CH 8 TB Notes - HHJHJH PDF

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Learning Objectives 1. Explain why profit maximization requires firms to equate marginal product per dollar spent for all factor - Firms choose the least cost method of production because they are trying to minimize costs and maximize profits 2. Explain why profit maximizing firms substitute away from factors whose price have risen and toward factors whose price have fallen - Substitute away because they want to minimize costs and to do that, they need to adjust something when factors price has risen - Substitute towards factors whose price has fallen in order to obtain the lowest cost method of production 3. Understand the relationship between short and long run cost curves - Short run cost curves have a tangent point on Long run cost curve - Each short run curves represents a specific plant size - Long run curve represents lowest attainable cost for each possible output 4. Discuss the importance of tech change and why firms are motivated to innovate - Change in tech can allow you to be more efficient and be able to reduce costs - For example: instead of tons of labours costing lots of money in wage expense, hiring fewer workers but have more automated robots in order to save costs and be more efficient Long Run: No fixed Factors: -short run; when at least 1 factor is fixed, only way to adjust output is to adjust input of the variable factors - long run; when all factors varied, numerous ways to produce any given output(using automated machines and few workers) Technically efficient: using no more of all inputs than necessary, not wasting inputs

Implications of Cost Minimization: - Cost Minimization: If firms seek to max profits in long run, select production method that produces output at lowest possible cost Long run minimization: - Possible to substitute 1 factor for another to keep output constant while reducing total cost K= capital L= labour PL,Pk= prices per unit of 2 factors MPk/pk = MPL/pL -whenever ratio of marginal product of each factor to its price is not equal for all factors, possibilities for factor substitution that will reduce costs - tells you how to increase current level of output by spending either on capital or labour( if not

balanced) - as firms substitutes between labour and capital, marginal products of both factors will change For eg: - Firm reduces use of capital and increases use of labour, Marginal Product capital will rise and Marginal Product of labour will fall- law of diminishing returns Principle of Substitution: -suggests that profit maximizing(cost minimizing) firms will react to changes in factor prices by changing their methods of production - plays central role in resource allocation because how firms react to changes in relative factor prices that are caused by the changing relative scarcities of factors in the economy as a whole - banks: instead of having hundreds of tellers, they switched to ATMS and online banking substitute away from labour and more toward ICT capital Long Run Cost Curves: - When all factors can be varied, there exists a least- cost method of producing any given level of output - With given factor prices, minimum achievable cost for each lvl of output; expressed in terms of dollars per unit of output Long run average cost(LRAC) curve: when curve is showing the lowest possible cost of producing each level of output when all inputs can be varied -

Determined by the firms current tech and by factors of production Kind of like a boundary Points below curve are unattainable, points on the curve are attainable if sufficient time passes for all inputs to be adjusted To move from one point to another on LRAC requires adjustment in all factor inputs- eg: require a large factory with more machinery

1. Decreasing Costs: - From 0 to Qm the firm has falling long-run avg cost- expansion of output permits a reduction in avg cost - Economies of scale: reduction of long run avg costs resulting from an expansion in the scale firms operation - Occurs bcz output is increasing more than in proportion to inputs as the scale of the firms production expands - Increasing Returns: situation which output increases more than inputs as the scale of firms production increases 2. Constant Costs: - Minimum Efficient scale: smallest lvl of output at which LRAC reaches its minimum

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LRAC is flat over a range of output; the for, encounter costs over the relevant range of output meaning that the firms long run avg cost do not change as its output rises - Constant Returns: situation which output increases in proportion to inputs as the scale of production is increased 3. Increasing Costs: - When LRAC curve is rising, long run expansion in production is accompanied by a rise in average costs - If firms factor prices are constant, firms output must be increasing less than in proportion to the increase in inputs - Decreasing Returns: situations where output increases less than in proportion to inputs as the scale of a firm's production increases- less output compared to increase in scale of production Each SRTAC curve is tangent to the LRAC curve at the level of output for which the quantity of the fixed factor is optimal Tech Changes and Productivity Growth: - In very long run, improvements in available knowledge and resources, such changes cause downward shifts in LRAC curves Tech changes: refer to all changes in available techniques of production - Invention of assembly lines, development of robotics, etc Productivity: measure of output produced per unit of input used - Output per worker - Output per hour of work

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Productivity growth is driven by technological change is the primary cause of rising material living standards over decades and centuries

Tech changes: - Scientific discoveries- non profit orgs, university and government research labs - New ideas to improve 1. New techniques: instead of ppl digging railways themselves, we have bulldozers and machine 2. Improved input: type and quality of metals has changes over time 3. New products: new goods and services are constantly being invented- called product innovation Changes in Technology In Response to Market Conditions: - Firms respond to market signals that indicate changes in the economic environment

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Firms faced with increase in price of inputs, firms may either substitute away or innovate away from the input- or do both over different time horizons...