Module 4

Supply
Firm supply curve -> Market Supply curve
Productivity and cost
- How output is affected by input
-How much output costs

4.2 Productivity
At cet-par the only variable is labour
Also assumption is that productivity occurs in an engineering efficient fashion ( no
waste of time or resources although doesnt mean resources are all utilized)
Since resources are limited ( eg no. of machines) total output has a limit of max
output that cannot be increased cet-par.
Also relation between input ( labor) and output is not constant.
Total product curve
Production frontier -> maximum possible output for different amount of varying
input cet par.
Any point BELOW production frontier means no engineering efficiency.
Production is not constant due to job specialization. Initially it increases but then
flattens out because even job spec is limited -> division of labor.
Production frontier can shift if fixed variable are changed ie not cet par. Eg size
factory or machines.
PF would never dip as labor increases. Extra workers would stay home/Out of way.
Average Product and Marginal Product

Marginal productivity is critical to efficiency.

After max TP the MP is zero
(( MP refers to the proportion of increase ie while it is increasing we can get an ever
increasing return))
1. When TP = 0, AP = 0
2. When AP is at its maximum, AP = MP
3. When MP is greater than AP, AP is increasing
proportionally more than AP
4. When MP is less than AP, AP is decreasing

Since TP is increasing

5. When the change in TP is 0, MP = 0

Marginal concept -> Rule of profit maximizing: Keep hiring until MP of the hire factor
equal the unit cost of that factor. ( indicated by graph and table).

At max AP, AP = MP

Below this value the labor unit is adding more product (MP) than its cost.
Above this value it costs more than the added value (MP) it produces
Gross product will still increase but the maximum net product ( and profit) will be at that
point.

4.3 Costs
TC

= All capital unit at their cost + All labor unit at their cost
= CnPcn + LnPLN
= all capital prices + all labor prices

Fixed cost of production = cannot be altered in necessary (((in short run)))

Variable cost of production = can be altered if necessary
The short run : is time period in which certain factors cannot be altered
The long run : time period in which all factors of production can be altered.
Sometimes labor is variable and there can be increase in shift or overtime
Sometimes labor is fixed eg by agreement with union and number of machines becomes
variables to inc production.
So also

TC = VC + FC

Productivity can be broken down into units of fixed cost (fixed cost divided by its lifetime) +
VC.
As previously explained an increase in input will result in increase in output (+ve relation)
but the increase are not proportional. ( is not a straight curve).
and at some point no further output even with inc input.

the shape of cost curve is determined by production curve. And total cost of output is a
function of productivity input.

Important to determine these at each level of production.

Average total cost of production

Average variable cost

Average fixed cost

ATC = AFC + AVC

Average cost and average production

1 As Q AFC since same FC divided by larger production Q
2 ATC will become more similar to AVC ( since based more on AVC)
3 When AVC is min AP is max
AVC of output is determined by AP of variable factor input

Marginal Cost
1 When MC is min MP is max
2) Ie the cost of producing another unit (output) is determined by the median productivity
of labor unit ( input).
When marginal prod is higher the marginal cost is lowest.
1)

L = labor and W = wage

Since wage is fixed AVC and AP vary inversely

2)

Since W is fixed MC and MP vary inversely

Therefore;
1.
2.
3.
4.
5.

When
When
When
When
When

TP = 0, TVC = 0 and TC = FC
ATC is minimum, ATC = MC
AVC is minimum, AVC = MC
MC is greater than ATC (AVC), ATC (AVC) is increasing
MC is less than ATC (AVC), ATC (AVC) is decreasing

MC intersects both graph at lowest

Average always chases the margin
4.4 Firm supply in the short run
Assumptions ;

Firm produces one good

Market prices outside of firms control and all goods are sold
Price of input is also outside of control ( only prod varies)
Goal is profit maximization. Profit is max when total revenue minus total
cost is max : TR TC is max

= TR TC
When = 0 = breakeven TR=TC
1) This was the 1st method of finding max profit. Calculate all = TR TC ad find max.
2) The 2nd method: Average revenue is fixed since price is fixed.
to be profitable firm must operate when TR > TC or AR > ATC

All input equivalent to this

output results in profit but
only 1 combination causes

All this is +ve profit

 = TR TC

so profit per kilo =

is max when AR ATC is max.
Since AR is fixed is max when ATC is minimum.
3) Method Marginal Analysis
Profit is max when MR = MC
MR : well since price is fixed MR = price
When MR > MC firm increases output since each unit adds more revenue than cost.
When MR < MC each unit adds more cost than revenue.
When MR = MC = max profit
Total profit = AR ATC x 314

All
profit
> ATC
(AR
ATCAR
would
give average profit per kilo).

Hypothesis : 1 product firm, production at production frontier/engineering efficient, profit

maximizing.
In short run so fixed costs dont change
How much to produce at diff prices.

MR=M
Since price is costs P = AR = MR
And profit is max when MC = MR
So Production will also way be at MR = MC intersect
P1 : AR<AVC so not even the variable costs are covered. So no production and only fixed
costs incurred.
P2: At Q2 AR=AVC ie variable costs covered. If this is produced or not indifferent. Loss of
FC anyway
P3: Still no profit since AR<ATC. But at Q3 it covers VC and some FC.
At Q2 MR>MC , more revenue than cost so Q inc till Q3
At Q4 MR<MC, more cost than revenue so Q reduced to Q3
P4: AR=AC and MR=MC , break even at Q4. All other ATC>AR
P5 and P6: max profit at MC=MR
Above or close to this the chart becomes a straight line because MP become zero ( eg all
machines are used so new
labor adds nothing)(in short run!)
Breakeve
Because same as MC curve in previous chart, at above AVC curve ie revenue at these
quantities covers at very least AVC.

Change in cost of variable input wage/labor shifts the curve.

Since MC stays same proportion but shifts upward.
So supple curve shifts upward as well.

4.5 MARKET SUPPLY

Total of amounts firms willing to supply
Start ofof
linefirms
is
Assumption ; large number
so no price monopoly.
still when at
least MC=AVC
intersect

Small
Short supply chart
Large added to create market supply.
QM equal to qAfirm
+ qB + qC
Change in variable input price/cost will shift MC and AVC curves so market curve as well.
Eg in recession and there is dec in wage, shift to right.

4.5.3 Equilibrium of the firm.

In short run is at MC=MR since this provides highest profit
In real world might never be reached due to constant changes (inventions, change in
customer preferences etc)
Opportunity cost is the profit forgone that could have been earned using same resources
When in
the next most profitable employment.
MR>AVC
In long since, since no fixed cost, if a resource owner doesnt get the opp cost he will shift
to new industry ( ie bigger profit elsewhere).
Therefore opp cost is included in fixed cost ( to justify staying in that business) and at this
breakeven point the firm is earning Normal Profit.
Ie Normal Profit = Opp cost
If profit>normal profit other firms will move into industry.

4.5.4 firm in long run

No cost is fixed
Assumption : all previous plans totally complete. All previous assets and resources
totally used up. Starting new.
Long run ends as soon as fixed costs ( capital goods) are set.
Profit is max when Long Run MC = MR
P = AR = MR means firm is a price taker.
When MR>LMC ( less than Q) the next output adds more revenue than cost.
When MR<LMC the next output adds more cost then revenue.
Also as long as AR>ATC there is still some profit.
To produce at Q the LAC curve shows the costs incurred.
At fixed price P (initial short run)
MR = MC and MR = LMC
Also at Q ATC=LAC
A soon as boat is purchase firm is back on the short run and change variable input as price
changes
Only at cet par (including price) firm is in SR and LR
Below LAC firm is not making normal profit ( opp cost) so closes up.

4.5.5 Market supply in long run

There is no long term market supply curve since there is long term market MC curve.
There are no existing firms in long run.
Assumption above firms are identical
Below P1 -> zero output
At Q1 VC are covered. Well assume firm decides to produce Q1 ( still zero FC
contribution).
At P2 ATC 9inc opp cost) are covered = normal profit
At P3 above normal profit new firms will move in.

Increase in firms but variable input doesnt change.

At price above P2 there is above normal profit so more firms move in that are ready to
produce at P2 so price doesnt change rise in long run. Inc in Q is proportional to increase
in firms. This is realistic if industry demand of resources is low.

If additional input come at highest price ( due to increase in resource demand) then curve
is no longer a straight line.
Once ATC increase then curve will curve.
Start at P2 and n firms. Firms will increase so ATC increases. They keep producing at q2
but now require P3 to attract a Q3 return.

4.6 Real world application.

4.6.1 Production frontier refer to actual data in real life
and not maximum achievable.
Eg same company and same producer but diff country.
Both not completely engineering efficient but B > A

4.6.2 Labour productivity

output/unit
Varies but not only cos of labor but also weak management, poor supervisors,. Training etc
Since most people can only sell their labor they sell it at cost of their marginal price,
therefore the more their skill the more value they add and increases their cost/
4.6.3 Factor return and scale of return
Relation between change in input and output is not constant. ( eg double labor and triple
Q)
Returns to factor inputs refer to varying one factor and holding all other inputs constant,
and so it is a short-run phenomenon.

Increasing
Constant
Decreasing
Returns to scale refer to a change in output resulting from a change in all factor inputs, so
that it is a long-run phenomenon.

Increasing
Constant

Decreasing
4.6.4 Supply elasticity
Price elasticity of supply -> is measure of responsiveness of Q with P