Welcome to week five of The Power of Markets course. Hello here from the Simon school of the University of Rochester. The last few weeks, we've focused on consumer theory. Looking through indifference curves and budget lines, how to better analyze consumer decision-making. And then to apply it to pressing public policy issues, like school choice and Obamacare. The next two weeks, we're going to focus on producer theory and getting behind the scenes, so we can better understand how producers make decisions. Now, two things we'll assume. First, that for any given output level if producers are interested in maximizing profit which again will be a core assumption, but the producers will need to take two steps. First, at any given output level, producers will want to minimize the cost of producing that output level. And then second, producers have to figure out what the right output level is. And that as we will see will depend on the market structure in which they operate, whether it is perfectly competitive or imperfectly competitive. The next two weeks, we're going to focus primarily on the production side, minimizing the cost of producing any given output level And we'll start first looking at production functions. At the way producers can mix together inputs to produce specified output levels. In a very simple case, we'll assume as shown on this first page, that a certain output level of Q is a function of two inputs. Labor and capital. Of course in the real world, the production process is much richer than that. There are variety of inputs. For example, if you're producing movies. if you're paramount pictures. You have to mix together producers, directors, actors. sound stages places where the filming takes place. The actual filming stages. I need to mix together a variety of inputs. But let's simplify stuff to just two inputs here. Labor and capital, L and K. We're going to assume that this production function is consistent with technological efficiency. And what economists mean by that, is for any combination of inputs. Any L and K in the simplified case. Labor and capital combination. We, the producer will seek to maximize the amount of output that can be achieved from that mix of inputs. The amount of Q that can be achieved from a given level of L and K. And let's look first in the short run. And what economists mean by the short run, is that certain inputs are fixed. They can't easily be varied. let's say you're a Nintendo, and producing game consoles, Wiis. And there's unexpectedly strong demand around the holiday season. There's certain inputs, factories that may not be able to ramp up the physical space that quickly. You can add more shifts instead of one shift, there can be two or three shifts by adding labor to the mix. But then other inputs, the capital involved, you may have a harder time varying in the short run. We'll focus first on the short run situation, then on the long run situation, where you can vary all inputs. And there'll be some important results that come out of those analysis. First let's focus on table 7.1 and three specific concepts. We're going to assume in the first column that the amount of capital this producer has is fixed over the short run at three units. Again a short run scenario and that the only thing that the producer can vary is the amount of labor, that he or she devotes to the production process and in Table 7.1 the units of labor range from zero to nine. The third column gives us total product. The total output or cube produced from three fixed amounts, fixed units of capital and different amount of labor in each different row. And as you see adding labor up to eight units keeps raising output, at least up to seven units, at eight it's flat and then at nine actually declines. It's conceivable there are situations where, as in having too many chefs spoil the soup, that adding an additional input can become productive. So we'll look at that special case as well. The fourth column measures average product of labor, and what this does is just divide total product in third column by the number of units of labor. Used in the second column. So let's take a case where we're using three units of capital and four units of labor. So, this would be the fifth row. Total products, 40. Average product to labor is 40 units of total output divided by four units of labor, or ten. Similar results are derived in each of the rows of the average product column. Marginal product, which we'll see is a very key element to analyzing production decisions, looks at how much total product changes for each incremental additional use of labor, the variable input. Let's move from the first row to the second row. When we add one unit of labor. And what we find in that situation, total product goes from zero to five. So the marginal product is five. If we add a second unit of labor from one to two. Total product goes from 18, goes from five to 18 units. So, that second unit of labor, it's marginal product was 13. It added 13 units of total output. And so on. And if we keep going down and we go, lets say from eight to nine units of labor. The switch between the final two rows in this table, total product actually goes down. So the marginal product at that point is minus four. It subtracts from total output by four units. And preceding that point, if we went from seven to eight, that eighth unit of labor, its marginal product is zero. We've looked at it now in a table type setting. Simply playing out the different output levels for, associated for a fixed amount of one input capitol and different units of labor. And we've shown what average product is, marginal product in table type setting. In the next session, we'll look at total product, average product and marginal product from a geometrical perspective. we'll look at it using a figure and we'll be able to tease out some important relationships between these three different product curves.
