KINH TẾ VI MÔ Chapter v quan nguyen

The Theories on Firm’s Behavior
CONTENT
*Theory on production
- Production and Production function
- Short run &Long run
- Economies and diseconomies of scale
*Theory on cost
- Total, average and marginal cost
- Economic, Accounting and Sunk cost
*Theory on profit
- Profit
- Total, average and marginal revenue
- Profit maximization and revenue maximization
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I. Theory on Production
1. Some definitions
-Production: is the process that transforms inputs into
outputs, i.e. goods and services, to satisfy human wants.
PRODUCTION

INPUTS

OUTPUTS

K

L

Goods

Services

(Capital)

(Labour)

(Tangible)

(Intangible)

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I. Theory on Production
1. Some definitions
- Inputs used to produce commodities to satisfy people’s
needs, including:
+ Capital (K)
 Capital: Physical capital (K) => Interests (i)
 Land: Nature resources => Land tax (r)
+ Labor (L)
 Labor: Human activity (L) => Wage (w)
 Entrepreneurship: The capacity and willingness to develop,
organize and manage a business venture
=> Profit (П)

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I. Theory on Production
1. Some definitions
Short run and long run
+ Short run: is a period of time in which the quantity of at least
one input is fixed (fixed input) and the quantities of the other
inputs can be varied (variable inputs)
+ Long run: is a period of time in which the quantity of all inputs
can be varied
* No specific time that can be marked on the calendar to
separate the short run from the long run

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I. Theory on Production
2. Production Decisions of a Firm
- Production Technology
+ Firms can produce different amounts of outputs using
different combinations of inputs
- Cost Constraints
+ Firms must consider prices of labor, capital and other inputs
+ Firms want to minimize total production costs partly
determined by input prices

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I. Theory on Production
2. Production Decisions of a Firm
- Input Choices



Given input prices and production technology, the firm must
choose how much of each input to use in producing output
Given prices of different inputs, the firm may choose different
combinations of inputs to minimize costs


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If labor is cheap, may choose to produce with more labor and less
capital

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I. Theory on Production
2. Production Decisions of a Firm
- If a firm is a cost minimize, we can also study
How total costs of production varies with output

 How does the firm choose the quantity to maximize its profits
- We can represent the firm’s production technology in form of a
production function: The maximum quantity of outputs gained
from certain quantity of inputs at current technology
constraint in a certain time period
Q = f (K, L)


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I. Theory on Production
2. Production Decisions of a Firm
Cobb-Douglas production function

Q = a Kα Lβ,
where:
Q = output
L = labor input
K = capital input
α, β = labour and capital's share of output.

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I. Theory on Production

3. Short-run production
Assumption: Labor is variable while capital is fixed
 Firm can increase output only by using more labor
 Two questions
- How many products that one labor unit can contribute on
average?
- Should the firm hire another labor unit? If so, how many products
this labor can contribute?

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I. Theory on Production
3. Short-run production
 Average product of labour, or APL, is the ratio of
total output to the numbers of labour unit used.

Q
APL 
L
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I. Theory on Production
3. Short-run production


Marginal product labour, or MPL, is the change in
total output resulting from the use of an extra unit
of labour, given the other production factor (K)
held constant

Q
MPL 
L
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I. Theory on Production
3. Short-run production


If production function is continuous, the we have

MPL  Q(L
 )
Q

max when MPL = 0
MPL measures the slope of the output curve.



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I. Theory on Production
3. Short-run production
The law of diminishing marginal returns: occurs when
the marginal product of an additional input (e.g.
worker) is less than the marginal product of previous
input (i.e. previous worker)
* What is the relationship between MP and AP?

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Capital
(K)
4

Labour
(L)
0

Output
(Q)
0

4

1

70

4

2

150

4

3

4

4

4

5

4

6

APL

MPL

75
288
}

}

4

7

52

52

10


Capital
(K)
4

Labour
(L)
0

Output
(Q)
0

APL

MPL

0

-

4

1

70

70

4

2

150

75

4
4
4
4
4

3
4
5
6
7

225
288
340
354
364

75

}

70

}

80

}

75

}

63

}

52

}

14

72
68
59
52

}

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Marginal Product & Average Product






When marginal product is greater than the average
product, the average product is increasing

When marginal product is less than the average product,
the average product is decreasing
When marginal product is zero, total product (output) is
at its maximum
Marginal product crosses average product at its maximum

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Marginal Product & Average Product


Q
Q
'
L

Q


APL    
2
L
L


20

Q
Q 

L  MPL  APL  0
L
L

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II. Production cost
1. Economic cost, Accounting cost and Sunk cost
Economic cost: Total amount paid for inputs used in
production, includes:
-

Explicit cost: Amount paid for inputs that do not
belong to the firm’s owner
Implicit cost: Amount paid for inputs that belong to
the firm’s owner

Economic Cost
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=

Explicit Cost +

Implicit cost

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II. Production cost
1. Economic cost, Accounting cost and Sunk cost
Accounting cost: Amount paid for inputs used in
production and reported in accounting notes:
Economic Cost

=

Accounting Cost + Opportunity cost

Sunk cost: Amount paid for inputs used in production
which neither be refundable nor changeable by future
decisions/ actions

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II. Production cost
2. Cost in short-run
2.1. Fixed cost, variable cost, total cost
- Fixed cost (FC): the cost of a fixed input, independent
with the output level
C

FC

FC

Q
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II. Production cost
2. Cost in short-run
2.1. Fixed cost, variable cost, total cost
- Variable cost (VC): the cost of a variable input, varies
with the output level.
C
VC

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Q


II. Production cost
2. Cost in short-run
C
2.1. Fixed cost, variable cost,
total cost
- Total cost (TC): is the
sum of total fixed cost and
total variable cost

FC
TC = VC + FC
=> The vertical distance
between total cost curve
and variable cost curve
remains constant.
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TC
VC
FC

Q