ECON 130 23/3/15

-Average fixed costs instead of demand of labour vs cost of capital

Aim of Producer
Choose bundle of inputs and outputs to maximise profit
Firms generate profits for owners who determine how to distribute it

MC = MR
Or:
MPL . P = W
MPK . P = V

Can look at raw materials as inputs, but instead it is the net output using capital
and labour
Assume output can be produced using labour/machine; more machines = more
workers

Let x = list of inputs

Y = maximum amount of outputs from capital and labour

Producer’s Problem
Producer is assumed to be a price taker
Competitive process – an industry can be competitive with 4 – 5 firms: price will
lower if price is too high through the competitive process; profits will be closer
to 0

Capital is long lasting, rental cost will be longer term eg. One year.
V is important to distinguish between rental cost and current market price (to
purchase the machine)

Profit:
= py – wL – vK

So long as output price is positive, therefore Output: y = f (L, K)

Production Function (Cobb-Douglas)

Alpha and beta – properties of the production function
Return to scale: (alpha + beta)
Larger firms – lower overall costs: alpha + beta > 1
Perfect competition:
Constant returns only
Increasing RTS, firm continues to grow larger so inconsistent with the
production function

Nature of production function – only a small number of large firms

Marginal Products
If increase the amount of labour/capital fixed, can measure the amount of output
produced
Increasing the amount of labour, decreases marginal product of labour

Profit Maximisation
Rather than have output and costs, differentiate:

Change in pi/change in K = p(delta f / delta K) – v]

pMPL = w

Marginal function depends on input cost and ouput prie.

Marginal revenue product = pMPL

Output price fixed

Cobb-Douglas Function
Constant returns – simplest function
1 unit labour produces 1 unit output

Constant returns to scale – capital:labour ratio is fixed and does not depend on
price; depends only on the price of the goods

Separation of prices and quantities

0 profit condition yields a particular function
Output depends on demand of consumers

Easy to contrast cost curve if:

Variables are variable
Average cost (minimising) at minimum of cot cuve
Rent on machinery is ficed’

TFC (total fixed costs) = VK

Costs that are fixed: marginal fixed costs = 0

Average fixed costs = total fixed costs/ (output)

AFC by nature are fixed

Fixed vs Sunk Costs

Same

Fixed costs – fixed as output changes

Sunk costs – already incurred if contract is already entered into
Fixed, non-sunk cost – exit the market, no costs to pay anymore