Understanding Animal Production Understanding Supply and Demand Concepts.
Production and Supply
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Transcript of Production and Supply
David Bryce © 1996-2002Adapted from Baye © 2002
David Bryce © 1996-2002Adapted from Baye © 2002
Production and SupplyProduction and Supply
MANEC 387MANEC 387
Economics of StrategyEconomics of Strategy
MANEC 387MANEC 387
Economics of StrategyEconomics of Strategy
David J. BryceDavid J. Bryce
David Bryce © 1996-2002Adapted from Baye © 2002
David Bryce © 1996-2002Adapted from Baye © 2002
The Structure of IndustriesThe Structure of Industries
Competitive Rivalry
Threat of newEntrants
BargainingPower of
Customers
Threat ofSubstitutes
BargainingPower of Suppliers
From M. Porter, 1979, “How Competitive Forces Shape Strategy”
David Bryce © 1996-2002Adapted from Baye © 2002
David Bryce © 1996-2002Adapted from Baye © 2002
Production and SupplyProduction and Supply
• Firms acquire inputs from suppliers• Economics of production determines
demand for inputs • Inputs are transformed into outputs
through a productivity relationship defined by the “production function”
• For example, consider the Cobb-Douglas production function:
Q = f(L,K) = ALK
• Firms acquire inputs from suppliers• Economics of production determines
demand for inputs • Inputs are transformed into outputs
through a productivity relationship defined by the “production function”
• For example, consider the Cobb-Douglas production function:
Q = f(L,K) = ALK
David Bryce © 1996-2002Adapted from Baye © 2002
David Bryce © 1996-2002Adapted from Baye © 2002
Total ProductThe Cobb-Douglas Production FunctionTotal ProductThe Cobb-Douglas Production Function
Q = f(K,L) = K0.5L0.5
• Assume that in the very short run, capital (K) is fixed at 16 units
• Short run production function:Q = 160.5 L0.5 = 4 L0.5
• What is total product (output) when we use 100 employees?
Q = 4 (1000.5) = 4 (10) = 40 units
Q = f(K,L) = K0.5L0.5
• Assume that in the very short run, capital (K) is fixed at 16 units
• Short run production function:Q = 160.5 L0.5 = 4 L0.5
• What is total product (output) when we use 100 employees?
Q = 4 (1000.5) = 4 (10) = 40 units
David Bryce © 1996-2002Adapted from Baye © 2002
David Bryce © 1996-2002Adapted from Baye © 2002
Product of LaborProduct of Labor
• Marginal product of labor – MPL = Q/L– Measures the output produced by the last
worker– Slope of the production function
• Average product of labor – APL = Q/L– Measures the output of an “average” worker
• Marginal product of labor – MPL = Q/L– Measures the output produced by the last
worker– Slope of the production function
• Average product of labor – APL = Q/L– Measures the output of an “average” worker
David Bryce © 1996-2002Adapted from Baye © 2002
David Bryce © 1996-2002Adapted from Baye © 2002
Productivity in StagesProductivity in Stages
LL
Q=F(K,L)Q=F(K,L)
IncreasingMarginalReturns
IncreasingMarginalReturns
DiminishingMarginalReturns
DiminishingMarginalReturns
NegativeMarginalReturns
NegativeMarginalReturns
MPMP
APAP
David Bryce © 1996-2002Adapted from Baye © 2002
David Bryce © 1996-2002Adapted from Baye © 2002
Optimal Choice of Input LevelsHow much of an input do I need?Optimal Choice of Input LevelsHow much of an input do I need?
• Use enough input such that marginal benefit equals marginal cost
• Logic – if one more unit provides more value (PQQ) than it costs (PLL), firm is better off – use another unit
• Use enough input such that marginal benefit equals marginal cost
• Logic – if one more unit provides more value (PQQ) than it costs (PLL), firm is better off – use another unit
TVPTVP
Input LInput L
PLLPLL
PQQPQQ
L*L*
Q*Q*
Tangency means MVP=MCTangency means MVP=MC
David Bryce © 1996-2002Adapted from Baye © 2002
David Bryce © 1996-2002Adapted from Baye © 2002
Marginal Rate of Technical Substitution – Cobb-Douglas
Marginal Rate of Technical Substitution – Cobb-Douglas
• Isoquants represent the combinations of inputs that produce a particular level of output
• Slope of isoquant gives the rate at which we can trade one input for another leaving output unchanged – marginal rate of technical substitution (MRTS)
• Isoquants represent the combinations of inputs that produce a particular level of output
• Slope of isoquant gives the rate at which we can trade one input for another leaving output unchanged – marginal rate of technical substitution (MRTS)
Input KInput K
Input LInput L
Q3Q3
Q2Q2
Q1Q1
Q1 < Q2 < Q3Q1 < Q2 < Q3
David Bryce © 1996-2002Adapted from Baye © 2002
David Bryce © 1996-2002Adapted from Baye © 2002
Linear IsoquantsPerfect substitutes – Perfect ComplementsLinear IsoquantsPerfect substitutes – Perfect Complements
Q3Q3Q2Q2Q1Q1
LL
KK
Q3Q3
Q2Q2
Q1Q1
LL
KK
Leontief (fixed proportion) technologyLeontief (fixed proportion) technology
David Bryce © 1996-2002Adapted from Baye © 2002
David Bryce © 1996-2002Adapted from Baye © 2002
Optimal Choice of Input CombinationsOptimal Choice of Input Combinations
• Choose optimal inputs Choose optimal inputs such that marginal such that marginal rate of technical rate of technical substitution equals substitution equals the price ratiothe price ratio
• LogicLogic – if MRTS > price – if MRTS > price ratio, you can get ratio, you can get more production/$ more production/$ from L than from K. from L than from K. Add more L until its Add more L until its marginal contribution marginal contribution equals that of Kequals that of K
• Choose optimal inputs Choose optimal inputs such that marginal such that marginal rate of technical rate of technical substitution equals substitution equals the price ratiothe price ratio
• LogicLogic – if MRTS > price – if MRTS > price ratio, you can get ratio, you can get more production/$ more production/$ from L than from K. from L than from K. Add more L until its Add more L until its marginal contribution marginal contribution equals that of Kequals that of K
Input KInput K
Input LInput L
Tangency means MRTS = price ratio
Tangency means MRTS = price ratio
L*L*
K*K*
PL/PKPL/PK
David Bryce © 1996-2002Adapted from Baye © 2002
David Bryce © 1996-2002Adapted from Baye © 2002
Input Factor DemandsHow much do we need from suppliers?Input Factor DemandsHow much do we need from suppliers?
Input KInput K
Input LInput LL0L0
K0K0
PL/PKPL/PK
L1L1
K1K1
When the price of labor rises, firm demand for labor falls and demand for capital rises
When the price of labor rises, firm demand for labor falls and demand for capital rises
David Bryce © 1996-2002Adapted from Baye © 2002
David Bryce © 1996-2002Adapted from Baye © 2002
Input Factor DemandInput Factor Demand
LL
KK
$$
LL
DLDLP1P1
L0L0 L1L1
The firm’s demand for an input (from a supplier) is derived from each new equilibrium point found on the isoquant as the price of the input is varied.
The firm’s demand for an input (from a supplier) is derived from each new equilibrium point found on the isoquant as the price of the input is varied. P0P0
David Bryce © 1996-2002Adapted from Baye © 2002
David Bryce © 1996-2002Adapted from Baye © 2002
Elements of CostFirms Incur Costs Using InputsElements of CostFirms Incur Costs Using Inputs
• Total cost is an (always) increasing function of output and assumes that firms produce efficiently.
• Variable cost is the cost of variable inputs (e.g., direct labor, raw materials, sales commissions) and varies directly with output.
• Fixed costs remain constant as output increases
• Total cost is an (always) increasing function of output and assumes that firms produce efficiently.
• Variable cost is the cost of variable inputs (e.g., direct labor, raw materials, sales commissions) and varies directly with output.
• Fixed costs remain constant as output increases
TC(Q) = VC(Q) + FCTC(Q) = VC(Q) + FC
VC(Q)VC(Q)
FCFC
$$
David Bryce © 1996-2002Adapted from Baye © 2002
David Bryce © 1996-2002Adapted from Baye © 2002
Properties of CostProperties of Cost
• The properties of cost are determined by the shape of total cost function
• Average cost (AC(Q)) is the average cost per unit (TC(Q)/Q)
• Marginal cost (MC(Q)) is the cost of the last unit and defines the rate at which cost changes as quantity changes
• The properties of cost are determined by the shape of total cost function
• Average cost (AC(Q)) is the average cost per unit (TC(Q)/Q)
• Marginal cost (MC(Q)) is the cost of the last unit and defines the rate at which cost changes as quantity changes
$$
ATCATC
AVCAVC
AFCAFC
MCMC
David Bryce © 1996-2002Adapted from Baye © 2002
David Bryce © 1996-2002Adapted from Baye © 2002
Fixed CostFixed Cost
$$
ATCATC
AVCAVC
MCMC
ATCATC
AVCAVC
Q0Q0
AFCAFC Fixed CostFixed CostFixed CostFixed Cost
Q0(ATC-AVC)
= Q0 AFC
= Q0(FC/ Q0)
= FC
Q0(ATC-AVC)
= Q0 AFC
= Q0(FC/ Q0)
= FC
David Bryce © 1996-2002Adapted from Baye © 2002
David Bryce © 1996-2002Adapted from Baye © 2002
Variable CostVariable Cost
$$
ATCATC
AVCAVC
MCMC
AVCAVC
Q0Q0
Variable CostVariable CostVariable CostVariable Cost
Q0AVC
= Q0 [VC(Q0)/Q0]
= VC(Q0 )
Q0AVC
= Q0 [VC(Q0)/Q0]
= VC(Q0 )
ATCATC
David Bryce © 1996-2002Adapted from Baye © 2002
David Bryce © 1996-2002Adapted from Baye © 2002
Total CostTotal Cost
$$
ATCATC
AVCAVC
MCMC
AVCAVC
Q0Q0
TotalTotalCostCostTotalTotalCostCost
Q0ATC
= Q0 [TC(Q0)/Q0]
= TC(Q0 )
Q0ATC
= Q0 [TC(Q0)/Q0]
= TC(Q0 )
ATCATC
David Bryce © 1996-2002Adapted from Baye © 2002
David Bryce © 1996-2002Adapted from Baye © 2002
Time and CostTime and Cost
• Once a firm commits to a technology, it cannot immediately change scale – costs are more fixed in the short-run
• In the long-run, firms can change technology and scale – costs are more variable
• The long-run average cost is the minimum of all short-run cost curves over time.
• Once a firm commits to a technology, it cannot immediately change scale – costs are more fixed in the short-run
• In the long-run, firms can change technology and scale – costs are more variable
• The long-run average cost is the minimum of all short-run cost curves over time.
SRAC1
SRAC5SRAC
3
LRAC
QuantityQuantity
CostCost
David Bryce © 1996-2002Adapted from Baye © 2002
David Bryce © 1996-2002Adapted from Baye © 2002
Decision-Making and CostDecision-Making and Cost
• Accounting costs inform external constituents.
• Economic costs inform internal decision makers and include opportunity costs.
• Sunk costs have already been incurred and cannot be avoided.– Economic decisions depend on avoidable costs.– When fixed costs can be redeployed or sold, they
are not entirely sunk.– Sunk costs are the basis for strategic commitment.
• Accounting costs inform external constituents.
• Economic costs inform internal decision makers and include opportunity costs.
• Sunk costs have already been incurred and cannot be avoided.– Economic decisions depend on avoidable costs.– When fixed costs can be redeployed or sold, they
are not entirely sunk.– Sunk costs are the basis for strategic commitment.