Managerial Economics

ELEMENTS OF SUPPLY AND OUTPUTS

Outline
1.1
1.
2
1.
3
1.
4
1.
5
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Goal of the Seller: Maximize Profit

How to make the product?

What is the cost of making the product?

How much can the seller get for the product in the
market?

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Why Do Firms Exist?

Firms offer a means of coordination that is extremely important and would be
sorely missing if workers operated independently.
Firms eliminate the need for every worker to negotiate every task that he or
she will perform, and bargain over the fees that will be paid for those tasks.
Firms can avoid this kind of bargaining by having managers that direct the
production of salaried workersthey tell workers what to do and when to do it,
and the workers (as well as the managers themselves) are simply paid a weekly
or monthly salary.

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Making the Goods: How Inputs are Turned

into Outputs
How do you make a cake?
Factors of production Inputs
Labor inputs include skilled workers
(carpenters, engineers) and unskilled
workers (agricultural workers), as well as
the entrepreneurial efforts of the firms
managers.
Materials include steel, plastics, electricity,
water, and any other goods that the firm
buys and transforms into final products.
Capital includes land, buildings,
machinery and other equipment, as well as
inventories.
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Time Period
Short run
Period of time when some of the firms inputs cannot be changed
Ex. In the short run, you cant buy another oven

Long run
Period of time when all of the firms inputs can be changed
Ex. In the long run, you can buy another oven, even build another kitchen

Variable factor of production

Input that can be changed in a certain period of time and that changes if the level of
output changes

Fixed factor of production

Input that cannot be changed in the short-run and that stays the same, regardless of
how much output is produced
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Production with One Variable Input (Labor)

PRODUCTION WITH ONE VARIABLE INPUT
AMOUNT OF LABOR (L)

AMOUNT OF CAPITAL (K)

TOTAL OUTPUT (q)

AVERAGE PRODUCT (q/L)

MARGINAL PRODUCT
(q/L)

10

10

10

10

10

10

30

15

20

10

60

20

30

10

80

20

20

10

95

19

15

10

108

18

13

10

112

16

10

112

14

10

108

12

-4

10

10

100

10

-8

Whats important about this production table?

Marginal product increases with the first workers = specialization
Workers are more efficient when they specialize in production and work together to produce a good.
Marginal product increases through Worker 3.
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Whats important about this production

table?
Eventually, marginal product falls= law of diminishing returns
At some point, each additional worker contributes less output than the worker before.
Why?
Production can lead to bottlenecks because capital is fixedworkers are waiting for
machinery to become open, etc.

Marginal product can be negative

Why?
Capital is fixed in the short run. If more and more workers keep getting added, they will get in
each others way and actually cause output to fall.

Marginal product becomes negative with the 9th worker.

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Slope of the Product Curve

The total product curve in (a) shows the output
produced for different amounts of labor input.
The average and marginal products in (b) can be
obtained (using the data in previous slide) the total
product curve.
To the left of point E in (b), the marginal product is
above the average product and the average is
increasing; to the right of E, the marginal product is
below the average product and the average is
decreasing.
As a result, E represents the point at which the average
and marginal products are equal, when the average
product reaches its maximum.
At D, when total output is maximized, the slope of the
tangent to the total product curve is 0, as is the
marginal product.
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Short-run Analysis of Total, Average, and Marginal Product

The Three Stages of Production in the short run:
Stage I: from zero units of the variable input to where AP is maximized (where MP=AP)
Stage II: from the maximum AP to where MP=0
Stage III: from where MP=0

In the short run, rational firms should be operating only in Stage II

Q: Why not Stage III? firm uses more variable inputs to produce less output
Q: Why not Stage I? underutilizing fixed capacity, so can increase output per unit by increasing the
amount of the variable input

What level of input usage within Stage II is best for the firm?
The answer depends upon:
how many units of output the firm can sell
the price of the product
the monetary costs of employing
the variable input
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