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ⅣProduction and Cost☻Production Theory ☻Cost TheoryThe Production Function…shows the relationship betweenquantity of inputs used to make a goodand the quantity of output of that good.Q=f (L，K，N，E)•Q=f (L，K ) Short-run•Q=f (L，K) Long-run•Total Product TP=f (L，K)•Average Product AP=TP/L or AP=TP/K •Marginal ProductIn the production process, marginalproduct of any input is the increase inoutput that arises from an additional unitof that input.MP = (dTP/dL ) or (dTP/ dK)a Production Function: Helen’s cookie factoryQuantity of(cookies per hour)150140130120110100908070605040302010Hungry Helen’s Production FunctionMPTP•The slope of TP curve measures the marginal product of an input.•When the marginal product declines, TP curve becomes flatter(decreasing).Diminishing Marginal Product•…is the property whereby the marginalproduct of an input declines as the quantityof the input increases.•As more and more workers are hired at a firm, each additional worker contributes less and less to production because the firm has a limited amount of equipment.•At the beginning of production process…typical production curve-106.2-5809.625211512.51014151520151512.51010627277777570604525101010910810710610510410310210110MP L AP L TP L L K Short-run<>=00TUMUXX•MU ＞0，TU ↑increasing •MU ＜0，TU ↓decreasing •MU ＝0，TU max00TPMP,APLLTP L & MP L•MP L ----the slope of TP L curve•MP L ＞0，TP L increasingMP L increasing & decreasing•MP L ＜0，TP L decreasing •MP L ＝0，TP L maxAP LMP LTP LAP L & MP L•MP L ＞AP L ，AP L increasing •MP L ＜AP L ，AP L decreasing •MP L ＝AP L ，AP L maxTP L & AP L•AP L ---the slope of segment whichlinks the original and any point on TP L curve•When the segment is just the tangent of TP L curve , MP L ＝AP L ，AP L maxL 2L 1L 3ⅠⅢⅡlong-run Q=f (L，K)•Isoquant curve•Isocost curve•OptimizationFour Properties of Isoquant Curves •Higher isoquant curves are preferred tolower ones.•Isoquant curves do not cross.•Isoquant curves are downward sloping.•Isoquant curves are bowed inward.KQ1Q2CBAD⊿K⊿K⊿L⊿LLLaw of Diminishing Marginal Rate of Technical Substitution•RTSLK =－⊿K/⊿L•It is the rate at which a firm is willing to trade one factor for another.RTS•If ⊿L→0, RTSLK=－dK / dL•C = w·L ＋r·K •K = C/ r －(w/ r)·LWhat the firm can affordThe slope (absolute value)of the isocost lineequals the relative price of the two factors.K LC/wC/ rProducer OptimumBest Combination of Factors•Given quantity, minimize cost •Given cost, maximize quantityKQ1 ABOptimumECLKQ1Q2Q3ABOptimumE CLProducer Optimum occurs…… at the point where the highest isoquant curve and the isocost curve are tangent.•C = w· L＋r· K ; Q=f (L, K)•RTS=w/ rLK•MP/ MP K =w/ rL/ w = MP K / rLAccording to the Law of Supply:•Firms are willing to produce and sell a greater quantity of a good when the price of the good is high.The economic goal of the firmis to maximize profits.Total Revenue, Total Cost, and Profit•Total RevenueThe amount a firm receives forthe sale of its output.•Total CostThe market value of the inputsa firm uses in production.•Profit…is the firm’s TR minus its TC.Costs as Opportunity CostsA firm’s cost of production includes all theopportunity costs of making its output ofgoods and services.Explicit and Implicit Costs •Explicit costs are input costs that require a direct outlay of money by the firm.•Implicit costs are input costs that do not require an outlay of money by the firm.Economic Profit & Accounting Profit π=TR（Q）－TC（Q）•Economists measure a firm’s economic profit as TR minus TC, including both explicit and implicit costs.•Accountants measure the accounting profit as the firm’s TR minus only the firm’s explicit costs.✶When TR exceeds both explicit and implicit costs, the firm earns economic profit.✶Economic profit is smaller than.accounting profit.✶Normal profitTypical Cost Curves•The relationship between the quantity a firm can produce and its costs determines pricing decisions.For many firms, the division of TC between fixed and variable costs depends on the time horizon being considered.•In the short run,some costs are fixed.•In the long run,fixed costs become variable costs.The Various Measures of Cost•Costs of production (TC)may be dividedinto fixed costs and variable costs.costs in the short-runFixed and Variable Costs•Fixed costs are those costs that do not varywith the quantity of output produced.•Variable costs are those costs that do varywith the quantity of output produced.Total Costs•Total Fixed Costs (TFC)•Total Variable Costs (TVC)•STC= TFC+ TVC= r· K ＋w· L (Q)Average Costs•AC can be determined by dividing the firm’s costs by the quantity of output it produces.•AC is the cost of each typical unit of product. ✓Average Total Costs SAC=STC/Q=AFC+ AVC ✓Average Fixed Costs AFC=TFC/Q✓Average Variable Costs AVC =TVC/QMarginal Cost•MC measures the increase in TC that arises from an extra unit of production.SMC = ⊿STC/⊿Q= ⊿TVC/⊿QIf ⊿Q→0, MC = d TC/ d Q= d TVC/ d QCost Curves and Their Shapes •SMC、STC、TVCSMC=⊿STC/⊿Q=⊿TVC/⊿Q=⊿w· L/⊿Q=w/(⊿Q/⊿L)=w/MP L•MC rises with the amount of output producedwhich reflects the property of diminishing MP L .•MP L ---reciprocal “U”-Shaped•MC ---“U”-ShapedTVC 、TFC 、STC●TFC---straight line●SMC----the slope of STC or TVC curveMC ---“U”-ShapedMC＞0，STC and TVC increasing✓MC increasing, STC and TVC increasing at increasing speed ✓MC decreasing, STC and TVC increasing at decreasing speed•AFC 、A VC 、SACA VC=TVC/Q=(w· L)/Q=w/ (Q/L)=w/AP L•AP---reciprocal “U”-ShapedL•AVC and SAC ---“U”-ShapedThe SAC curve is U-shaped.•At very low levels of output SAC is high because FC is spread over only a few units.•SAC declines as output increases.•SAC starts rising because AVC rises substantially.•The bottom of the U-shaped SAC curve occurs at the quantity that minimizes SAC. •This quantity is sometimes called the efficient scale of the firm.Relationship between MC and SAC(AVC)✓Whenever MC is less than SAC, SAC is falling.✓Whenever MC is greater than SAC, SAC is rising. MC crosses SAC at the efficient scale which is the quantity that minimizes SAC.Three Important Properties of Cost Curves•MC eventually rises with the quantity of output.•SAC,A VC curve are U-shaped.•MC curve crosses the A VC and SAC curve at the minimum of A VC and SAC successively .•Because many costs are fixed in the short run but variable in the long run, a firm’s long-run cost curves differ from its short-run cost curves.•LTC = r· K(Q)＋w· L (Q)•LAC = LTC/Q•LMC= dLTC / dQLTC Q 0LMC LTCLMCLAC2013-7-2347STC 1STC 2STC 3TC Q0Q 1Q 2Q 3LTCSAC 1SAC 2SAC 3C 1C 2C 3Q 1Q 2Q 3Q’ 2Q’1O CQEconomies and Diseconomies of Scale •Economies of scale refer to the property whereby LAC falls as the quantity of output increases.•Diseconomies of scale refer to the property whereby LAC rises as the quantity of output increases.•Constant returns of scale refers to the property whereby LAC stays the same as the quantity of output increases.•f（λL，λk）＞λf（L，k）•f（λL，λk）= λf（L，k）•f（λL，λk）＜λf（L，k）。
Department of EconomicsA DVANCED M ICROECONOMICS -Course Outline and Reading Guide Students who have solid background and are not adverse to a mathematical approach may use H.R. Varian, Microeconomic Analysis, Norton, 3rd edition, 1992. An alternative advanced text emphasizing game theory is David M. Kreps, A Course in Microeconomic Theory, Princeton University Press, 1990. Even more advanced texts includes:Andreu Mas-Colell, Michael D. Whinston and Jerry R. Green, 1995. Microeconomics Theory. Oxford University Press. (An advanced textbook in microeconomics theory.)However, the following texts are referred to frequently.Geoffery A. Jehle & Philip J. Reny (2001). Advanced Microeconomic Theory (2nd Edition). Boston: Addison-Wesley. (JR)Y.-K. Ng, Mesoeconomics: A Micro-Macro Analysis, London: Harvester, 1986.A simpler alternative to JR is:David G. Luenberger (1995). Microeconomic Theory. McGraw-Hill. (DL)The following topics are provided for reading. The lectures may not cover all topics and may not proceed in the same order.:(0) Mathematical Introduction (May be skipped if students are already familiar)JR: Ch. A1 & A2DL: Appendix C(1) Basic Consumer TheoryMainly on consumer preferences and the existence of utility functions, properties of demand functions, the composite commodity theorem, and the Slutsky equation.DL: Ch. 4JR: Ch. 1, 2, 3.Ng, Welfare Economics, App.1B.H.A.J. Green, Consumer Theory, Chapters 1-7P.R.G. Layard and A.A. Walters, Microeconomic Theory, McGraw-Hill, Sections 5.1 and 5.2Varian, Chapters 7-9(2) Some ExtensionsR.H. Frank, “If Homo Economicus could choose his own utility function, would he want one with a conscience?” American Economic Review, September 1987,593-604; June 1989, 588-596.Y.-K. Ng, “Step-optimization, secondary constraints, and Giffen goods”, Canadian Journal of Economics, November 1972, 553-560.Y.-K. Ng, “Diamonds are a government’s best friend: Burden-free taxes on goods valued for their values”, American Economic Review, March 1987, 77: 186-191.Y.-K. Ng, “Mixed diamond goods and anomalies in consumer theory: Upward-sloping compensated demand curves with unchanged diamondness”, Mathematical Social Sciences, 1993, 25: 287-293.(3) UncertaintyDL: Ch.11Gravelle & Rees, Chapters 19 and 20Green, Chapters 13, 14 & 15Y.-K. Ng, “Why do people buy lottery tickets? Choices involving risk and the indivisibility of expenditure”, Journal of Political Economy, October 1965, 530-535.Varian, Chapter 11Y.-K. Ng, “Expected subjective utility: Is the Neumann-Morgenstern utility the same as the neoclassical’s?” Social Choice Welfare, 1984, pp. 177-186.(4) Production and Marginal Productivity TheoriesDL: Ch. 5JR: Ch. 2, 3.Baumol, Chapter 11Henderson & Quandt, Chapter 3Varian, Chapters 1-5R.H. Frank, “Are workers paid their marginal products”, American Economic Review, 1984, 549-571.L. Borghans & L. Groot, “Superstardom and monopolistic power: Why media stars earn more than their marginal contribution to welfar e”, Journal of Institutional and Theoretical Economics, 1998, pp.546-(5) Introduction to Mesoeconomic AnalysisY.-K. Ng, Mesoeconomics: A Micro-Macro Analysis, London: Harvester, 1986.Y.-K. Ng, “Business confidence and depression prevention: A meso economic perspective”, American Economic Review, May 1992, 82(2): 365-371.Ng, “Non-neutrality of money under non-perfect competition: why do economists fail to see the possibility?” In Arrow, Ng, and Yang, eds., Increasing Returns and Economic Analysis, London: Macmillan, 1998, pp.232-252.(6) General EquilibriumDL: Ch. 7; JR: Ch.5K.J. Arrow & F. Hahn (1971), General Competitive Analysis, Chapter 1F. Black (1995), Exploring General Equilibrium, Cambridge, Mass.: MIT Press.J.S. Chipman, “The nature and meaning of equilibrium in economic theory”, in D.Martindale, ed., Functionalism in Social Sciences; reprinted in H. Townsend, ed., Price Theory, Penguin.Gravelle & Rees, Chapter 16W. Nicholson, Appendix B to Chapter 19, “The existence of genera l equilibrium prices”, Microeconomic Theory, 1985, The Dryden Press, 684-694.Starr. R.M. (1997). General Equilibrium Theory: An Introduction. Cambridge University Press.Varian, Chapters 17 & 21S. Zamagni, Microeconomic Theory. Oxford: Blackwell, 1987, Ch. 16.(7) Selected Topics in Microeconomic Analysis(a)Adverse selection, signalling, and screening.Akerlof, G. “The market for lemons: quality uncertainty and the market mechanism”, Quarterly Journal of Economics, 1970, 89: 488-500.Mas-Colell, Andreu, Whinston, Michael D. & Green, Jerry R., Microeconomic theory New York : Oxford University Press, 1995, Ch. 13.(b)The principal-agent problemHolmstrom, B., (1979), “Moral hazard and Observability”, Bell Journal of Economics, 10(1), 74-91Mas-Colell, Andreu, Whinston, Michael D. & Green, Jerry R., Microeconomic theory New York : Oxford University Press, 1995, Ch. 14.3typescript.(h) Specialization and Economic OrganizationYang, Xiaokai, Economics: New Classical versus Neoclassical Frameworks, Blackwell, 2001, Chs.5-7, 11.Yang, Xiaokai & Ng, Y.-K. Specialization and Economic Organization: A New Classical Microeconomic Framework. In "Contributions to Economic Analysis", V ol. 215, 1993, Amsterdam: North Holland, pp. xvi + 507. (Mainly Chs.0-2, 5.)Yang, X iaokai & Ng, Siang, “Specialization and Division of Labour: A Survey”, in Kenneth J. Arrow, et al, eds., Increasing Returns and Economic Analysis, London: Macmillan, 1998, pp. 3-63.Yang, Xiaokai & Ng, Y.-K. “Theory of the Firm and Structur e of Residual Rights”, Journal of Economic Behaviour and Organization, V ol. 16, pp. 107-28, 1995.(i)Does the enrichment of a sector benefit others?Ng, "The Enrichment of a Sector (Individual/Region/Country) Benefits Others: The Third Welfare Theorem?", Pacific Economic Review, Nov. 1996, V ol. 1, No.2, pp.93-115.Ng, Siang & Y.-K., “The enrichment of a sector(individual/region/country) benefits others: a generalization”, Pacific Economic Review, Oct. 2000, 5(3): 299-302.Ng, Siang & Y.-K., “The enrichmen t of a sector(individual/region/country) benefits others: the case of trade for specialization”, International Journal of Development Planning Literature, 1999, 14(3): 403-410.。
