Economics for CED

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Economics for CED

• Noémi GiszpencSpring 2004Lecture 3 Micro
  Supply
• February 24, 2004

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First, a little expansion of Demand From Lecture
2The proximate causes of demand
A
Tastes
Effective Demand
B
Prices
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From Lecture 2 longer causal chains
A1 A2 A3
Tastes
Effective Demand
B1 B2 B3
Prices
Other (e.g.laws)
C1 C2 C3
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A bigger picture
Commercial persuaders
Wants and desires
Effective demands
Prices
Marketers perspective
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An even bigger picture
Nature, Law, Culture, Home School, other
persuaders
Commercial persuaders
Wants and desires
Effective demands
Provident or improvident uses of the environment
Prices
Environmentalists perspective
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An even bigger picture
Deprivation, anxiety, unhappiness, bad behavior
Nature, Law, Culture, Home School, other
persuaders
Unsatisfied desires
Commercial persuaders
Wants and desires
Effective demandssatisfied desires
Fit or misfit between wants generated and wants
satisfied
Prices
Sociologists, social psychologists perspective
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An even bigger picture
Deprivation, anxiety, unhappiness, bad behavior
Few households own capital
Unsatisfied desires
Commercial persuaders
Wants and desires
Bargaining strengths
Effective demands
Incomes
HH rewards firms costs of production
Prices
Many households contribute labor
Left economists perspective
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Deprivation, anxiety, unhappiness, bad behavior
Nature, Law, Culture, Home School, other
persuaders
Few households own capital
Unsatisfied desires
Commercial persuaders
Fit or misfit between wants generated and wants
satisfied
Wants and desires
Bargaining strengths
Effective demands
Incomes
HH rewards firms costs of production
Prices
Provident or improvident uses of the environment
Many households contribute labor
Broad economists perspective
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Can even that picture be broadened?
Sixto Roxas, a Filipino economist, argues that
the main problem with conventional economics is
that it focuses its analysis on the interests of
the individual and the firm rather than those of
the family and the community. Neo-classical
economics is not just a mathematical framework or
analytical guideline to facilitate the
understanding of reality it is a full-fledged
ideology and design for remaking the world, he
says People are reduced to flesh-and-blood
machines that earn wages and salaries and
generate profits but whose non-economic existence
is not recognized. emphasis added
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Now, on to supply

• Who produces for the market? Firms.
• Households and Government are also producers, but
  not for the market
• Relations between producers
• Organized relations (within-firm)
• Market relations (beyond firm)
• Ex Restaurant owner organizes menu, shoppers,
  cooks, and waiters
• But goes to market for meat, vegetables supplied
  by farmers, truckers, and shopkeepers

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Firms purposes (1)

• Maximize profit, silly
• Remember, profits revenue - costs
• Or p PxQ - C(Q)
• Assume firms Q has no effect on P (for now)
• So main focus is effect of Q on C

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Another way to see profit
Rev3Q Cost5Q2/4 And pRev-Cost
At what point is profit maximized? What is the
slope of the cost curve?
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Firms costs

• (Do not include all costs--i.e., external)
• In the short run means during the time that you
  cannot replace existing fixed K
• What is the most economical way to use existing
  fixed K (capital) or, how to produce goods at
  least cost?
• A dual problem productivity (subject to
  diminishing marginal returns) and costs

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First, costs a few simple definitions

• Total costs
• All the accrued costs of producing
• Average cost
• Total cost divided by number of units produced
• Marginal cost
• Additional cost of producing the last unit

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Lets produce some widgets!

• Typical good produced in economics classes.
• Nobody knows what they are, really.
• At left, a drawing of a widget by Leonardo da
  Vinci.

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A numerical example
Quantity produced Total cost Average cost Marginal cost of last unit
0 5 - -
1 8 8 3
2 10 5 2
3 12 4 2
4 16 4 4
5 25 5 9
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The example graphed
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Marginal cost drives TC and AC

• Marginal cost is always positive total cost is
  always rising
• If marginal cost lt average cost, then marginal
  cost is pulling average cost down
• If marginal cost gt average cost, then marginal
  cost is pulling average cost up

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What happens to profits?

• Assume the price for output sold is 6

units Total cost Sell for Total p Avg. cost Sell for Avg p/unit Addl cost Addl rev. Addl p
3 12 18 6 4 6 2 2 6 4
4 16 24 8 4 6 2 4 6 2
5 25 30 5 5 6 1 9 6 -3
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Information from Costs

• All three cost measures show that biggest total
  profit comes from producing 4 units.
• Only marginal cost shows when firm is actually
  losing, and how much.
• Rule Produce until MC price
• This will give us the supply curve

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Types of costs

• Fixed cant be altered at short notice
• Factory, equipment, salaried staff
• Also called sunk costs, overheads
• Predictable economies of scale
• average fixed cost per unit output declines w/ Q
• Variable can vary w/ Q of output
• Raw materials, fuel, temp workers
• May not vary evenly

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Costs Fixed Variable

• Total Costs C(Q) F V(Q)
• Average Costs AC (F V(Q) ) Q
• Average Fixed costs F Q
• Average Variable costs V(Q) Q
• Marginal Costs MC d(FV(Q))/dQ
• Fixed costs have no effect on MC

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Some cost curves
TC
TC
VC
AC
MCAC1
MCAVC
AFC
F 0, V(Q) Q
F 1, V(Q) Q
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Another cost curve U-shaped
V(Q)(Q/3-2)2
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Yet another cost curve very high fixed costs,
low MC
TC
F100V(Q)Q/100
MC
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A counter-intuitive result

• If a firm has fixed costs, and if it can keep
  meeting its variable costs, it should keep
  producing regardless of whether it is making a
  loss.
• Making a little toward meeting fixed costs is
  better than making nothing at all
• Explains success of early railroads despite lack
  of profitability--they just kept chugging!

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Now, productivity diminishing returns

• Holding other factor(s) of production fixed,
  increasing a factor eventually adds less and less
  output
• Not all producers encounter rising costs and
  diminishing returns as output increases
• Some producers dont get demand for that level of
  volume
• Some factors of production have fixed capacity
• Beyond limit, no production at all
• Some factors of production are variable (can vary
  in proportion to each other)

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Production Function

• In general, Production is the transformation of
  inputs into outputs.
• Inputs are the factors of production -- land,
  labor, and capital -- plus raw materials and
  business services.
• A production function -- f(L,K, etc.)q --
  describes how combinations of inputs produce
  output (given a certain technology)
• We saw a production function in first class

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Average and marginal productivity

• Productivity is ratio of output to input
• Average productivity is total output divided by
  total input
• Marginal productivity is increase in output with
  addition of last unit of input
• With all other inputs held steady (cet. par.)

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A numerical example farmer Ted
Hours of Labor Output bushels of wheat Average Productivity Marginal Productivity
0 0 0 9.45
100 945 9.45 8.35
200 1780 8.9 7.25
300 2505 8.35 6.15
400 3120 7.8 5.05
500 3625 7.25 3.95
600 4020 6.7 2.85
700 4305 6.15 1.75
800 4480 5.6 0.65
900 4545 5.05 -0.45
1000 4500 4.5 0
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Output Diagram

• As the variable input increases, output increases
  at a decreasing rate.
• This is the Law of Diminishing Marginal
  Productivity

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Average and marginal productivity

• Marginal productivity is decreasing and pulling
  average productivity down.

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What happens to profits?

• Assume
• cost of variable input fixed (wage rate of
  farmeropportunity cost of working elsewhere),
  and
• price of good produced fixed (price of wheat
  determined by world markets)
• Profits revenue - costs PxQ - C(Q) Pxf(L,K)
  - C(L,K) for given L,K

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The relationship will look like this

• As labor input increases, output does not
  increase as fast.
• Cost of labor input goes up steadily but return,
  or value of marginal product slows down

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How to maximize Profit

• What does one additional labor unit add to cost?
  w wage
• What does one additional labor unit add to
  revenue? pMP value of marginal product
• Profit is maxed when pMP w

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Costs and types of firms

• Natural monopolies
• Ex power gas, water sewerage, canals RR
• Continually increasing returns to scale
• Big firms out-compete small firms
• Ex steel, machine-making, petro-chemicals
• U-shaped costs
• Medium-sized firms
• Ex house-building, furniture-making, textiles

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Costs and types of firms

• Constant unit costs
• Can be big or small
• Ex book publishing, brewing, wineries
• Diseconomies of scale
• Small firms have lower unit costs than big
• Ex tailoring, repair, individual arts, some
  farming
• Each type of industry has different temptations
  and remedies

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Firms purposes (2)

• Working and managing for owners
• When firms were mostly sole propietorships
• Maximizing profit or return on equity
• Directors purposes
• In 20th C., more separation of ownership and
  control
• Adolf A. Berle and Gardner C. Means, The modern
  corporation and private property (1932)
• What are the directors going to do?

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Berle and Means 3 alternatives

• Directors maximize owners p
• but own p motive weakened
• Manage for their own benefit
• Just enough p paid out to comply with law,
  attract K
• Keeps p motive but leads to corp. plunder
• Manage for good of all society
• Purely neutral technocracy

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The state seeks in some aspects to regulate the
corporation, while the corporation, steadily
becoming more powerful, makes every effort to
avoid such regulation. Berle and Means (1932)
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Firms are responsible to

• (Cant survive without any of the below)
• Owners
• Creditors
• Employees
• Customers
• Community
• Local National government

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Firms policy choices

• Profit maximize, moderate, or (for tax purposes)
  minimize?
• Short, medium, or long-term profit?
• How to divide profit between dividends and
  reinvestment in growth?
• Aim for big revenue, market share, profit,
  profit/sales, profit/equity?
• Stability or growth? Safety or risk?
• Working conditions? Neighborliness?
• Sketchiness offshore taxes, unsavory partners,
  bribery?