Micro economics
Production function
- Firm transforms inputs into output
- Firm uses two types of inputs:
1. Fixed input: cannot be changed in the short run, fixed for a period of time (e.g
land)
2. Variable input: can be changed at any time (e.g labor, intermediary good from
firm a and b)
- Short vs long run: in the long run all inputs can be adjusted
- For now, we focus on the short run
- Production function: relationship between quantity of input and quantity of output
(for a given amount of the fixed input)
- Slope is positive: increasing line
- Marginal product input: change in output generated by adding one unit of input,
given an amount of the other input (marginal analysis)
- But marginal product can even become negative at some point
- Example: if firm hires too many employees who distract each other
,Describing production: economies of scale
- A firm’s costs depend on its scale of production and the type of production
technology it has.
- Large firms can be more profitable than small firms because of technological and or
cost advantages. We say that production exhibits
- Increasing returns to scale: if inputs increase by a given proportion, and production
increases more than proportionally
- Constant returns to scale: if inputs increase by a given proportion and production
increases by the same proportion
- Decreasing returns to scale: if inputs increase by a given proportion and production
increases less than proportionally.
Economies of scale examples
- Cost advantages- large firms can purchase inputs on more favorable terms, because
they have greater bargaining power when negotiating with suppliers
- Demand advantages- network effects (value of output rises with number of users e.g
software application)
- However, large firms can also suffer from diseconomies of scale, e.g additional layers
of bureaucracy due to too many employees.
Cost function:
- Fixed cost= cost of fixed input (e.g rent per month for location of restaurant or
production site, rent for land etc)
- FC does not depend on the quantity of output produced in the short-run
- Variable cost= costs such as salary of workers, electricity cost of intermediary goods
etc
- VC increases with the quantity of output produced: more output requires more units
of variable input
Cost function
, - To make pricing and production decisions, managers need to know the costs of
production
- Cost production: show how total production costs vary with quantity produced
- Average total cost: average cost per unit produced
- Marginal cost: the effect on total cost of producing one additional unit of output
- Calculated as the slope of the cost function at a given point
- In this example, the marginal costs increase with production
Production function
- Firm transforms inputs into output
- Firm uses two types of inputs:
1. Fixed input: cannot be changed in the short run, fixed for a period of time (e.g
land)
2. Variable input: can be changed at any time (e.g labor, intermediary good from
firm a and b)
- Short vs long run: in the long run all inputs can be adjusted
- For now, we focus on the short run
- Production function: relationship between quantity of input and quantity of output
(for a given amount of the fixed input)
- Slope is positive: increasing line
- Marginal product input: change in output generated by adding one unit of input,
given an amount of the other input (marginal analysis)
- But marginal product can even become negative at some point
- Example: if firm hires too many employees who distract each other
,Describing production: economies of scale
- A firm’s costs depend on its scale of production and the type of production
technology it has.
- Large firms can be more profitable than small firms because of technological and or
cost advantages. We say that production exhibits
- Increasing returns to scale: if inputs increase by a given proportion, and production
increases more than proportionally
- Constant returns to scale: if inputs increase by a given proportion and production
increases by the same proportion
- Decreasing returns to scale: if inputs increase by a given proportion and production
increases less than proportionally.
Economies of scale examples
- Cost advantages- large firms can purchase inputs on more favorable terms, because
they have greater bargaining power when negotiating with suppliers
- Demand advantages- network effects (value of output rises with number of users e.g
software application)
- However, large firms can also suffer from diseconomies of scale, e.g additional layers
of bureaucracy due to too many employees.
Cost function:
- Fixed cost= cost of fixed input (e.g rent per month for location of restaurant or
production site, rent for land etc)
- FC does not depend on the quantity of output produced in the short-run
- Variable cost= costs such as salary of workers, electricity cost of intermediary goods
etc
- VC increases with the quantity of output produced: more output requires more units
of variable input
Cost function
, - To make pricing and production decisions, managers need to know the costs of
production
- Cost production: show how total production costs vary with quantity produced
- Average total cost: average cost per unit produced
- Marginal cost: the effect on total cost of producing one additional unit of output
- Calculated as the slope of the cost function at a given point
- In this example, the marginal costs increase with production
