Moving alongside the curve makes MRTS to decrease

Economics

2 credits

Lecture # 12: Production in the short-run and in the long-run. Production calculations.

2012-2013

1. Lecture content.

Production – is an activity directed to transfer economic resources into economic goods and services. There are three basic types of production:

· Unit production

· Mass production

· Processed production

Factors of production can be:

• Fixed
• Variable

Such division of factors creates two periods:

· Short-run

· Long-run

Short-run production function shows maximum possible amount of production which firm can reach changing quantity and combination of variable resources at given volume of fixed resources.

Quantity of labor (L)	Total Product (TP)	Marginal Labor Product ( )	Average Labor Product ( )
	-	-	-
		-13
		-43

Three stages in the short-run:

• Increasing returns

• Diminishing returns

• Negative returns

Law of diminishing returns –

In the long-run all factors of production can be changed. Hypothetic example:

Labor (L)	Volume of production (Q) for given amount of capital (K)

Isoquant – is a curve which shows set of all combinations of factors of production for a given volume of production. The slope of the curve is characterized by Marginal Rate of Technical Substitution. It shows how many units of labor is needed to substitute unit of capital for the same amount of production.

Real example: Oil transporting has two factors – tube diameter and pump’s output. For transporting 125,000 barrels of oil it is possible to use the following combinations:

Tube diameter (inches)
Pump’s output	37.5	22.5	8.5
MRTS	-	7.5	3.5	1.125	0.5

Moving alongside the curve makes MRTS to decrease.

Total costs of production of some good presents total payments for al factors of production and consist of total fixed costs and total variable costs.

Q	Costs
TFC	TVC	TC	MC	AFC	AVC	ATC
				-	-	-	-
						5,5	8,5
						5,3	7,3
					1,5	5,5
					1,2	5,8

• Marginal costs – additional costs which firm takes while changing quantity of production per unit.

• Average total costs

• Average fixed costs

• Average variable costs

In the long-run production all resources can be changed. This results in the fact that difference between fixed and variable costs disappears. The analysis considers LATC (longtime average total costs) and LMC (longtime marginal costs).

In a three-case model of SATC-LATC choice of a project is determined by forecasted market demand. Combining three parts of SATC curves with optimum volume of production produces LATC curve. If number of volumes of production tends to infinity, LATC curve becomes smoother. (Second graph)

The shape of LATC is determined by economies of scale:

• Increasing returns to scale (economies of scale)

• Decreasing returns to scale (diseconomies of scale)

Example below suggests a rough analysis of a firm’s production.

Total Sales = Price * Quantity

Total Costs = Total Fixed Costs + Total Variable Costs

Total Variable Costs = Variable Cost per Item * Quantity

Operations Income = Total Sales – Total Costs

After-Tax Income (Net Income) = Operations Income – Tax Rate * Operations Income

Sales:
10,000 items at $ 1,000 price per item	$ 10,000,000 per year
Fixed costs:
Rent	-
Property tax	-
Administrative expenses	-
Advertising	-
Depreciation	-
Other expenses	-
Total fixed costs:	$ 2,300,000 per year
Variable costs:
Labor	-
Materials	-
Sales expenses	-
Other expenses	-
Variable costs per item:	$ 500 per item
Total variable costs:	$ 5,000,000 per year
Total costs:	$ 7,300,000 per year
Total operations income:	$ 2,700,000 per year
Taxes (30%):	$ 810,000
After tax income	$ 1,890,000

Sensitivity analysis for an investment project is a checking of a project’s profitability if some of the variable factors of a project will be different from those which were planned. This analysis can be easily made in MS Excel. When profitability equals zero this stands for break-even point.

Economic analysis can be used to find break-even point in production and optimum amount of production.

1. Questions:
1. Describe types of production.
2. Differentiate between fixed and variable factors of productions.
3. Describe three stages in the short-run.
4. What is isoquant? What does MRTS show?
5. Explain the shape of LATC.
6. What are economies and diseconomies of scale?
7. What does sensitivity analysis show?
2. Glossary.

Unit production	Штучное производство
Mass production	Массовое производство
Processed production	Поточное производство
Production function	Производственная функция
Fixed factors of production	Постоянные факторы производства
Variable factors of production	Переменные факторы производства
Total product	Совокупный продукт
Marginal product	Предельный продукт
Average product	Средний продукт
Law of diminishing returns	Закон убывающей отдачи
Isoquant	Изокванта
Marginal Rate of Technical Substitution	Предельная норма технологического замещения
Longtime average total costs	Долгосрочные средние совокупные издержки
Longtime marginal costs	Долгосрочные предельные издержки
Economies of scale	Эффект масштаба производства
Increasing returns to scale	Положительный эффект масштаба производства
Decreasing returns to scale	Отрицательный эффект масштаба производства
Net income	Доход
Sensitivity analysis	Анализ чувствительности
Break-even point	Точка безубыточности