agri 2312 chapter 7 economics of input and product substitution
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AGRICULTURAL ECONOMICSTRANSCRIPT
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Introduction to Agricultural Economics, 5th edPenson, Capps, Rosson, and Woodward
© 2010 Pearson Higher Education,Upper Saddle River, NJ 07458. • All Rights
Reserved.
Economics of Inputand ProductSubstitution
Chapter 7
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Introduction to Agricultural Economics, 5th edPenson, Capps, Rosson, and Woodward
© 2010 Pearson Higher Education,Upper Saddle River, NJ 07458. • All Rights
Reserved.
Topics of DiscussionConcepts of isoquants and iso-cost lineLeast-cost use of inputs Long-run expansion of input useEconomics of business expansion and
contractionProduction possibilities frontierProfit maximizing combination of
products
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Introduction to Agricultural Economics, 5th edPenson, Capps, Rosson, and Woodward
© 2010 Pearson Higher Education,Upper Saddle River, NJ 07458. • All Rights
Reserved.
Physical Relationships
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Introduction to Agricultural Economics, 5th edPenson, Capps, Rosson, and Woodward
© 2010 Pearson Higher Education,Upper Saddle River, NJ 07458. • All Rights
Reserved.
Page 107
Output isidentical alongan isoquant
Output isidentical alongan isoquant
Isoquant means “equal quantity”Isoquant means “equal quantity”
Two inputsTwo inputs
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Introduction to Agricultural Economics, 5th edPenson, Capps, Rosson, and Woodward
© 2010 Pearson Higher Education,Upper Saddle River, NJ 07458. • All Rights
Reserved.
Slope of an Isoquant
The slope of an isoquant is referred to as the Marginal Rate of Technical Substitution, or MRTS. The value of the MRTS in our example is given by:
MRTS = Capital ÷ labor
Pages 106-107
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Introduction to Agricultural Economics, 5th edPenson, Capps, Rosson, and Woodward
© 2010 Pearson Higher Education,Upper Saddle River, NJ 07458. • All Rights
Reserved.
Slope of an Isoquant
The slope of an isoquant is referred to as the Marginal Rate of Technical Substitution, or MRTS. The value of the MRTS in our example is given by:
MRTS = Capital ÷ labor
If output remains unchanged along an isoquant,the loss in output from decreasing labor must beidentical to the gain in output from adding capital.
Pages 106-107
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Introduction to Agricultural Economics, 5th edPenson, Capps, Rosson, and Woodward
© 2010 Pearson Higher Education,Upper Saddle River, NJ 07458. • All Rights
Reserved.
Page 107
MRTShere is-4÷1= -4
MRTShere is-4÷1= -4
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Introduction to Agricultural Economics, 5th edPenson, Capps, Rosson, and Woodward
© 2010 Pearson Higher Education,Upper Saddle River, NJ 07458. • All Rights
Reserved.
Page 107
What is the slope overrange B?
What is the slope overrange B?
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Introduction to Agricultural Economics, 5th edPenson, Capps, Rosson, and Woodward
© 2010 Pearson Higher Education,Upper Saddle River, NJ 07458. • All Rights
Reserved.
Page 107
What is the slope overrange B?
What is the slope overrange B?
MRTShere is-1÷1= -1
MRTShere is-1÷1= -1
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Introduction to Agricultural Economics, 5th edPenson, Capps, Rosson, and Woodward
© 2010 Pearson Higher Education,Upper Saddle River, NJ 07458. • All Rights
Reserved.
Page 107
What is the slope overrange C?
What is the slope overrange C?
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Introduction to Agricultural Economics, 5th edPenson, Capps, Rosson, and Woodward
© 2010 Pearson Higher Education,Upper Saddle River, NJ 07458. • All Rights
Reserved.
Page 107
What is the slope overrange C?
What is the slope overrange C?
MRTShere is-.5÷1= -.5
MRTShere is-.5÷1= -.5
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Introduction to Agricultural Economics, 5th edPenson, Capps, Rosson, and Woodward
© 2010 Pearson Higher Education,Upper Saddle River, NJ 07458. • All Rights
Reserved.
Introducing Input Prices
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Introduction to Agricultural Economics, 5th edPenson, Capps, Rosson, and Woodward
© 2010 Pearson Higher Education,Upper Saddle River, NJ 07458. • All Rights
Reserved.
Plotting the Iso-Cost Line
Capital
Labor
Firm can afford 10 units ofcapital at a rental rate of $100for a budget of $1,000
Firm can afford 10 units ofcapital at a rental rate of $100for a budget of $1,000
Page 109
10
100
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Introduction to Agricultural Economics, 5th edPenson, Capps, Rosson, and Woodward
© 2010 Pearson Higher Education,Upper Saddle River, NJ 07458. • All Rights
Reserved.
Plotting the Iso-Cost Line
Capital
Labor
Firm can afford 100 units oflabor at a wage rate of $10 fora budget of $1,000
Firm can afford 100 units oflabor at a wage rate of $10 fora budget of $1,000
Page 109
10
100
Firm can afford 10 units ofcapital at a rental rate of $100for a budget of $1,000
Firm can afford 10 units ofcapital at a rental rate of $100for a budget of $1,000
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Introduction to Agricultural Economics, 5th edPenson, Capps, Rosson, and Woodward
© 2010 Pearson Higher Education,Upper Saddle River, NJ 07458. • All Rights
Reserved.
Slope of an Iso-cost LineThe slope of an iso-cost in our example is given by:
Slope = - (wage rate ÷ rental rate)
or the negative of the ratio of the price of the twoInputs. See footnote 5 on page 179 for the derivation of this slope based upon the budget constraint (hint: solve equation below for the use of capital).
($10 × use of labor)+($100 × use of capital)=$1,000
Page 109
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Introduction to Agricultural Economics, 5th edPenson, Capps, Rosson, and Woodward
© 2010 Pearson Higher Education,Upper Saddle River, NJ 07458. • All Rights
Reserved.
Original iso-cost line Change in budget or both costs
Change in wage rate Change in rental rate
Page 109
Line AB representsthe original iso-costline for capital andlabor…
Line AB representsthe original iso-costline for capital andlabor…
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Introduction to Agricultural Economics, 5th edPenson, Capps, Rosson, and Woodward
© 2010 Pearson Higher Education,Upper Saddle River, NJ 07458. • All Rights
Reserved.
Original iso-cost line Change in budget or both costs
Change in wage rate Change in rental rate
Page 109
The iso-cost line would shift outto line EF if the firm’s availablebudget doubled (or costs fell inhalf) or back to line CD if theavailable budget halved (or costsdoubled.
The iso-cost line would shift outto line EF if the firm’s availablebudget doubled (or costs fell inhalf) or back to line CD if theavailable budget halved (or costsdoubled.
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Introduction to Agricultural Economics, 5th edPenson, Capps, Rosson, and Woodward
© 2010 Pearson Higher Education,Upper Saddle River, NJ 07458. • All Rights
Reserved.
Original iso-cost line Change in budget or both costs
Change in wage rate Change in rental rate
Page 109
If wage rates doubled the linewould shift out to AF whilethe iso-cost line would shiftin to line AD if wage ratesdoubled…
If wage rates doubled the linewould shift out to AF whilethe iso-cost line would shiftin to line AD if wage ratesdoubled…
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Introduction to Agricultural Economics, 5th edPenson, Capps, Rosson, and Woodward
© 2010 Pearson Higher Education,Upper Saddle River, NJ 07458. • All Rights
Reserved.
Original iso-cost line Change in budget or both costs
Change in wage rate Change in rental rate
Page 109
The iso-cost line wouldshift out to line BE if rentalrate fell in half while theline would shift in to lineBC if the rental rate forcapital doubled…
The iso-cost line wouldshift out to line BE if rentalrate fell in half while theline would shift in to lineBC if the rental rate forcapital doubled…
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Introduction to Agricultural Economics, 5th edPenson, Capps, Rosson, and Woodward
© 2010 Pearson Higher Education,Upper Saddle River, NJ 07458. • All Rights
Reserved.
Least Cost Combinationof Inputs
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Introduction to Agricultural Economics, 5th edPenson, Capps, Rosson, and Woodward
© 2010 Pearson Higher Education,Upper Saddle River, NJ 07458. • All Rights
Reserved.
Least Cost Decision RuleThe least cost combination of two inputs (labor and capital in our example) occurs where the slope of the iso-cost list is tangent to the isoquant:
MPPLABOR ÷ MPPCAPITAL = -(wage rate ÷ rental rate)
Page 111
Slope of an isoquant
Slope of an isoquant
Slope of iso- cost line
Slope of iso- cost line
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Introduction to Agricultural Economics, 5th edPenson, Capps, Rosson, and Woodward
© 2010 Pearson Higher Education,Upper Saddle River, NJ 07458. • All Rights
Reserved.
Least Cost Decision RuleThe least cost combination of labor and capital in out example also occurs where:
MPPLABOR ÷ wage rate = MPPCAPITAL ÷ rental rate
Page 111
MPP per dollar spent on labor
MPP per dollar spent on labor
MPP per dollar spent on capitalMPP per dollar spent on capital=
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Introduction to Agricultural Economics, 5th edPenson, Capps, Rosson, and Woodward
© 2010 Pearson Higher Education,Upper Saddle River, NJ 07458. • All Rights
Reserved.
Least Cost Decision RuleThe least cost combination of labor and capital in out example also occurs where:
MPPLABOR ÷ wage rate = MPPCAPITAL ÷ rental rate
Page 111
MPP per dollar spent on labor
MPP per dollar spent on labor
MPP per dollar spent on capitalMPP per dollar spent on capital=
This decision rule holds for a larger number of inputs as well…
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Introduction to Agricultural Economics, 5th edPenson, Capps, Rosson, and Woodward
© 2010 Pearson Higher Education,Upper Saddle River, NJ 07458. • All Rights
Reserved.
Least Cost Combination of Inputs to Produce a
Specific Level of Output
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Introduction to Agricultural Economics, 5th edPenson, Capps, Rosson, and Woodward
© 2010 Pearson Higher Education,Upper Saddle River, NJ 07458. • All Rights
Reserved.
Page 111
Iso-cost line for $1,000.Its slope reflects price oflabor and capital.
Iso-cost line for $1,000.Its slope reflects price oflabor and capital.
Least Cost Input Choice for 100 UnitsLeast Cost Input Choice for 100 Units
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Introduction to Agricultural Economics, 5th edPenson, Capps, Rosson, and Woodward
© 2010 Pearson Higher Education,Upper Saddle River, NJ 07458. • All Rights
Reserved.
Page 111
Least Cost Input Choice for 100 UnitsLeast Cost Input Choice for 100 Units
We can determinethis graphically byobserving wherethese two curves are tangent….
We can determinethis graphically byobserving wherethese two curves are tangent….
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Introduction to Agricultural Economics, 5th edPenson, Capps, Rosson, and Woodward
© 2010 Pearson Higher Education,Upper Saddle River, NJ 07458. • All Rights
Reserved.
Page 111
We can shift the original iso-cost line from AB out in a parallel fashion to A*B* (which leaves pricesunchanged) which just touches the isoquant at G
We can shift the original iso-cost line from AB out in a parallel fashion to A*B* (which leaves pricesunchanged) which just touches the isoquant at G
Least Cost Input Choice for 100 UnitsLeast Cost Input Choice for 100 Units
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Introduction to Agricultural Economics, 5th edPenson, Capps, Rosson, and Woodward
© 2010 Pearson Higher Education,Upper Saddle River, NJ 07458. • All Rights
Reserved.
Page 111
Least Cost Input Choice for 100 UnitsLeast Cost Input Choice for 100 Units
At the point of tangency, we know that:slope of isoquant = slope of iso-cost line, or…MPPLABOR ÷ MPPCAPITAL = - (wage rate ÷ rental rate)
At the point of tangency, we know that:slope of isoquant = slope of iso-cost line, or…MPPLABOR ÷ MPPCAPITAL = - (wage rate ÷ rental rate)
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Introduction to Agricultural Economics, 5th edPenson, Capps, Rosson, and Woodward
© 2010 Pearson Higher Education,Upper Saddle River, NJ 07458. • All Rights
Reserved.
Page 111
Least Cost Input Choice for 100 UnitsLeast Cost Input Choice for 100 Units
At the point of tangency, therefore, the MPP per dollar spent on labor is equal to the MPP per dollar spent on capital!!! See equation (8.5) on page 181, which is analogous to equation (4.2) back on page 76 for consumers.
At the point of tangency, therefore, the MPP per dollar spent on labor is equal to the MPP per dollar spent on capital!!! See equation (8.5) on page 181, which is analogous to equation (4.2) back on page 76 for consumers.
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Introduction to Agricultural Economics, 5th edPenson, Capps, Rosson, and Woodward
© 2010 Pearson Higher Education,Upper Saddle River, NJ 07458. • All Rights
Reserved.
This therefore represents the cheapest combination of capital and labor to produce 100 units of output…
This therefore represents the cheapest combination of capital and labor to produce 100 units of output…
Page 111
Least Cost Input Choice for 100 UnitsLeast Cost Input Choice for 100 Units
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Introduction to Agricultural Economics, 5th edPenson, Capps, Rosson, and Woodward
© 2010 Pearson Higher Education,Upper Saddle River, NJ 07458. • All Rights
Reserved.
If I told you the value of C1
and L1 and asked you for the value of A* and B*, how would you find them?
If I told you the value of C1
and L1 and asked you for the value of A* and B*, how would you find them?
Page 111
Least Cost Input Choice for 100 UnitsLeast Cost Input Choice for 100 Units
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Introduction to Agricultural Economics, 5th edPenson, Capps, Rosson, and Woodward
© 2010 Pearson Higher Education,Upper Saddle River, NJ 07458. • All Rights
Reserved.
If I told you that point G represents 7 units of capital and 60 units of labor, and that the wage rate is $10 and the rental rate is $100, then at point G we must be spending $1,300, or:
$100×7+$10×60=$1,300
If I told you that point G represents 7 units of capital and 60 units of labor, and that the wage rate is $10 and the rental rate is $100, then at point G we must be spending $1,300, or:
$100×7+$10×60=$1,300
Page 111
Least Cost Input Choice for 100 UnitsLeast Cost Input Choice for 100 Units
7
60
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Introduction to Agricultural Economics, 5th edPenson, Capps, Rosson, and Woodward
© 2010 Pearson Higher Education,Upper Saddle River, NJ 07458. • All Rights
Reserved.
Page 111
Least Cost Input Choice for 100 UnitsLeast Cost Input Choice for 100 Units
130
7
60
If point G represents a total cost of $1,300, we know that every point on this iso-cost line also represents $1,300. If the wage rate is $10, then point B* must represent 130 units of labor, or: $1,300$10 = 130
If point G represents a total cost of $1,300, we know that every point on this iso-cost line also represents $1,300. If the wage rate is $10, then point B* must represent 130 units of labor, or: $1,300$10 = 130
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Introduction to Agricultural Economics, 5th edPenson, Capps, Rosson, and Woodward
© 2010 Pearson Higher Education,Upper Saddle River, NJ 07458. • All Rights
Reserved.
Page 111
Least Cost Input Choice for 100 UnitsLeast Cost Input Choice for 100 Units
130
13
7
60
And the rental rate is $100, then point A* must represents 13 units of capital, or:
$1,300 $100 = 13
And the rental rate is $100, then point A* must represents 13 units of capital, or:
$1,300 $100 = 13
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Introduction to Agricultural Economics, 5th edPenson, Capps, Rosson, and Woodward
© 2010 Pearson Higher Education,Upper Saddle River, NJ 07458. • All Rights
Reserved.
What Happens if the Price of an Input
Changes?
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Introduction to Agricultural Economics, 5th edPenson, Capps, Rosson, and Woodward
© 2010 Pearson Higher Education,Upper Saddle River, NJ 07458. • All Rights
Reserved.
Page 112
Assume the initialwage rate and costof capital results inthe iso-cost line AB
Assume the initialwage rate and costof capital results inthe iso-cost line AB
What Happens if Wage Rate Declines?What Happens if Wage Rate Declines?
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Introduction to Agricultural Economics, 5th edPenson, Capps, Rosson, and Woodward
© 2010 Pearson Higher Education,Upper Saddle River, NJ 07458. • All Rights
Reserved.
Page 112
Wage rate declinemeans that the firmcan now afford B* instead of B…
Wage rate declinemeans that the firmcan now afford B* instead of B…
What Happens if Wage Rate Declines?What Happens if Wage Rate Declines?
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Introduction to Agricultural Economics, 5th edPenson, Capps, Rosson, and Woodward
© 2010 Pearson Higher Education,Upper Saddle River, NJ 07458. • All Rights
Reserved.
Page 112
What Happens if Wage Rate Declines?What Happens if Wage Rate Declines?
The new point of tangencyoccurs at H rather than G.
The new point of tangencyoccurs at H rather than G.
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Introduction to Agricultural Economics, 5th edPenson, Capps, Rosson, and Woodward
© 2010 Pearson Higher Education,Upper Saddle River, NJ 07458. • All Rights
Reserved.
Page 112
What Happens if Wage Rate Declines?What Happens if Wage Rate Declines?
As a consequence,the firm woulddesire to use morelabor and less capital…
As a consequence,the firm woulddesire to use morelabor and less capital…
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Introduction to Agricultural Economics, 5th edPenson, Capps, Rosson, and Woodward
© 2010 Pearson Higher Education,Upper Saddle River, NJ 07458. • All Rights
Reserved.
Least Cost Combination of Inputs and Outputfor a Specific Budget
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Introduction to Agricultural Economics, 5th edPenson, Capps, Rosson, and Woodward
© 2010 Pearson Higher Education,Upper Saddle River, NJ 07458. • All Rights
Reserved.
What Inputs to Use for a Specific Budget?What Inputs to Use for a Specific Budget?
M
N
Labor
Cap
ital
An iso-cost line fora specific budget
An iso-cost line fora specific budget
Page 113
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Introduction to Agricultural Economics, 5th edPenson, Capps, Rosson, and Woodward
© 2010 Pearson Higher Education,Upper Saddle River, NJ 07458. • All Rights
Reserved.
Page 113
What Inputs to Use for a Specific Budget?What Inputs to Use for a Specific Budget?
A set of isoquantsfor different levelsof output…
A set of isoquantsfor different levelsof output…
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Introduction to Agricultural Economics, 5th edPenson, Capps, Rosson, and Woodward
© 2010 Pearson Higher Education,Upper Saddle River, NJ 07458. • All Rights
Reserved.
Page 113
Firm can afford toproduce only 75 units of output using C3 unitsof capital and L3 unitsof labor
Firm can afford toproduce only 75 units of output using C3 unitsof capital and L3 unitsof labor
What Inputs to Use for a Specific Budget?What Inputs to Use for a Specific Budget?
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Introduction to Agricultural Economics, 5th edPenson, Capps, Rosson, and Woodward
© 2010 Pearson Higher Education,Upper Saddle River, NJ 07458. • All Rights
Reserved.
Page 113
The firm’s budgetis not large enoughto operate at 100 or 125 units…
The firm’s budgetis not large enoughto operate at 100 or 125 units…
What Inputs to Use for a Specific Budget?What Inputs to Use for a Specific Budget?
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Page 113
Firm is not spendingavailable budget here…
Firm is not spendingavailable budget here…
What Inputs to Use for a Specific Budget?What Inputs to Use for a Specific Budget?
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Economics ofBusiness Expansion
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The Planning Curve
The long run average cost (LAC) curve reflects pointsof tangency with a series of short run average total cost (SAC) curves. The point on the LAC where the following holds is the long run equilibrium position (QLR) of the firm:
SAC = LAC = PLR
where MC represents marginal cost and PLR represents the long run price, respectively.
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Page 117
What can we say about the fourfirms in this graph?
What can we say about the fourfirms in this graph?
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Page 117
Size 1 would losemoney at price P
Size 1 would losemoney at price P
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Page 117
Q3
Firm size 2, 3 and 4would earn a profitat price P….
Firm size 2, 3 and 4would earn a profitat price P….
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Page 117
Q3
Firm #2’s profit would be the area shown below…
Firm #2’s profit would be the area shown below…
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Page 117
Q3
Firm #3’s profit would be the area shown below…
Firm #3’s profit would be the area shown below…
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Page 117
Q3
Firm #4’s profit would be the area shown below…
Firm #4’s profit would be the area shown below…
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Page 145
If price were to fall to PLR, only size 3 wouldnot lose money; it would break-even. Size 4 would have to down size its operations!
If price were to fall to PLR, only size 3 wouldnot lose money; it would break-even. Size 4 would have to down size its operations!
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Page 118
Optimal inputcombinationfor output=10
Optimal inputcombinationfor output=10
How to Expand Firm’s CapacityHow to Expand Firm’s Capacity
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Page 118
How to Expand Firm’s CapacityHow to Expand Firm’s Capacity
Two options: 1. Point B ?
Two options: 1. Point B ?
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Page 118
How to Expand Firm’s CapacityHow to Expand Firm’s Capacity
Two options: 1. Point B?2. Point C?
Two options: 1. Point B?2. Point C?
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Page 118
Optimal inputcombinationfor output=10with budget DE
Optimal inputcombinationfor output=10with budget DE
Optimal inputcombination for output=20with budget FG
Optimal inputcombination for output=20with budget FG
Expanding Firm’s CapacityExpanding Firm’s Capacity
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Page 118
This combinationcosts more toproduce 20 units of output sincebudget HI exceedsbudget FG
This combinationcosts more toproduce 20 units of output sincebudget HI exceedsbudget FG
Expanding Firm’s CapacityExpanding Firm’s Capacity
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Production Possibilities
The goal is to find that combination of products that maximizes revenue for the maximum technical efficiency on the production possibilities frontier.
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Page 120
Shows the substitution between two products given the most efficientuse of firm’s resources
Shows the substitution between two products given the most efficientuse of firm’s resources
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Slope of the PPF
The slope of the production possibilities curveis referred to as the Marginal Rate of Product Transformation, or MRPT. The value of the MRPT in our example is given by:
MRPT = canned fruit ÷ canned vegetables
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Page 120
Drops from 108 to 95
Drops from 108 to 95
Increases from30 to 40
Increases from30 to 40
Slope over rangebetween D and Eis –1.30, or:-1310
Slope over rangebetween D and Eis –1.30, or:-1310
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Page 148
95,000- 108,000 -13,000
40,000- 30,000 10,000
÷ - 1.30 =
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Page 120
Inefficientuse of firm’sresources
Inefficientuse of firm’sresources
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Page 120
Level of outputunattainable withwith firm’s existingresources
Level of outputunattainable withwith firm’s existingresources
Inefficientuse of firm’sexisting resources
Inefficientuse of firm’sexisting resources
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Accounting forProduct Prices
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Plotting the Iso-Revenue Line
Cannedfruit
Cannedvegetables
30,000 cases of canned fruitrequired at price of $33.33/caseto achieve A TARGET revenue of $1 million
30,000 cases of canned fruitrequired at price of $33.33/caseto achieve A TARGET revenue of $1 million
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30,000
40,000
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Plotting the Iso-Revenue Line
Cannedfruit
Cannedvegetables
40,000 cases of canned vegetablesrequired at price of $25.00/caseto achieve revenue of $1 million
40,000 cases of canned vegetablesrequired at price of $25.00/caseto achieve revenue of $1 million
Page 122
30,000
40,000
30,000 cases of canned fruitrequired at price of $33.33/caseto achieve revenue of $1 million
30,000 cases of canned fruitrequired at price of $33.33/caseto achieve revenue of $1 million
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Original iso-revenue line Changes in income or both prices
Change in price of fruit Change in price of vegetables
Line AB is the originaliso-revenue line, indicatingthe number of cases neededto reach a specific salestarget.
Line AB is the originaliso-revenue line, indicatingthe number of cases neededto reach a specific salestarget.
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Original iso-revenue line Changes in income or both prices
Change in price of fruit Change in price of vegetables
The iso-revenue line wouldshift out to line EF if therevenue target doubled (orprices fell in half) while theline would shift in to lineCD if revenue targets fell inhalf or prices doubled.
The iso-revenue line wouldshift out to line EF if therevenue target doubled (orprices fell in half) while theline would shift in to lineCD if revenue targets fell inhalf or prices doubled.
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Original iso-revenue line Changes in income or both prices
Change in price of fruit Change in price of vegetablesThe iso-revenue line wouldshift out to line BC is the price of fruit fell in halfbut shift in to line BD ifthe price of fruit doubled
The iso-revenue line wouldshift out to line BC is the price of fruit fell in halfbut shift in to line BD ifthe price of fruit doubled
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Original iso-revenue line Changes in income or both prices
Change in price of fruit Change in price of vegetablesThe iso-revenue line wouldshift out to line AD if the price of vegetables fell in halfbut shift in to line AC is theprice of fruit doubled.
The iso-revenue line wouldshift out to line AD if the price of vegetables fell in halfbut shift in to line AC is theprice of fruit doubled.
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Profit Maximizingcombination ofProduct Prices
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Combination of ProductsThe profit maximizing combination of two productsis found where the slope of the production possibilitiesfrontier (PPF) is equal to the slope of the iso-revenueCurve, or where:
Canned fruit Price of vegetablesCanned vegetables Price of fruit= –
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Slope of an PPF curve
Slope of an PPF curve
Slope of iso- revenue line
Slope of iso- revenue line
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Assume Line AB representsrevenue for $1 million.
Assume Line AB representsrevenue for $1 million.
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Page 124
We want to find the profit maximizing combination to “can”given the current prices of canned fruitand vegetables.
We want to find the profit maximizing combination to “can”given the current prices of canned fruitand vegetables.
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Canned fruit Price of vegetables
Canned vegetables Price of fruit
Canned fruit Price of vegetables
Canned vegetables Price of fruit= –
Shifting line AB out in a parallel fashion holds both prices constant at their current level
Shifting line AB out in a parallel fashion holds both prices constant at their current level
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Page 120
18,000 cases of vege-tables
18,000 cases of vege-tables
MRPTequals-0.75
MRPTequals-0.75
125,000 cases of
fruit
125,000 cases of
fruit
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Page 120
18,000 cases of vege-tables
18,000 cases of vege-tables
MRPTequals-0.75
MRPTequals-0.75
125,000 cases of
fruit
125,000 cases of
fruit
Price ratio = -($25.00 ÷ $33.33) = - 0.75Price ratio = -($25.00 ÷ $33.33) = - 0.75
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18,000 cases of vege-tables
18,000 cases of vege-tables
MRPTequals-0.75
MRPTequals-0.75
125,000 cases of
fruit
125,000 cases of
fruit
Price ratio = -($25.00 ÷ $33.33) = - 0.75Price ratio = -($25.00 ÷ $33.33) = - 0.75
Canned fruit Price of vegetables
Canned vegetables Price of fruit
Canned fruit Price of vegetables
Canned vegetables Price of fruit= –
Page 152
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Doing the Math…Let’s assume the price of a case of canned fruit is $33.33 while the price of a case of canned vegetables is $25.00. If point M represents 125,000 cases of fruit and 18,000 cases of vegetables, then total revenue at point M is:
Revenue = 125,000 × $33.33 + 18,000 × $25.00 = $4,166,250 + $450,000 = $4,616,250
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Doing the Math…At these same prices, if we instead produce 108,000 cases of fruit and and 30,000 cases of vegetables, then total revenue would fall to:
Revenue = 108,000 × $33.33 + 30,000 × $25.00 = $3,599,640 + $750,000 = $4,349,640
which is $266,610 less than the $4,616,250 earned at point M.
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Effects of a Changein the Price of One Product
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If the price of canned fruit fell in half, the firm must sell twice as many cases ofcanned fruit to earn $1 million if it focused solely on fruit production.
If the price of canned fruit fell in half, the firm must sell twice as many cases ofcanned fruit to earn $1 million if it focused solely on fruit production.
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This gives us a new iso-revenue curve… line CB.
This gives us a new iso-revenue curve… line CB.
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To see the effects of this price change, we can shift the new iso-revenue curve out to the point of tangency with the PPF curve….
To see the effects of this price change, we can shift the new iso-revenue curve out to the point of tangency with the PPF curve….
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Shifting the new iso-revenue curve in a parallel fashion out to a point of tangency with the PPF curve, we get a new combination of products required to maximize profit.
Shifting the new iso-revenue curve in a parallel fashion out to a point of tangency with the PPF curve, we get a new combination of products required to maximize profit.
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The firm would shift from point M on the PPF to point N as a result of the decline in the price of fruit. That is, to maximize profit, the firm would cut back its production of canned fruit and produce more canned vegetables.
The firm would shift from point M on the PPF to point N as a result of the decline in the price of fruit. That is, to maximize profit, the firm would cut back its production of canned fruit and produce more canned vegetables.
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Introduction to Agricultural Economics, 5th edPenson, Capps, Rosson, and Woodward
© 2010 Pearson Higher Education,Upper Saddle River, NJ 07458. • All Rights
Reserved.
Summary #1Concepts of iso-cost line and isoquantsMarginal rate of technical substitution (MRTS)Least cost combination of inputs for a specific
output levelEffects of change in input priceLevel of output and combination of inputs for a
specific budgetKey decision rule …seek point where MRTS = ratio
of input prices, or where MPP per dollar spent on inputs are equal.
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Introduction to Agricultural Economics, 5th edPenson, Capps, Rosson, and Woodward
© 2010 Pearson Higher Education,Upper Saddle River, NJ 07458. • All Rights
Reserved.
Summary #2Concepts of iso-revenue line and the
production possibilities frontierMarginal rate of product transformation
(MRPT)Concept of profit maximizing combination
of productsEffects of change in product priceKey decision rule – maximize profits where
MRPT equals the ratio of the product prices
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Introduction to Agricultural Economics, 5th edPenson, Capps, Rosson, and Woodward
© 2010 Pearson Higher Education,Upper Saddle River, NJ 07458. • All Rights
Reserved.
Chapter 8 focuses on market equilibrium conditions under perfect competition….