Changes

A smart economist might observe that Shakespeare was expressing the undesirability of transaction costs caused by lawyers nearly 200 years before Adam Smith discovered the invisible hand, and over 350 years before Ronald Coase discovered and criticized transaction costs.  Perhaps Shakespeare understood economics before it was even recognized as a field of study!<ref>Believe it or not, lawyers claim that Shakespeare was actually ''complimenting'' them, because the line was spoken by an enemy of freedom.  See http://www.johnlocke.org/news_columns/display_story.html?id=962</ref>

A smart economist might observe that Shakespeare was expressing the undesirability of transaction costs caused by lawyers nearly 200 years before Adam Smith discovered the invisible hand, and over 350 years before Ronald Coase discovered and criticized transaction costs.  Perhaps Shakespeare understood economics before it was even recognized as a field of study!<ref>Believe it or not, lawyers claim that Shakespeare was actually ''complimenting'' them, because the line was spoken by an enemy of freedom.  See http://www.johnlocke.org/news_columns/display_story.html?id=962</ref>

But many careers other than lawyers create transaction costs.  Real estate brokers, stock brokers, accountants, waiters and waitresses, and countless other occupations live off of transaction costs.  One student who took this course in 2004 is paying her way through college by working as a waitress in a fancy New York restaurant, where the tips can be very profitable!  Waiting on tables is a service, and some develop the skills to be much better at it than others.  There will always be restaurants, even when the economy is not doing well, and there is nothing wrong with developing a skill as a good waiter or waitress.  People are going to pay transaction costs in many different ways, and it is better to be successful at delivering those services than unsuccessful.

But many careers other than lawyers create transaction costs.  Real estate brokers, stock brokers, accountants, waiters and waitresses, and countless other occupations live off of transaction costs.  One student who took this course in 2004 is paying her way through college by working as a waitress in a fancy New York restaurant, where the tips can be very profitable!  Waiting on tables is a service, and some develop the skills to be much better at it than others.  There will always be restaurants, even when the economy is not doing well, and there is nothing wrong with developing a skill as a good waiter or waitress.  People are going to pay transaction costs in many different ways, and it is better to be successful at improving delivery of those services than unsuccessful at complaining about them!

Let's return for a moment to an important concept we mentioned earlier in this course:  opportunity cost.  Recall what the opportunity cost is: it is the value of the best forgone alternative.  Now consider this:  '''''the real price of a good is its opportunity cost'''''.  When someone buys something for $10, the real cost of that good is the best alternative use of that $10.  The real price of watching television for one hour is value of that time if you had spent it in the best way possible.  It may seem like the cost of that hour watching television was $0, but in fact the real cost is the best alternative use of that hour.  The real price of that hour of television watching is your highest hourly wage if you worked, or your future wages made possible by studying harder now.

== The "Firm" ==

Defining the real price of a good in terms of opportunity cost is helpful in avoiding the confusion caused by "inflation".  Inflation is the amount that prices increase each year for the same goods.  Back in the late 1970s, inflation was more than 10% per year.  What cost $10 one year would cost $11 the next year, and over $12 in the third year.  

On the CLEP exam that a few of you might take for college credit, 10–15% of the questions are devoted to the "Firm".  That term refers to the seller, which is alternatively describes as a "company", a "producer", a "manufacturer", a "store", or, mostly simply, the "firm".  The Firm makes decisions about how much to produce and how to try to earn a profit, such that revenue is in excess of costs.

Economists created something called the “Consumer Price Index,” or CPI, to measure changes in basic prices of many goods over time.  It looks at the typical purchases by urban (not farming) families and monitors the change in prices of those goods and services from month-to-month.  It includes the costs of food, beverages, housing, clothes, transportation, medical care, recreation, education, and even services like haircuts.  It then combines all those values into one number.  To make it easier to compare, the values are combined in a way that the CPI for the period 1982-84 averaged “100".  In January 2004, the CPI was 185.2.  You can view all the CPI numbers going back nearly a hundred years on the internet.<ref>ftp://ftp.bls.gov/pub/special.requests/cpi/cpiai.txt</ref>  In July 2009, the CPI was 215.351.  Inflation causes it to go higher and higher, as the government prints more and more dollars and cause them to lose their value.

We are on the "supply side" when we discuss companies or firms.  It is on this side (rather than the demand or consumer side) where we have to decide how much you would produce if you were the President of a company.  Recall that microeconomics is about supply and demand.  When we are on the demand side, then we are discussing what you would buy as a consumer, and how much you would pay.  When we are on the supply side, we are considering what you would produce in managing a company.  Keep these concepts separate in your mind.

By comparing a change in price of a good to the change in the CPI, you can tell whether the real price of the good is becoming more or less expensive.  If the good’s price increases by less than the CPI’s increase, then the good has a real price that is falling.

There are three subtopics in this field:

Now think about this: if inflation is 10% per year for three years, but one particular good keeps the same price during those three years, then its opportunity cost and real price actually decreased.  Think about that.  An honors homework problem will ask you to explain why.

*total, average, and marginal costs and revenue

We are going to spend another week on the supply side: what you would produce if you were the President of a company. Recall that microeconomics is about supply and demand.  When we are on the demand side, then we are discussing what you would buy as a consumer, and how much you would pay.  When we are on the supply side, we are considering what you would produce in managing a company.  Keep these concepts separate in your mind.

This leads us to the second point above.  Essential to microeconomics are the two concepts of  “marginal ____” and “average ____.” For example, we have “marginal cost” and “average cost.”  The “marginal cost” is how much it costs to make one more widget.  The “average cost” is the overall average per-unit cost for all the widgets you make.   

Recall that there are “short run” costs and “long run” costs associated with the supply of a good or service.  Short-run costs include overtime labor to try to increase supply immediately.  “Variable inputs” are the focus of short-run costs: they are the inputs (such as materials or labor) that are increased in order to produce more goods or services in the short run.  Variable inputs are different from fixed inputs, which cannot be increased in the short run.  An example of a fixed input is a manufacturing facility, which cannot be built quickly.  A stadium is a fixed input in the sports world.

And now the third point above is as follows.  The “marginal product” is the increase in supply due to one more unit of input (typically labor).  If you hire one more laborer (e.g., employee or worker), how much will your output of widgets increase?  “Marginal product,” or MP, gives you that answer.  Your overall product output (Q) is the sum of all your marginal products (MP).  You could then take the average of that, defining “average product” as your total output Q divided by your total labor (L).  Expressed as an equation, this is AP = Q/L.

 

Essential to microeconomics are the two concepts of  “marginal ____” and “average ____.”  For example, we have “marginal cost” and “average cost.”  The “marginal cost” is how much it costs to make one more widget.  The “average cost” is the overall average per-unit cost for all the widgets you make. 

 

Similarly, the “marginal product” is the increase in supply due to one more unit of input (typically labor).  If you hire one more laborer (e.g., employee or worker), how much will your output of widgets increase?  “Marginal product,” or MP, gives you that answer.  Your overall product output (Q) is the sum of all your marginal products (MP).  You could then take the average of that, defining “average product” as your total output Q divided by your total labor (L).  Expressed as an equation, this is AP = Q/L.

The average _____ always moves towards the marginal _____ as the relevant activity increases.  Average cost approaches marginal cost, and average product approaches marginal product.  Think about that, providing your own examples to convince yourself.

The average _____ always moves towards the marginal _____ as the relevant activity increases.  Average cost approaches marginal cost, and average product approaches marginal product.  Think about that, providing your own examples to convince yourself.

As President of your company, you do not want to be paying overtime wages to your employees for a long period of time.  By law, overtime wages are 1.5 times regular wages.  So when you pay overtime, you are paying 50% more than what you would pay if you could hire another worker.  It is inefficient to be paying overtime.  You only do it as a quick fix to an increase in demand.

As President of your company, you do not want to be paying overtime wages to your employees for a long period of time.  By law, overtime wages are 1.5 times regular wages.  So when you pay overtime, you are paying 50% more than what you would pay if you could hire another worker.  It is inefficient to be paying overtime.  You do it only as a quick fix to an increase in demand.

In the “long run,” you maximize efficiency by making fundamental changes to your business.  If you own a professional baseball team, a short-run change to increased demand for tickets by fans would be to build temporary bleachers.  But the fans would prefer to pay more for permanent seats, and you would make more money with a larger stadium.  So the long-run change is to build an entire new stadium.  Many owners have done that.

In the “long run,” you maximize efficiency by making fundamental changes to your business.  If you own a professional baseball team, a short-run change to increased demand for tickets by fans would be to build temporary bleachers.  But the fans would prefer to pay more for permanent seats, and you would make more money with a larger stadium.  So the long-run change is to build an entire new stadium.  Many owners have done that.

Today we are going to focus on the “long run.” 

Let's discuss the "short run" and the "long run" in greater detail now.

== Introduction to Short and Long Run ==

== Introduction: the Short Run and Long Run ==

In our last Lecture we focused on “demand”.  This time we turn to “supply”.  We look at how companies decide how much product to make and put out into the market.  How many goods should a company produce, or how many services should it provide?

Keep in mind that in this Lecture we are focusing only on “demand”, not “supply”.  We look at how companies decide how much product to make and put out into the market.  How many goods should a company produce, or how many services should it provide?

Before we start, however, we define two terms essential to economics: the “short run” and the “long run.”  As its name implies, the “short run” is a relatively short period of time in which a company can only make temporary changes to its operation.  In a sporting contest, the “short run” would during a game, when the coach decides to substitute his players or alter the game plan to try to win that particular contest.  During the “short run” only quick and temporary reactions by a company or firm to a fluctuation in demand are possible.  For example, changes like using more overtime labor would be a short run adjustment.  Or telling workers to take an extended vacation due to lack of demand for the goods would be another short run change.  This class we will be focusing on the “short run.”

Before we start, however, we define two terms essential to economics: the “short run” and the “long run.”  As its name implies, the “short run” is a relatively short period of time in which a company can only make temporary changes to its operation.  In a sporting contest, the “short run” would during a game, when the coach decides to substitute his players or alter the game plan to try to win that particular contest.  During the “short run” only quick and temporary reactions by a company or firm to a fluctuation in demand are possible.  For example, changes like using more overtime labor would be a short run adjustment.  Or telling workers to take an extended vacation due to lack of demand for the goods would be another short run change.  In this Lecture we will be focusing on the “short run.”

In the “short run” it is impossible to change the fixed costs, or “sunk costs.”  The cost of factory, and the equipment inside, cannot be altered.  These fixed costs can be easily measured by seeing what the total costs are when output is zero.  That is because when output is zero, there are no marginal costs, and all the costs are the fixed ones.

In the “short run” it is impossible to change the fixed costs, or “sunk costs.”  The cost of factory, and the equipment inside, cannot be altered.  These fixed costs can be easily measured by seeing what the total costs are when output is zero.  That is because when output is zero, there are no marginal costs, and all the costs are the fixed ones.

The “long run” consists of a time period long enough to make basic and permanent changes, like building new factories, buying new equipment, and hiring and training new employees.  In a sporting contest, it would include scouting and drafting new players, or building a new weight room.  Everything can be adjusted in the “long run”: workforce, facilities, materials, equipment, investment, etc.  We’ll discuss the “long run” next class.

The “long run” consists of a time period long enough to make basic and permanent changes, like building new factories, buying new equipment, and hiring and training new employees.  In a sporting contest, it would include scouting and drafting new players, or building a new weight room.  Everything can be adjusted in the “long run”: workforce, facilities, materials, equipment, investment, etc.

For now, let’s focus on the “short run.”  The key concepts are “marginal cost” and “marginal revenue.”  How much does it cost to make one more widget, and much revenue does that extra widget generate for the company?  That additional cost per unit is called “marginal cost.”  The additional revenue per unit is called “marginal revenue.”  As long as marginal revenue is slightly higher than marginal cost, then it makes sense to produce that extra widget.  Typically, companies continue making more and more goods until marginal revenue falls below marginal cost, at which time they stop production because they begin to lose money on each additional good they produce.

For now, let’s focus on the “short run.”  The key concepts for the "short run" are “marginal cost” and “marginal revenue.”  How much does it cost to make one more widget, and much revenue does that extra widget generate for the company?  That additional cost per unit is called “marginal cost.”  The additional revenue per unit is called “marginal revenue.”  As we discussed in the last Lecture, as long as marginal revenue is slightly higher than marginal cost, then it makes sense to produce more goods or services (e.g., produce that extra widget).  Typically, companies continue making more and more goods until marginal revenue falls below marginal cost, at which time they stop production because they begin to lose money on each additional good they produce.  This is just like our example in our last Lecture where the store owner closes his store at night as soon as the marginal cost of his electricity and employee wages starts the exceed the marginal revenue of new customers coming into the store.

==The Short Run==

===The Short Run===

 

Imagine yourself as the President of a company making widgets, our imaginary good.  If it costs you $200 to make 10 widgets and $205 to make 11 widgets, then what is your marginal cost (MC) of the 11th unit?  It is only $5.  What is its average cost?  Nearly $19 ($205 total cost divided by 11 total units).  Average cost is often greater than the marginal cost.  This makes sense, because once you pay for your factory and workers, you do not have much additional cost to produce an extra unit.  This is called economies of scale: the bigger your operation, the cheaper you can make one more unit.

Imagine yourself as the President of a company making widgets, our imaginary good.  If it costs you $200 to make 10 widgets and $205 to make 11 widgets, then what is your marginal cost (MC) of the 11th unit?  It is only $5.  What is its average cost?  Nearly $19 ($205 total cost divided by 11 total units).  Average cost is often greater than the marginal cost.  This makes sense, because once you pay for your factory and workers, you do not have much additional cost to produce an extra unit.  This is called economies of scale: the bigger your operation, the cheaper you can make one more unit.

Let’s make sure we understand this by looking at another example.  Suppose that hiring one more sales agent at $80 per day in our clothing store enables us to sell 8 more dresses.  What is our marginal cost for dresses at that point?  It is simply the additional cost of $80 (the wage) divided by that employee’s marginal productivity of 8 new sales, yielding a marginal cost of $10 per dress.

Let’s make sure we understand this by looking at another example.  Suppose that hiring one more sales agent at $80 per day in our clothing store enables us to sell 8 more dresses.  What is our marginal cost for dresses at that point?  It is simply the additional cost of $80 (the wage) divided by that employee’s marginal productivity of 8 new sales, yielding a marginal cost of $10 per dress.

==The Long Run==

===The Long Run===

Jesus’ teachings were not always what the public wanted to hear.  At one point it seemed like nearly everyone wanted to abandon Him.  Jesus then turned to his apostles and said, “Will ye also go away?”  Simon Peter responded, “Lord, to whom shall we go? thou hast the words of eternal life.”  John 6:68 (KJV).  Peter was committed for the long run.  Over thirty years after Jesus’ crucifixion, Peter remained true to what he said and allowed himself to be crucified (upside down).  Jesus picked apostles for the long run.

Jesus’ teachings were not always what the public wanted to hear.  At one point it seemed like nearly everyone wanted to abandon Him.  Jesus then turned to his apostles and said, “Will ye also go away?”  Simon Peter responded, “Lord, to whom shall we go? thou hast the words of eternal life.”  John 6:68 (KJV).  Peter was committed for the long run.  Over thirty years after Jesus’ crucifixion, Peter remained true to what he said and allowed himself to be crucified (upside down).  Jesus picked apostles for the long run.

Times are different today, and GM may no longer deserve that motto.  GM is now one of the largest private employers in Mexico.  In its defense, it would say it has to move production to Mexico to lower its costs and compete with cars imported from Japan and Korea.

Times are different today, and GM may no longer deserve that motto.  GM is now one of the largest private employers in Mexico.  In its defense, it would say it has to move production to Mexico to lower its costs and compete with cars imported from Japan and Korea.

==Assignment==

==Assignment==