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Producer decision Making
City University
2007
Producer Decision MakingTC
05
10
152025303540
45
1 2 3 4 5
TR
The firmprofit
0
1400
1 2 3 4 5 6
Production FunctionQ = F(L,K, N)
Economic and Accounting Costs Costs vs. expenditures Opportunity cost Explicit and implicit cost Accounting cost vs. economic cost Sunk cost Depreciation Accounting profit =
TR – accounting cost Economic profit =
TR – economic cost
Analysis of the Production Function in the Short Run technological choice
Technology – a way of putting resources together
Efficient technology
Technological choice and consumer choice
Consumer choice
MUa/Pa = MUb/Pb
The firm as a consumer:
MUL/PL = MUK/Pk
Technological choice
MPL/PL = MPK/Pk
Analysis of the production functionshort run
short run There is at least one fixed factor Firm’s decisions are constrained by
the fixed factor Is the demand changes, the firm
can respond only by changing the quantity of output, not the scale of production
short run The Law of Diminishing Returnstotal, average and marginal product
L TPL0 01 152 323 574 805 956 1087 1198 128
short run The Law of Diminishing Returns
total, average and marginal product
L TPL MPL APL0 01 15 15 152 32 17 163 57 25 194 80 23 205 95 15 196 108 13 187 119 11 17
Analysis of the Production Functionlong run
Long run All factors are variable The firm can change its production
capacity – the scale of production
Short-Run vs.Long-Run Costs
Short run – Diminishing marginal returns results from adding successive quantities of variable factors to a fixed factor
Long run – Increases in capacity can lead to increasing, decreasing or constant returns to scale
Returns to Scale
Rs = % change in the output : % change in production factors
Economies of Scale Rs > 1 Constant Returns to Scale Rs = 1 Diseconomies of Scale Rs < 1
Short-Run CostsShort-Run Costs
Q FC VC TC = FC+ VC0 10 0 101 10 6 162 10 11 213 10 14 244 10 16 265 10 21 316 10 27 377 10 35 458 10 46 56
Short run – there is at least one fixed factor
Fixed cost – does not vary with the output
Variable cost – directly related to variations in output
The Law of diminishing marginal returns
Short-Run Costs Total Cost - the sum of all costs incurred
in production TC = FC + VC
Average Cost – the cost per unit of output
AC = TC/Output Marginal Cost – the cost of one more or
one fewer units of production MC = TCn – TCn-1 units
Short Run CostsMarginal Costs
Q FC VC TC = FC+ VC MC = ΔTC/Δ Q0 10 0 101 10 6 16 62 10 11 21 53 10 14 24 34 10 16 26 25 10 21 31 56 10 27 37 67 10 35 45 88 10 46 56 11
Marginal costs
МС –Extra cost involved in the
production of an extra unit of
output
Short-Run Costs
Q FC VC TC = FC+ VC AFC = FC/Q AVC= VC/Q AC = TC/Q0 10 0 101 10 6 16 10 6 162 10 11 21 5 5,5 10,53 10 14 24 3,3 4,7 84 10 16 26 2,5 4 6,55 10 21 31 2 4,2 6,26 10 27 37 1,7 4,5 6,127 10 35 45 1,4 5 6,48 10 46 56 1,25 5,75 7
Q FC VC TC = FC+ VC AFC = FC/Q AVC= VC/Q AC = TC/Q MC = TC/ΔQ0 10 0 101 10 6 16 10 6 16 62 10 11 21 5 5,5 10,5 53 10 14 24 3,3 4,7 8 34 10 16 26 2,5 4 6,5 25 10 21 31 2 4,2 6,2 56 10 27 37 1,7 4,5 6,12 67 10 35 45 1,4 5 6,4 88 10 46 56 1,25 5,75 7 11
Short-Run Costs
The Revenues of the Firm
Total Revenue TR = P x Q
Average RevenueAR = P
Marginal RevenueMR = Δ TR/Δ Q
The Profit of the Firm
Short RunMaximum Profit
MC = MR P > ACMinimum Loss
MC = MR P > AVC
Long RunMaximum Profit
MC = MR P > AC
The Theory of the Firm
City University
2007
Theories of the Firm
Neoclassical theory – profit maximization
Assumptions: Single-minded purpose Rationality Operational rules: MC = MR
Transaction Costs
Transaction costs – “the costs of providing for some good or service through the market rather than having it provided from within the firm” – Ronald Coase
Search and information costs Bargaining and decision costs Policing and enforcement costs
Transaction costs
Three dimensions along which transactions may vary:
asset specificity uncertainty frequency
The three main characteristics of the firm
Collectivity of people in an organization
Action by superior-subordinate direction
Continuity over time
Firms vs. Markets
The firm’s benefits
specialization in teams
transaction-cost savings
corporate capital formation
morale
The firm’s costs
shirking
agent misdirection
rent seeking
The Problem of X-inefficiency
X-inefficiency - the difference between efficient behaviour of firms assumed or implied by economic theory and their observed behaviour in practice.
- the cost that is higher than it needs to be because the firm is operating inefficiently
Factors causing X-inefficiency
Internal Factors Poor contracts
between principals and agents
Large firms may be difficult to control
External Factors Diffuse share
ownership Limited threat of
takeover Degree of
competition Barriers to entry
The Principal – Agent Problem the principal-agent problem - the difficulties
that arise under conditions of incomplete and asymmetric information when a principal hires an agent
the agent’s actions affect the principal's payoff, but they are not directly observable by the principal, or they are not verifiable to outsiders.
The central dilemma - how to get the employee or contractor (agent) to act in the best interests of the principal (the employer) when the employee or contractor has an informational advantage over the principal and has different interests from the principal.
Theories of the Firm
Theory of Managerial Utility – Oliver Williamson
Sales Revenue Maximization Model – William Baumol
Maximizing Present Value of the Firm’s Future Stream of Sales Revenues – William Baumol
Theories of the Firm
Maximizing Growth – Robin Marris - the managerial utility depends on
the firm’s rate of growth Supply led growth vs. Demand led
growth, or profitability vs. diversification The principal-agent problem
The Theory of the Firm
The Integrative Model – Oliver Williamson
Integrates the growth maximization model and the profit/sales maximization models and the maximization of the present value of future sales
Max growth = max sales
Theories of the Firm
Behavioral theories - Herbert Simon, Richard Cyert and James March
Firms – multi-goal, multi-decision, organizational coalitions
Imperfect knowledge and bounded rationality
Managers cannot meet the aspiration levels of all stakeholders
Managers cannot maximize, instead they have to satisfice
Stakeholders in the Firm Owners/investors Employees Customers Suppliers Distributors Creditors/banks The government Public at large
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