The

3 Production
Why do suppliers
Decision
choose the quantities
that they do?

DAMIEN KING
University of the West Indies, Jamaica
 What determines the amount of
?orange juice (or anything else)
produced?
How do producers respond to
?changing market conditions?
Why cant Red Stripe get all its
?bottles back?

2
Outline 1The Production Decision

2Costs of Production

The Production Decision with

3Varying Costs
Marginal Cost and Marginal
4Revenue

3
The
Production
Decision
 Engaged in the activity
The of bringing commodities
Produc to market
er encompassing
production, distribution,
and retail.
5
 Not a particular person
The
or business, but rather,
Produc
a representation of a
er sectors or the whole
economys production
choice.
6
 Objective
The Profit
Produc Choices
er Price, volume

Feasible Set
Market demand

7
 $125
Pennys
Painters
$85

Work $10

teams
$10
paint a
house in $10
a day
$10
Every
8
LOW MARK-UP
ON A HIGH
VOLUME? OR
HIGH MARK-UP
ON A SMALL
VOLUME?

Penny

9
 0
20
1 LOW MARK-UP
ON A HIGH
20
0 VOLUME? OR

2 200 0 HIGH MARK-UP
20 ON A SMALL
VOLUME?
$200
3
4
$100

$67

1 2 3 $50
4 5 6 7
All the ways of
making $200 total Penny

profit
10
 40
0
$
$325
30 All the price and
0 volume
$200
$225 combinations
20 $100 $192 that yield a $200
0 Profit = profit
$67

$50
$200
$125 10
Business cares
UNIT COST

0 only about the

amount of profit
0
Q and so is
0 1 2 3 4 5 6 7 8 indifferent to the
various 11
40
0
$
30
0

20 Profit =
Profit
$400 =
0 Profit
$300 =
Profit =
$200
Isoprofit
10 Profit
$100 = $ Curves
UNIT COST

0 0

0
Q
0 1 2 3 4 5 6 7 8
12
 What constrains

Q
The producers
Feasibl choices of price
and quantity?
e Set
The
The quantities

A
consumers are
Demand
willing to
Curve at each
purchase
possible price.
13
40
0
$
30
0

20 Mar
0 Fir Cur ket D
m ve em
De an d
Cu m
10 rv an
e d
0

0
Q
0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15

14
40
0
$ Demand
30 curve for
0 Pennys
20 house
0 painting
10
is the
0 producers
feasible
0
Q set
0 1 2 3 4 5 6 7 8
15
 40
0
$ Which is the
30 price/quantity
0 combination
that delivers
20
$19
0
the maximum
0 profit?
10
0

0
Q
0 1 2 3 4 5 6 7 8
16
There is a surge in
demand for the
product. How does the
producer respond?
Same quantity and raise price?
Same price and produce more?

18
$
An
Increas
e in
deman
Q
d
19
Greater demand raises
price and induces
producers to produce a
larger quantity, thereby
attracting more of the
economys resources into
this activity.
20
$
An
Increase
in the
cost of
Cost of
Production producti
on
Q
21
 Why is
infrastructure so
important to an
economy?

22
 The way in which road
infrastructure, whether
domestic or cross-border,
affects trade is quite
clear and operates
mainly through transport
costs
(Page 7)

23
$
Better
infrastruct
ure
reduces
productio
n costs
Q
24
Costs of
Production

25
Average cost not
constant as
output varies
Fixed Costs
Diminishing Returns

26
 Fixed Costs
Classifyi Invariant to quantity produced
ng Costs

Variable Costs
Vary with quantity produced

27
 Fixed Costs
Classifyi Rent
Management
ng Costs Advertising
Fixtures
Security
Variable Costs
Telephone
Labour
Raw Materials
Fuel

Uniforms
Packaging 28
 An extreme
example of
fixed versus
variable costs

29
 0
10
1
0 Fixed
10 00 0
$100
2 1 10
3 4
Costs
$50

$3 Average Fixed
3 Cost
1 2 3 4 5 6 7
The recovery of
fixed costs can be
spread over a larger
quantity of output
30
40
0
$
30
0

20
0

10
0

0
Q
0 1 2 3 4 5 6 7 8
31
 In n g
spec ternal i s h i
ialis Diminurns
atio ret
n
Variabl
$100
e Costs
Average Variable

$94
$75

$73
$60

$60
$55
Cost

1 2 3 4 5 6 7

There may be
efficiencies at first,
but diminishing
returns eventually
set in
32
40
0
$
30
0 Average Variable
Cost
20
0

10
0

0
Q Average Fixed
Cost
0 1 2 3 4 5 6 7 8
33
40
0
$
30
0
Average cost is
20 the sum of AFC
0 and AVC.
Average (Total) Cost
10
Average Variable
0
Cost

0
Q Average Fixed
Cost
0 1 2 3 4 5 6 7 8
34
35
The
Production
Decision with
Changing
Costs
 Fixed Variable
Garys
Gardeners

Work
team
landscape
s in a day
Unit costs
vary with
37
40
0
$
30
0

20
0 Average
Cost
10
0

0
Q
0 1 2 3 4 5 6 7 8
38
40
0
$
30
0
Profit =
20 $200
0

10
0

0
Q
0 1 2 3 4 5 6 7 8
39
40
0
$
30
0

20
Profit =
0 $200

10
0

0
Q
0 1 2 3 4 5 6 7 8
40
40
0
$
30
0
Profit =
20 Profit
$400 =
Profit
$300 =
0 Profit
$200 =
Profit
$100 =$
10 0
0

0
Q
0 1 2 3 4 5 6 7 8
41
 40
0
$
30
0

20
0
160
10
0

0
Q
0 1 2 3 4 5 6 7 8
42
The previous
results hold that
higher demand or
lower costs
stimulate greater
43
40
0
$ How much
30 profit at the
0
profit
20 maximum?
0 Average
Cost
10 Profit per
0 unit
Pric
(or Average Revenue)
0
Q e
0 1 2 3 4 5 6 7 8
44
This model of the
production decision can
be applied equally well to
a single firm in the
economy or to the
production of the entire
economy.
45
Marginal Cost
and Marginal
Revenue
Marginal Cost
The addition to total
cost incurred by
producing one more
unit.

47
40
0
$
30 320
0

20
185
0 Average
133
126 Cost
10 110 104 110
0

0
Q
0 1 2 3 4 5 6 7 8
48
320

185

133
126
110 104 110

49
 Marginal 100 50 30 40 80 140 220
Cost
TC(1) TC(0) Derivin
Total Costs 220 320 370 400 440 520 660 880 g
average quantity Margin
Average Cost
320 185 133 110 104 110 126
al Cost
Quantity 0 1 2 3 4 5 6 7

50
40
0
$
30 100 50 30 40 80 140 220
0
Marginal Cost
20
0

10
0

0
Q
0 1 2 3 4 5 6 7 8
51
Why cant
Red Stripe
get all its
bottles
back? 52
 MC
$
$14

$10

$6

Q
8 9 9 10
53
40
Isoprofit
0
$ Curves
30
0
Margina
l Cost
Averag
20
e Cost
0 chases
10
0 Averag Margin
e Cost

Q
al Cost
0
0 1 2 3 4 5 6 7 8
54
 Marginal
Revenue
The additional
revenue earned from
selling one more unit.

55
40
0
$
30
0
250
20 220
190
0
160
130
10 100
0 70
Price
0
Q
0 1 2 3 4 5 6 7 8
56
Marginal Revenue 250 190 130 70 10 -50 -110

TR(1) TR(0) Derivin

Total Revenue 250 440 570 640 650 600 490 g
price quantity Margin
Price 250 220 190 160 130 100 70
al
Quantity 0 1 2 3 4 5 6 7
Reven
ue
57
40
0
$250 190 130 70 10 -50 -110
30
0

20
0

10
0 Margin
al

0
Revenu
e Q
0 1 2 3 4 5 6 7 8
58
40
0
$
30
0 Why
20 Margin
al
Price
0 (Avera
ge

Reven
Revenu
10 e)
0
ue is
Margin
al
Revenu
Q
0
below
e
0 1 2 3 4 5 6 7 8
59
40
0
$
30
0 Why
20 Margin
al
Price
0 (Avera
ge

Reven
Revenu
10 e)
0
ue is
Margin
al
Revenu
Q
0
below
e
0 1 2 3 4 5 6 7 8
60
40
0
$
30 Another
0 Margin
al
Margin
al Cost
view of
20
Revenu
e
profit
0 maximizati
on
10
0

0
Q
0 1 2 3 4 5 6 7 8
61
Maximum profit is
achieved where
marginal revenue
is equal to
marginal cost.
62
 If demand increases, the
1producer raises price and
produces more
The producer meets demand not
2because of benevolence but
profit-seeking
Fixed costs accrue even with no
3production; variable costs aligned
to output
Marginal costs will rise at some
4quantity, and so eventually pull
up
Theaverage cost
profit-maximizing level or
5MC
production is where MR equals

63