18 visualizzazioni14 pagine

    Producer Theory Overview

    Caricato da

    waste33
    Economics Theory

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    © All Rights Reserved
    Scarica in formato PDF o leggi online su Scribd
    Segnala contenuti inappropriati
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    Introduction to Producer Theory Unit of observation - the FIRM A firm is an economic unit that produces a good or service for sale. Assumed objective of the firm - Maximize economic profit Economic Profit = Total Revenue - Total (economic) Cost Economic vs. Accounting costs Variables that affect a firm’s production decision >» Price of the good or service they are selling (Px) ¢ —_Isthe firma price maker or a price taker (product market structure) > Price of other goods or services they could produce (Py) >» Technology - represented by the production function - X=f(L,K) ¢ Does the production function exhibit decreasing, constant, or increasing returns to scale? (Long run question) # Does the production function exhibit diminishing, constant, or increasing returns to factors? (Short run question) > Price of inputs - w=wage, r=rental rate of capital (sometimes i, interest) @ Is the firma price maker or a price taker in the factor market (factor market structure) > Time period -- short run vs. long run Is the assumption of profit maximizing behavior a valid assumption? Other possible goals/problems >» Achieving better social conditions in the firm’s community? > Increasing/maintaining market share >» Creating an image as a good employer/community citizen > Principal-agent problem (separation of ownership and control) PRODUCERS OBJECTIVE - Maximize profit - [] = TR-TC TI = economic profit TR = total revenue (economic revenue) TC = total cost (economic cost) TOTAL REVENUE - The total revenue function relates total revenue to output. How total revenue and output are related will depend on the market structure (perfect competition, monopolistic competition, oligopoly, pure monopoly) Total Revenue for a Price Taking Firm In the simplest case, perfect competition, the firm is a price taker. To say that the firm is a price taker means that it has no control over the price of its product. No matter how much or little it produces, the market price stays the same. For a price taking firm, the firm specific demand curve will be a horizontal line at the market price and the graph of the total revenue function will be a linear, upward sloping line with a slope equal to the price. The revenue function for the price taking firm is simply, P X Q (price times quantity). Total Revenue for a Price Making Firm If the firm operates in an imperfectly competitive industry (monopolistic competition, oligopoly, pure monopoly), the firm will be a price maker. To say that a firm is a price maker means that the price of its product depends on the level of output it produces (P>MR). The firm sets the price when it chooses its output level. For a price making firm, the firm specific demand curve will be downward sloping and the graph of the total revenue function have the shape of an inverted “U.” It will begin with and upward, decreasing slope, reach some maximum level of revenue, then decrease with in increasing slope. The revenue function for the price making firm is P(Q) X Q (price, a function of quantity, times quantity). MARGINAL REVENUE - The change in total revenue when one more unit of output is produced and sold in the market. With calculus, marginal revenue is found by taking the first partial derivative of the total revenue function with respect to quantity (MR=@TR/EP). Graphically, marginal revenue is the slope of the total revenue function. For a price taking firm, marginal revenue is constant and equal to price. Fora price making firm, marginal revenue is decreasing an less than price. TOTAL COST - The total cost function relates total costs to output. Two things will influence _ total cost, the production function (technology, Q@=f[L, K]), and the price of inputs (w, 1). Market structure also influences the characteristics/behavior of costs. Technology The production function is a mathematical relationship that tells the maximum output (total product) to expect from various levels and combinations of inputs (labor and capital). There are several technology related concepts one needs to understand. Total product - The maximum amount of output that can produced for a given level and combination of inputs (put input quantities in the production function and solve for output). Marginal product - The change in total product if one more unit of input is added. With calculus, marginal product is found by finding the first partial derivative of the production function with respect to the input you are concerned about. MP,=6Q/aL MP,=8Q/8K Average product - Total product per unit of input. (Q/L or Q/K) Technological Characteristies - Production functions are classified according to the way that output changes when inputs change. (Internal) Returns to Scale - When we discuss returns to scale we are talking about how output changes when all factors of production are changed proportionately. We ask, for example, what will happen to output if we double all inputs? There can be increasing, constant, or decreasing returns to scale. Returns to scale is a long run concept. Increasing Returns to Seale (economies of scale) - Output more than doubles when all inputs are doubled. Constant Returns to Scale - Output exactly doubles when all inputs are doubled. Decreasing Returns to Scale (diseconomies of scale) - Output increases by less than double when all inputs are doubled. Returns to Factors - When we discuss returns to factors we are talking about how output changes when a single factor of production is changes. We ask, for example, if I hire one more worker (or unit of capital), how much will output increase (remember marginal product)? This is largely a short run production concept. Short Run vs Long Run- In the short run, there are both fixed and variable inputs to the productive process. In the long run, all inputs are variable. When doing short run analysis, we typically assume labor to be the a variable factor and capital to be the fixed factor. Increasing Marginal Product - when one more variable input is added to the productive process, marginal product of the input increases. The short run production function has a positive, increasing slope. Constant Marginal Product - when one more variable input is added to a set of fixed inputs in production, marginal product of the variable input is constant. The short run production function has a positive, constant slope. Diminishing Marginal Product - when one more variable input is added to the productive process, marginal product of the input decreases. ‘The short run production function has a positive, decreasing slope. The “nature” of technology is one important determinant of the cost structure of the firm. Factor Prices (Prices of Inputs) - The prices of inputs and whether the firm can influence factor prices also help to determine the price structure of the firm. Price Taking Firm (in the factor markets) - The firm treats factor prices (w, r) as exogenous variables. No matter how many factors the firm does or does not use, the factor prices stay the same. Price Making Firm (in the factor markets) - Factor prices (w, r) are endogenous. The firm sets factor prices when it decides how many and what factors to hire (oligoposony, monopsony). Profit Maximization Problem - find the level of production with the greatest difference between total revenue and total cost. Basics of Producer Theory There is assumed to be a group of people in society who have a special ability called entrepreneurial ability. We assume that these entrepreneurs are constantly looking for opportunities to combine resources in productive ways and sell their products or services for a profit. We assume that the basic motive of the entrepreneur is to make the most profit possible. This typically means that he or she will be constantly moving from less profitable productive activities (industries) to more profitable productive activities (industries) and that, for any particular level of production, he or she will seek to produce at the lowest cost. The cost structure associated with a particular productive activity will ultimately determine the entrepreneur's (firm’s) willingness and ability to produce and sell his or her product or service (product supply). In a similar way, the production function, combined with the influence of the demand for the firm’s good or service, will determine how many resources (labor and capital) that the firm will be willing and able to buy (factor demand) at various factor prices (w and r).. The cost structure of the firm is influenced by three things: ‘Technology Technology is represented by the production function, a mathematical rule that relates inputs of factors of production to outputs of a good or service. Technologies can exhibit decreasing, constant, or incteasing retums to scale (long run phenomenon) or decreasing, constant, or increasing returns to factors (short run phenomenon). More is written on this below. Factor Prices ‘There are four categories of factor prices, wage, rental rate of capital, rent, normal profit. To keep things simple, we typically assume that labor (L) and capital (K) are the only inputs making wage {w} and rental rate of capital {r} the only relevant factor prices. Whether factor prices are ‘exogenous (the firm is a price taker in the factor markets) or endogenous (the firm is a price maker in the factor markets) depends on the structure of the factor markets (purely competitive vs oligopsony or monopsony). Most analysis at the intermediate level assumes that factor prices are exogenous (wages and rental rate of capital are not influenced by the individual firm’s decisions). Time Period There are two types of inputs, fixed inputs and variable inputs. Fixed inputs do not vary with the level of output. Variable inputs do vary with the level of output. In the short run at least one factor input cannot be changed (is fixed) so that output can be changed only by changing the amount of variable inputs used. In the long run all inputs are variable. That is to say that the distinction between the short and long run is determined by the length of time required to change all inputs. In a typical short run analytical problem we would assume capital to be fixed and labor to be variable. A typical production function might look something like Q, = 6K'L where Q, 1¢ output of good X (sometimes referred to as TP, total product), K ints of capital input, and L——=units of labor input, ‘The production function will tell us the maximum output possible for any given combination of inputs. For example if K=8 and L=16, the production function tells us the maximum output possible is 48 units of X. A factor mix of K=18,963 and L=9 will also produce 48 units. RETURNS TO FACTORS - The first partial derivative of the production function with respect to L and K will tell us how much total output will change if one input is change slightly, holding the other input constant (marginal physical product or, simply, marginal product). cox a) a @X/AL = the marginal product of labor - for the function above - ( pe? X/AK = the marginal product of capital - for the function above - (2 = us| ‘The first derivative will typically be positive over the range of production that is relevant to any economic analysis (indicating positive marginal product). ‘The second partial derivative of the production function with respect to L and K will tell us how ‘marginal product is changing as inputs are changed. 1ta'x/e* L=0 then the marginal product of labor is constant as more labor inputs are used (see TPI below). EXE L>0 then the marginal product of labor is increasing as more labor inputs are used (see TP2 below). WeXeL0 then the marginal product of capital is increasing as more capital inputs 2 are used. 1ENEK

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