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Lecture 3: Supply Advanced Micro Theory MSc.EnviNatResEcon. 1/2005 Charit Tingsabadh 1 Outline • • • • Supply concept Production function Cost function Empirical examples 2 Supply concept • Supply: offer of goods at a price • Goods are produced-output • Using inputs-- as factors of production—in combination • Factors include: land, labour, capital, energy, materials, etc. • Technology of production 3 Supply concept • Scale effect: constant, increasing, decreasing return to scale • Relation between output and input at different levels of output • Division of labour as an example: 4 Supply concept • The short run and the long run • Short run: all factors fixed except one • Usually capital/technology are fixed, only labour variable. Capacity utilization index. • Long run: all factors variable, new technology • Let’s have some case examples: IT, automation etc. 5 Representation • Production function • Relation between output Q and factors of production – labour, capital, materials, energy, nature etc. • Various functional forms • Cobb-Douglas, CES, Translog etc. 6 Production function • • • • • • Example: Q=f(K,L) Cobb-Douglas: Q=aKa L (1-a) Other forms Total, average, marginal product Factor substitution as part of technology option-may be possible, may be not. 7 Cost function • Dual of production function • Factors have prices, so can calculate cost of production • C = wL + rK, • So, what is the production problem? • What combination of factors (what technology) to choose to produce the output? 8 Supply concept • So far, assume fixed output • But decision is about how much to produce, with what combination of factors, so need to account for the output side as well • So, cost expressed in terms of output. • Total, average, marginal cost, with respect to output. 9 Supply concept • Types of costs • Fixed cost and variable cost • Varies with output 10 Supply concept • Demand for factors of production-labour, capital • As derived demand • Demand determined by marginal product of factor • Consider case of labour, when to employ new worker? • And capital, when to invest? 11 Dynamic perspectives • • • • Technology on the move, innovations Types of innovation: product, process Stable vs. disruptive Types of technical progress: Hicks-neutral, capital/labour saving;Harrod-neutral; vintageembodied/disembodied technical progress • Measurement of technical progress: growth accounting 12 13 Empirical functions • Search and destroy mission: • Find your own production/cost function and write a critique of the study. 14 15 16 17 Homework • Using the internet, obtain data on bananas: quantities, prices, etc. • Develop 1 demand function and 1 supply function for your bananas and • Estimate the price and income elasticities for your bananas, using the equation that you have developed. • Enjoy! 18