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Presentation Transcript

Slide1: 

Background to Supply

Background to Supply: 

Background to Supply The Short-run Theory of Production

SHORT-RUN THEORY OF PRODUCTION: 

SHORT-RUN THEORY OF PRODUCTION Profits and the aims of the firm Long-run and short-run production: fixed and variable factors The law of diminishing returns The short-run production function: total physical product (TPP) average physical product (APP) APP = TPP/QV marginal physical product (MPP) MPP = TPP/QV

Wheat production per year from a particular farm (tonnes): 

Wheat production per year from a particular farm (tonnes)

Wheat production per year from a particular farm (tonnes): 

Wheat production per year from a particular farm (tonnes)

Wheat production per year from a particular farm (tonnes): 

Wheat production per year from a particular farm (tonnes)

Wheat production per year from a particular farm (tonnes): 

Wheat production per year from a particular farm (tonnes)

SHORT-RUN THEORY OF PRODUCTION: 

SHORT-RUN THEORY OF PRODUCTION Profits and the aims of the firm Long-run and short-run production: fixed and variable factors The law of diminishing returns The short-run production function: total physical product (TPP) average physical product (APP) APP = TPP/QV marginal physical product (MPP) MPP = TPP/QV graphical relationship between TPP, APP and MPP

Wheat production per year from a particular farm: 

Number of farm workers Wheat production per year from a particular farm Tonnes of wheat produced per year Number of workers 0 1 2 3 4 5 6 7 8 TPP 0 3 10 24 36 40 42 42 40

Wheat production per year from a particular farm: 

Number of farm workers Wheat production per year from a particular farm Tonnes of wheat produced per year Number of workers 0 1 2 3 4 5 6 7 8 TPP 0 3 10 24 36 40 42 42 40

Wheat production per year from a particular farm: 

Wheat production per year from a particular farm Number of farm workers Tonnes of wheat produced per year TPP b d

Wheat production per year from a particular farm: 

Wheat production per year from a particular farm Number of farm workers (L) Tonnes of wheat per year TPP Tonnes of wheat per year Number of farm workers (L)

Wheat production per year from a particular farm: 

Wheat production per year from a particular farm Tonnes of wheat per year TPP Tonnes of wheat per year MPP Number of farm workers (L) Number of farm workers (L)

Wheat production per year from a particular farm: 

Wheat production per year from a particular farm Tonnes of wheat per year TPP Tonnes of wheat per year APP MPP Number of farm workers (L) Number of farm workers (L)

Wheat production per year from a particular farm: 

Wheat production per year from a particular farm Tonnes of wheat per year TPP Tonnes of wheat per year APP MPP Number of farm workers (L) Number of farm workers (L)

Wheat production per year from a particular farm: 

Wheat production per year from a particular farm Tonnes of wheat per year TPP Tonnes of wheat per year APP MPP b Number of farm workers (L) Number of farm workers (L) b

Wheat production per year from a particular farm: 

Wheat production per year from a particular farm Tonnes of wheat per year TPP Tonnes of wheat per year APP MPP b b d d Number of farm workers (L) Number of farm workers (L)

Background to Supply: 

Background to Supply Short-run Costs

SHORT-RUN COSTS: 

SHORT-RUN COSTS Measuring costs of production: opportunity costs explicit costs implicit costs Fixed costs and variable costs Total costs total fixed cost (TFC) total variable cost (TVC) total cost (TC = TFC + TVC)

Total costs for firm X: 

Output (Q) 0 1 2 3 4 5 6 7 TFC (£) 12 12 12 12 12 12 12 12 Total costs for firm X

Total costs for firm X: 

TFC Output (Q) 0 1 2 3 4 5 6 7 TFC (£) 12 12 12 12 12 12 12 12 Total costs for firm X

Total costs for firm X: 

TFC Total costs for firm X Output (Q) 0 1 2 3 4 5 6 7 TFC (£) 12 12 12 12 12 12 12 12 TVC (£) 0 10 16 21 28 40 60 91

Total costs for firm X: 

TVC Output (Q) 0 1 2 3 4 5 6 7 TFC (£) 12 12 12 12 12 12 12 12 TVC (£) 0 10 16 21 28 40 60 91 TFC Total costs for firm X

Total costs for firm X: 

TVC TFC Total costs for firm X Output (Q) 0 1 2 3 4 5 6 7 TFC (£) 12 12 12 12 12 12 12 12 TVC (£) 0 10 16 21 28 40 60 91 TC (£) 12 22 28 33 40 52 72 103

Total costs for firm X: 

TC Output (Q) 0 1 2 3 4 5 6 7 TFC (£) 12 12 12 12 12 12 12 12 TVC (£) 0 10 16 21 28 40 60 91 TC (£) 12 22 28 33 40 52 72 103 TVC TFC Total costs for firm X

Total costs for firm X: 

TC TVC TFC Total costs for firm X

SHORT-RUN COSTS: 

Marginal cost marginal cost (MC) and the law of diminishing returns SHORT-RUN COSTS

Average and marginal physical product: 

Average and marginal physical product Output Quantity of the variable factor

Average and marginal physical product: 

Output Quantity of the variable factor MPP b APP Average and marginal physical product

Marginal cost: 

Output (Q) Costs (£) Marginal cost

SHORT-RUN COSTS: 

Marginal cost marginal cost (MC) and the law of diminishing returns the relationship between the marginal and total cost curves SHORT-RUN COSTS

Total costs for firm X: 

TC TVC TFC Total costs for firm X

SHORT-RUN COSTS: 

Marginal cost marginal cost (MC) and the law of diminishing returns the relationship between the marginal and total cost curves Average cost SHORT-RUN COSTS

SHORT-RUN COSTS: 

Marginal cost marginal cost (MC) and the law of diminishing returns the relationship between the marginal and total cost curves Average cost average fixed cost (AFC) SHORT-RUN COSTS

SHORT-RUN COSTS: 

Marginal cost marginal cost (MC) and the law of diminishing returns the relationship between the marginal and total cost curves Average cost average fixed cost (AFC) average variable cost (AVC) SHORT-RUN COSTS

SHORT-RUN COSTS: 

Marginal cost marginal cost (MC) and the law of diminishing returns the relationship between the marginal and total cost curves Average cost average fixed cost (AFC) average variable cost (AVC) average (total) cost (AC) SHORT-RUN COSTS

SHORT-RUN COSTS: 

Marginal cost marginal cost (MC) and the law of diminishing returns the relationship between the marginal and total cost curves Average cost average fixed cost (AFC) average variable cost (AVC) average (total) cost (AC) relationship between AC and MC SHORT-RUN COSTS

Average and marginal costs: 

Output (Q) Costs (£) Average and marginal costs

Background to Supply: 

Background to Supply The Long-run Theory of Production

LONG-RUN THEORY OF PRODUCTION: 

LONG-RUN THEORY OF PRODUCTION All factors variable in long run The scale of production: constant returns to scale increasing returns to scale decreasing returns to scale

Slide41: 

Short-run and long-run increases in output

LONG-RUN THEORY OF PRODUCTION: 

Economies of scale specialisation & division of labour indivisibilities container principle greater efficiency of large machines by-products multi-stage production organisational & administrative economies financial economies economies of scope LONG-RUN THEORY OF PRODUCTION

LONG-RUN THEORY OF PRODUCTION: 

Diseconomies of scale External economies and diseconomies of scale Optimum combination of factors MPPa/Pa = MPPb/Pb ... = MPPn/Pn LONG-RUN THEORY OF PRODUCTION

Background to Supply: 

Background to Supply Isoquant–Isocost Analysis

ISOQUANT- ISOCOST ANALYSIS: 

ISOQUANT- ISOCOST ANALYSIS Isoquants their shape

An isoquant: 

Units of K 40 20 10 6 4 Units of L 5 12 20 30 50 Point on diagram a b c d e Units of labour (L) Units of capital (K) An isoquant

An isoquant: 

Units of K 40 20 10 6 4 Units of L 5 12 20 30 50 Point on diagram a b c d e a Units of labour (L) Units of capital (K) An isoquant

An isoquant: 

Units of K 40 20 10 6 4 Units of L 5 12 20 30 50 Point on diagram a b c d e a b Units of labour (L) Units of capital (K) An isoquant

An isoquant: 

Units of K 40 20 10 6 4 Units of L 5 12 20 30 50 Point on diagram a b c d e a b c d e Units of labour (L) Units of capital (K) An isoquant

ISOQUANT- ISOCOST ANALYSIS: 

ISOQUANT- ISOCOST ANALYSIS Isoquants their shape diminishing marginal rate of substitution

Diminishing marginal rate of factor substitution: 

Units of capital (K) Units of labour (L) g h isoquant MRS = 2 Diminishing marginal rate of factor substitution

Diminishing marginal rate of factor substitution: 

Units of capital (K) Units of labour (L) g h j k DK = 2 DL = 1 isoquant MRS = 2 MRS = 1 MRS = DK / DL Diminishing marginal rate of factor substitution

ISOQUANT- ISOCOST ANALYSIS: 

ISOQUANT- ISOCOST ANALYSIS Isoquants their shape diminishing marginal rate of substitution an isoquant map

An isoquant map: 

Units of capital (K) Units of labour (L) An isoquant map

ISOQUANT- ISOCOST ANALYSIS: 

ISOQUANT- ISOCOST ANALYSIS Isoquants their shape diminishing marginal rate of substitution isoquants and returns to scale

An isoquant map: 

Units of capital (K) Units of labour (L) An isoquant map

ISOQUANT- ISOCOST ANALYSIS: 

ISOQUANT- ISOCOST ANALYSIS Isoquants their shape diminishing marginal rate of substitution isoquants and returns to scale isoquants and marginal returns

Diminishing marginal rate of factor substitution: 

Units of capital (K) Units of labour (L) g h j k DK = 2 DL = 1 isoquant MRS = 2 MRS = 1 MRS = DK / DL Diminishing marginal rate of factor substitution

ISOQUANT- ISOCOST ANALYSIS: 

ISOQUANT- ISOCOST ANALYSIS Isoquants their shape diminishing marginal rate of substitution isoquants and returns to scale isoquants and marginal returns Isocosts

ISOQUANT- ISOCOST ANALYSIS: 

ISOQUANT- ISOCOST ANALYSIS Isoquants their shape diminishing marginal rate of substitution isoquants and returns to scale isoquants and marginal returns Isocosts slope and position of the isocost

An isocost: 

Units of labour (L) Units of capital (K) Assumptions PK = £20 000 W = £10 000 TC = £300 000 An isocost

An isocost: 

Units of labour (L) Units of capital (K) TC = £300 000 a b c d Assumptions PK = £20 000 W = £10 000 TC = £300 000 An isocost

ISOQUANT- ISOCOST ANALYSIS: 

ISOQUANT- ISOCOST ANALYSIS Isoquants their shape diminishing marginal rate of substitution isoquants and returns to scale isoquants and marginal returns Isocosts slope and position of the isocost shifts in the isocost

ISOQUANT- ISOCOST ANALYSIS: 

Least-cost combination of factors for a given output point of tangency ISOQUANT- ISOCOST ANALYSIS

Finding the least-cost method of production: 

Units of labour (L) Units of capital (K) Finding the least-cost method of production

Finding the least-cost method of production: 

Units of labour (L) Units of capital (K) Finding the least-cost method of production

ISOQUANT- ISOCOST ANALYSIS: 

Least-cost combination of factors for a given output point of tangency comparison with marginal productivity approach ISOQUANT- ISOCOST ANALYSIS

ISOQUANT- ISOCOST ANALYSIS: 

Least-cost combination of factors for a given output point of tangency comparison with marginal productivity approach Highest output for a given cost of production ISOQUANT- ISOCOST ANALYSIS

Finding the maximum output for a given total cost: 

TPP2 TPP3 TPP4 TPP5 Units of capital (K) Units of labour (L) O TPP1 Finding the maximum output for a given total cost

Finding the maximum output for a given total cost: 

O Units of capital (K) Units of labour (L) TPP2 TPP3 TPP4 TPP5 TPP1 Finding the maximum output for a given total cost

Finding the maximum output for a given total cost: 

O Units of capital (K) Units of labour (L) TPP2 TPP3 TPP4 TPP5 TPP1 Finding the maximum output for a given total cost

Finding the maximum output for a given total cost: 

O K1 L1 Units of capital (K) Units of labour (L) TPP2 TPP3 TPP4 TPP5 r v s u TPP1 Finding the maximum output for a given total cost

Background to Supply: 

Background to Supply Long-run Costs

LONG-RUN COSTS: 

LONG-RUN COSTS Long-run average costs shape of the LRAC curve assumptions behind the curve

Alternative long-run average cost curves: 

Alternative long-run average cost curves Output O Costs Economies of Scale

Alternative long-run average cost curves: 

Output O Costs Alternative long-run average cost curves Diseconomies of Scale

Alternative long-run average cost curves: 

Output O Costs Alternative long-run average cost curves Constant costs

A typical long-run average cost curve: 

A typical long-run average cost curve Output O Costs

A typical long-run average cost curve: 

A typical long-run average cost curve Output O Costs Economies of scale Constant costs Diseconomies of scale

LONG-RUN COSTS: 

LONG-RUN COSTS Long-run average costs shape of the LRAC curve assumptions behind the curve Long-run marginal costs

Long-run average and marginal costs: 

Long-run average and marginal costs Output O Costs LRAC Economies of Scale

Long-run average and marginal costs: 

Output O Costs LRAC Long-run average and marginal costs Diseconomies of Scale

Long-run average and marginal costs: 

Output O Costs LRAC Long-run average and marginal costs = LRMC Constant costs

Long-run average and marginal costs: 

Output O Costs Long-run average and marginal costs LRAC Initial economies of scale, then diseconomies of scale

LONG-RUN COSTS: 

LONG-RUN COSTS Long-run average costs shape of the LRAC curve assumptions behind the curve Long-run marginal costs Relationship between long-run and short-run average costs

LONG-RUN COSTS: 

LONG-RUN COSTS Long-run average costs shape of the LRAC curve assumptions behind the curve Long-run marginal costs Relationship between long-run and short-run average costs the envelope curve

Deriving long-run average cost curves: factories of fixed size: 

Deriving long-run average cost curves: factories of fixed size Costs Output O 3 factories 2 factories 1 factory

Deriving long-run average cost curves: factories of fixed size: 

SRAC1 SRAC3 SRAC2 SRAC4 SRAC5 LRAC Costs Output O Deriving long-run average cost curves: factories of fixed size

Deriving a long-run average cost curve: choice of factory size: 

Deriving a long-run average cost curve: choice of factory size Costs Output O Examples of short-run average cost curves

Deriving a long-run average cost curve: choice of factory size: 

LRAC Costs Output O Deriving a long-run average cost curve: choice of factory size

LONG-RUN COSTS: 

LONG-RUN COSTS Long-run average costs shape of the LRAC curve assumptions behind the curve Long-run marginal costs Relationship between long-run and short-run average costs the envelope curve Long-run cost curves in practice

LONG-RUN COSTS: 

LONG-RUN COSTS Long-run average costs shape of the LRAC curve assumptions behind the curve Long-run marginal costs Relationship between long-run and short-run average costs the envelope curve Long-run cost curves in practice the evidence

LONG-RUN COSTS: 

LONG-RUN COSTS Long-run average costs shape of the LRAC curve assumptions behind the curve Long-run marginal costs Relationship between long-run and short-run average costs the envelope curve Long-run cost curves in practice the evidence minimum efficient plant size

LONG-RUN COSTS: 

Derivation of long-run costs from an isoquant map derivation of long-run costs LONG-RUN COSTS

Slide95: 

Units of capital (K) O Units of labour (L) Deriving an LRAC curve from an isoquant map

Slide96: 

Units of capital (K) O Units of labour (L) TC1 TC2 TC3 TC4 TC5 TC6 TC7 100 200 300 400 500 600 700 Deriving an LRAC curve from an isoquant map

LONG-RUN COSTS: 

Derivation of long-run costs from an isoquant map derivation of long-run costs the expansion path LONG-RUN COSTS

Slide98: 

Units of capital (K) O Units of labour (L) TC1 TC2 TC3 TC4 TC5 TC6 TC7 100 200 300 400 500 600 700 Expansion path Deriving an LRAC curve from an isoquant map

Background to Supply: 

Background to Supply Revenue

REVENUE: 

REVENUE Defining total, average and marginal revenue Revenue curves when firms are price takers (horizontal demand curve) average revenue (AR) marginal revenue (MR)

Deriving a firm’s AR and MR: price-taking firm: 

O O Price (£) AR, MR (£) Q (millions) Q (hundreds) S D (a) The market (b) The firm Deriving a firm’s AR and MR: price-taking firm

Deriving a firm’s AR and MR: price-taking firm: 

O O Price (£) AR, MR (£) Pe S D D = AR = MR Q (millions) Q (hundreds) (a) The market (b) The firm Deriving a firm’s AR and MR: price-taking firm

REVENUE: 

REVENUE Defining total, average and marginal revenue Revenue curves when firms are price takers (horizontal demand curve) average revenue (AR) marginal revenue (MR) total revenue (TR)

Total revenue for a price-taking firm: 

Total revenue for a price-taking firm TR (£) Quantity Quantity (units) 0 200 400 600 800 1000 1200 Price = AR = MR (£) 5 5 5 5 5 5 5

Total revenue for a price-taking firm: 

TR (£) Quantity Quantity (units) 0 200 400 600 800 1000 1200 Price = AR = MR (£) 5 5 5 5 5 5 5 TR (£) 0 1000 2000 3000 4000 5000 6000 Total revenue for a price-taking firm

Total revenue for a price-taking firm: 

TR TR (£) Quantity Quantity (units) 0 200 400 600 800 1000 1200 Price = AR = MR (£) 5 5 5 5 5 5 5 TR (£) 0 1000 2000 3000 4000 5000 6000 Total revenue for a price-taking firm

Total revenue for a price-taking firm: 

TR TR (£) Quantity Total revenue for a price-taking firm

REVENUE: 

Revenue curves when price varies with output (downward-sloping demand curve) average revenue (AR) marginal revenue (MR) total revenue (TR) REVENUE

Revenues for a firm facing a downward-sloping demand curve: 

Revenues for a firm facing a downward-sloping demand curve

Revenues for a firm facing a downward-sloping demand curve: 

Revenues for a firm facing a downward-sloping demand curve

Revenues for a firm facing a downward-sloping demand curve: 

Revenues for a firm facing a downward-sloping demand curve

AR and MR curves for a firm facing a downward-sloping D curve: 

AR and MR curves for a firm facing a downward-sloping D curve Q (units) 1 2 3 4 5 6 7 P =AR (£) 8 7 6 5 4 3 2 AR AR, MR (£) Quantity

AR and MR curves for a firm facing a downward-sloping D curve: 

Q (units) 1 2 3 4 5 6 7 P =AR (£) 8 7 6 5 4 3 2 TR (£) 8 14 18 20 20 18 14 MR (£) 6 4 2 0 -2 -4 MR AR, MR (£) Quantity AR and MR curves for a firm facing a downward-sloping D curve AR

REVENUE: 

Revenue curves when price varies with output (downward-sloping demand curve) average revenue (AR) marginal revenue (MR) total revenue (TR) REVENUE

TR curve for a firm facing a downward-sloping D curve: 

TR curve for a firm facing a downward-sloping D curve Quantity TR (£)

TR curve for a firm facing a downward-sloping D curve: 

TR curve for a firm facing a downward-sloping D curve TR Quantity TR (£) Quantity (units) 1 2 3 4 5 6 7 P = AR (£) 8 7 6 5 4 3 2 TR (£) 8 14 18 20 20 18 14

REVENUE: 

Revenue curves when price varies with output (downward-sloping demand curve) average revenue (AR) marginal revenue (MR) total revenue (TR) revenue curves and price elasticity of demand REVENUE

TR curve for a firm facing a downward-sloping D curve: 

TR curve for a firm facing a downward-sloping D curve TR Elastic Inelastic Quantity TR (£)

AR and MR curves for a firm facing a downward-sloping D curve: 

AR, MR (£) Quantity AR and MR curves for a firm facing a downward-sloping D curve MR AR

REVENUE: 

Revenue curves when price varies with output (downward-sloping demand curve) average revenue (AR) marginal revenue (MR) total revenue (TR) revenue curves and price elasticity of demand Shifts in revenue curves REVENUE

Background to Supply: 

Background to Supply Profit Maximisation

PROFIT MAXIMISATION: 

PROFIT MAXIMISATION Using total curves maximising difference between TR and TC

Finding maximum profit using total curves: 

TR, TC, TP (£) Quantity Finding maximum profit using total curves

Finding maximum profit using total curves: 

TR, TC, TP (£) TR Quantity Finding maximum profit using total curves

Finding maximum profit using total curves: 

TR, TC, TP (£) TR TC Quantity Finding maximum profit using total curves

PROFIT MAXIMISATION: 

PROFIT MAXIMISATION Using total curves maximising difference between TR and TC the total profit curve

Finding maximum profit using total curves: 

TR, TC, TP (£) TP TR TC Quantity Finding maximum profit using total curves

Finding maximum profit using total curves: 

TR, TC, TP (£) TP TR TC a b c d Quantity Finding maximum profit using total curves

Finding maximum profit using total curves: 

TR, TC, TP (£) TP TR TC Quantity Finding maximum profit using total curves

PROFIT MAXIMISATION: 

PROFIT MAXIMISATION Using total curves maximising difference between TR and TC the total profit curve Using marginal and average curves

PROFIT MAXIMISATION: 

PROFIT MAXIMISATION Using total curves maximising difference between TR and TC the total profit curve Using marginal and average curves stage 1: profit maximised where MR = MC

Finding the profit-maximising output using marginal curves: 

Quantity Costs and revenue (£) Finding the profit-maximising output using marginal curves

Finding the profit-maximising output using marginal curves: 

Quantity Costs and revenue (£) MC Finding the profit-maximising output using marginal curves

Finding the profit-maximising output using marginal curves: 

Quantity Costs and revenue (£) MR MC Finding the profit-maximising output using marginal curves

PROFIT MAXIMISATION: 

PROFIT MAXIMISATION Using total curves maximising difference between TR and TC the total profit curve Using marginal and average curves stage 1: profit maximised where MR = MC stage 2: using AR and AC curves to measure maximum profit

Measuring the maximum profit using average curves: 

Quantity Costs and revenue (£) Measuring the maximum profit using average curves MR MC

Measuring the maximum profit using average curves: 

Quantity Costs and revenue (£) MR MC AR Measuring the maximum profit using average curves

Measuring the maximum profit using average curves: 

T O T A L P R O F I T MR Quantity Costs and revenue (£) MC AC AR Total profit = £1.50 x 3 = £4.50 Measuring the maximum profit using average curves

PROFIT MAXIMISATION: 

Some qualifications long-run profit maximisation the meaning of profit What if a loss is made? loss minimising: still produce where MR = MC PROFIT MAXIMISATION

Loss-minimising output: 

O Costs and revenue (£) Quantity Loss-minimising output

PROFIT MAXIMISATION: 

Some qualifications long-run profit maximisation the meaning of profit What if a loss is made? loss minimising: still produce where MR = MC short-run shut-down point: P = AVC PROFIT MAXIMISATION

The short-run shut-down point: 

The short-run shut-down point O Costs and revenue (£) Quantity

PROFIT MAXIMISATION: 

Some qualifications long-run profit maximisation the meaning of profit What if a loss is made? loss minimising: still produce where MR = MC short-run shut-down point: P = AVC long-run shut-down point: P = LRAC PROFIT MAXIMISATION