Theory of Producer

1. Total Product Curve 2. Deriving Isoquant curves from 3D diagram 3. Producer Choice in Long Run

 Prior to the early 1990s, the Walt Disney Company dominated the market for animated films. Disneys films were produced using hundreds of animators drawing most of the film by hand. Each film may contain as many as 170,000 individual drawings. In 1994, The Lion King was produced at cost $50 million only but earned more than $1 billion in profit. Then Disney and other film makers produced more animated film and the demand for animators and the salaries for them increase sharply.

Case Study

In 1996, Pixar Animation released Toy Story, which is the first animated film that using computer to produce. With more development in the computer software, the cost of producing animated film decreases a lot and more films like Toy Story 2 and The Incredible were produced by computer instead of animator.

What is reason changing the trend of animated movies?

1. Total Product Curve

The production function can be expressed by Q = A*F(L,K)
The maximum amount of output that can be produced with K units of capital and L units of labor.

L (Variable Input) 0 1 2 3 4 5 6 7 8 9 10 11

L (Change in Labor)

APL = Q/L

APK = Q/K

MPL = dQ/dL Marginal Product per L

(Fixed Input) 2 2 2 2 2 2 2 2 2 2 2 2

Average (Output or Average Product Total product) Product per L per K 0 76 248 492 784 1100 1416 1708 1952 2124 2200 2156 76 124 164 196 220 236 244 244 236 220 196 38 124 246 392 550 708 854 976 1062 1100 1078

1 1 1 1 1 1 1 1 1 1 1

76 172 244 292 316 316 292 244 172 76 -44

 If we hold A and K constant, the total product curve of Labor is:

TPL Increasing Marginal Returns

Diminishing Marginal Returns

Marginal Product Curve

Marginal Product on an Input: change in total output by adding one more unit of input
Marginal Product of Labor: MPL = dQ/dL Measures the output produced by one additional worker. Slope of the short-run production function (with respect to labor). Marginal Product of Capital: MPK = dQ/dK Measures the output produced by one additional capital. When capital is allowed to vary in the short run, MPK is the slope of the production function (with respect to capital).

Increasing Marginal Returns Increasing Marginal Returns Diminishing Marginal Returns

Diminishing Marginal Returns

Law of diminishing marginal product when more and more variable inputs are added into production in short run, the marginal product will rise at first but will eventually fall.

Average Product (AP) Curves

Average Product of an Input: measure of output produced per unit of input.
Average Product of Labor: APL = Q/L. On average, how many outputs can be produced by one labor Average Product of Capital: APK = Q/K. On average, how many outputs can be produced by one capital

Turning pt of APL Turning pt of APL

167

APL = 150/3=167

Increasing, Diminishing and Negative Marginal Returns

Q
Increasing Marginal Returns Diminishing Marginal Returns Negative Marginal Returns

Q=F(K,L)

When AP is rising, MP must be greater than AP. When AP is decreasing, MP must be smaller than AP. Why?

MP

AP L

2. Deriving Isoquant curves from 3D diagram

According to our production function, we can derive the TP curve for L and K:
TPL K=3 TPK L=3 L=2 L =1

K=2
K=1

The 3D production diagram

U = f(X,Y)
Isoquant curves shows any combination of L and K that yields the same level of output.

Y 3 2 1 0 1 3 2

The Isoquant curves

K Q2 Q3

Q1

Increasing Output

Marginal Rate of Technical Substitution (MRTS) Slope of Isoquant curves The rate at which two inputs are substituted while maintaining the same output level.

MPL dK MRTSKL dL MPK

In general English, it means, how many K can be saved from hiring one more unit of L.

Isocost Curves
The combinations of inputs that produce a given level of output at the same cost: wL + rK = C Rearranging, K= (1/r)C - (w/r)L For given input prices, isocosts farther from the origin are associated with higher costs.
K C1/r C0/r C0 C0/w C1 C1/w New Isocost Line associated with higher costs (C0 < C1).

The slope of Isocost is the relative price of L, w/r. In general English, it means, in the market, if you hire one more unit of Labor, how many K it costs

 Changes in input prices change the slope of the isocost line.

K
C/r New Isocost Line for a decrease in the wage (price of labor: w0 > w1).

C/w0

C/w1

Cost Minimization
K
C/r

Producer equilibrium

Producer equilibrium represents a point that the total cost of production is minimized given that our output is produced at a target level. When the amount of K saved from increasing 1 unit of L is equal to the cost (in terms of K) in hiring 1 unit of L, it reaches producer equilibrium.

K1
Q

L1

C/w

Cost Minimization
K
C/r

Cost is not minimized at this point

By this cost level, we cannot produce output level Q. Q

C/w

Cost Minimization
When MRTS = Relative price of labor, cost is minimized given output at a specified level.
MPL w MRTSKL MPK r You can also say, when the amount of capital saved is equal to the price of labor (in terms of capital) in the market, cost is minimized.

Exercise
Draw an isoquant-isocost line graph to illustrate the following situation: Johnson can rent photocopy machines for $200 per day and hire workers for $100 per day. Currently, she is using 5 machines and 10 workers to produce 20,000 copies per day and has total costs of $2000. Johnsons marginal rate of technical substitution (MRTS) = -1. Explain why this means that she is not minimizing costs and what she could do to minimize costs.

Price Increase for On-campus Catering Outlets Dear students and colleagues, We are writing to give you advance notice that menu prices at the oncampus catering outlets will be increased from 20 July 2011. The affected outlets include Student Canteen, City Chinese Restaurant (8/F), City Top (9/F), Garden Cafe and Coffee Cart. The University approved the request from the on-campus caterers to raise menu prices after carefully consideration of the following factors: Continue rising food costs; Appreciation of Renminbi; and Rising labor and other operating costs.

Use Isoquant-Isocost analysis, illustrate the effect of rising labor cost on the input combination of student canteen.

Exercise
1. You are an efficiency expert hired by a manufacturing firm that uses K and L as inputs. The firm produces and sells a given output. If w = $40, r = $100, MPL = 4, and MPK = 40 the firm: a. Is cost minimizing b. Should use less L and more K to cost minimize c. Should use more K and less L to cost minimize d. Is profit maximizing but not cost minimizing. 2. Which of the following conditions is true when a producer minimizes the cost of producing a given level of output? a. The MRTS is equal to the ratio of input prices b. The marginal product per dollar spent on all inputs are equal c. The marginal products of all inputs are equal d. The MRTS is equal to the ratio of input prices and the marginal product per dollar spent on all inputs is equal 3. Isoquants are normally drawn with a convex shape because: a. Inputs are perfectly substitutable b. Inputs are perfectly complementary c. Inputs are not perfectly substitutable d. Inputs are not perfectly complementary

Exercise
4. Given the linear production function Q = 10K + 5L, if Q = 10,000 and K = 500, how much labor is utilized? a. 600 units b. 800 units c. 500 units d. 1000 units 5. Which of the following sets of economic data is minimizing the cost of producing a given level of output? a. MPL = 20, MPK = 40, w = $16, r = $32 b. MPL = 20, MPK = 40, w = $32, r = $16 c. MPL = 40, MPK = 20, w = $16, r = $32 d. MPL = 40, MPK = 40, w = $16, r = $32