Module 4 Supply
.
Productivity
Production Frontier
The production frontier
identifies for any given variable input
level (labour in this case) the maximum
possible output; the frontier traces all possible maximum outputs
for all possible inputs. Maximum possible output for a given level of inputs
constitutes technical or engineering efficiency
|
Total Product
(TP) |
Total Output |
|
|
|
|
|
Average Product
(AP) |
Variable factor
input |
APL= |
Total Product /
Output (Q) |
¸ |
Number
varriable Factors eg Labour (L) |
|
Marginal
Product (MP) |
Change in
Output attributed to change in quantity |
MPL= |
Change in
Output (DQ) |
¸ |
Change in Input
(DL) |
|
Labour |
Output |
APL = Q¸L |
MPL = DQ¸DL |
|
0 |
0 |
0 |
0 |
|
1 |
7 |
7 ¸1 = 6.8 |
7 |
|
2 |
18 |
18 ¸2 = 9.0 |
(18-7) ¸1 = 11 |
|
3 |
36 |
36 ¸3 = 11.9 |
(36-18) ¸1 = 18 |
AP and MP derived from TP few
assumptions
|
1. TP |
= 0 |
AP=0 |
|
|
|
2. AP |
maximum |
AP=MP |
|
|
|
3. MP |
> AP |
AP Ý |
|
|
|
4. MP |
< AP |
AP ß |
|
|
|
5. TP |
Change is 0 |
MP = 0 |
|
|
Marginal
Concept of Profit Maximization is to
add additional factor of production up to the point at which the marginal
product (MP) just equals the unit costs of the factor.
MP ³ P
The
shaded area shows the labor cost of hiring. Stop hiring when the amount of
labor falls below the wage rate.
The height of the curve
at any given level labour input indicates the contribution to output made by
the last unit hired. By summing the additions to output by each unit hired,
i.e. by summing the marginal products, total output is reached. Thus the area under the curve between zero and any level of variable factor input
yields total output/product.
If the going wage rate
were to decrease more labour would be hired. Whether W would increase would
depend upon whether the proportional increase in labour input were greater than
the proportional decrease in wages. Thus W might increase or decrease. The
return to all other factors is the area under the curve and above the
horizontal wage line W1.
Since W1 fell, R
had to increase.
Costs
|
Total
cost (TC) |
=
|
Fixed
Cost (FC) |
+ |
Variable
cost (VC) |
|
Average
Total Cost (ATC) |
= |
Total
Cost (TC) |
¸ |
Output
/Quantity (Q) |
|
Average
Variable Cost (AVC) |
= |
Total
Variable Cost (TVC) |
¸ |
Output
/Quantity (Q) |
|
Average
Fixed Cost (AFC) |
= |
Total
Fix Cost (TC) |
¸ |
Output/Quantity
(Q) |
|
Marginal
Cost (MC) |
= |
Cost
of producing another unit |
||
|
|
|
|
||
As output increases average fix cost (AFC) ß decreases and small difference between Average fixed
cost (AFC) and Average Total Cost (ATC)
Marginal cost MC) is at its minimum, marginal product
of labour is at its maximum
Average Variable Cost (AVC) is minimum Average
Production (AP) is maximum
As long as total revenue exceeds total cost, a profit
is made and there may be a range of outputs where this is possible. It follows
that there may be a range of outputs where marginal cost is less than, equal to
or greater than marginal revenue and a profit is made given that total revenue
(average revenue) exceeds total cost (average total cost) in that range.
|
1. TP |
= 0 |
TVC=0 |
TC= FC |
|
2. ATC |
Minimum |
ATC = MC |
|
|
3. AVC |
Minimum |
AVC = MC |
|
|
4. MC |
> ATC(AVC) |
ATC (AVC) increasing |
|
|
5 MC |
< ATC (AVC) |
ATC (AVC) decreasing |
|
Short
Run Supply Curve
·
Fixed factor inputs costs do not affect short run
supply curves by definition
·
short run supply curve will shift to the right i.e. a
firm would be willing to supply more at each and every price if the costs of
production fell; thus it could occur if either there were a movement towards
the production frontier, i.e. greater efficiency or the cost of variable factor
inputs decreased
the number of firms is fixed and changes in the prices of fixed factor inputs do not affect short run supply curves.
Long Run Supply Curve
The firm in the long
run is in the planning stage, deciding on the optimally sized plant; it
estimates long run marginal cost and equates this with MR. As soon as the plant
is built the firm is back in the short run.
A firm’s infinitely
elastic long run supply curve has no meaning.
For the industry supply curve to be infinitely elastic it means that as new firms enter the cost
of inputs do not change,
i.e. the industry in question is infinitely small relative to all other
industries taken together which are using the same factor inputs.
If input prices were to increase as new firms
entered, the average total cost curves of all firms would shift upwards, the
marginal cost curves (firm’s short run supply curves) shift left and the
industry long run supply curve would be upwards sloping.
number of firms is fixed and changes in the prices of fixed factor inputs do affect long run supply curves.
Return to
factor inputs (RF) refers to a firm varying one factor input holding all others constant
and seeing what happens to output. RF can be positive,
constant or negative. By holding at least one other factor
constant Return to factors (RF) is a short run
phenomenon.
Returns to
Scale (RC) refers to a firm altering all factor inputs (a long run issue) and observing the change in
output. Returns to Scale (RC) can be positive,
constant or negative
Both Returns to factor
inputs (RF) and Returns to Scale (RC) refer to a firm not an industry,
Return to factor inputs
(RF) and Return to Scale (RC) are independent of each other.