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 improving delivery of those services than unsuccessful at complaining about them!

But many careers in addition to 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!

== The "Firm" ==

== The "Firm" ==

There are three subtopics in this field:

There are three subtopics in this field:

*the "short run" as compared with the "long run", and "economies of scale"

*the "short run" as compared with the "long run," and "economies of scale"

*total, average, and marginal costs and revenue

*total, average, and marginal costs and revenue

*marginal product and diminishing returns

*marginal product and diminishing returns

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 do it only 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 in order to supply more to satisfy 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.

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

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

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?

Keep in mind that in this Lecture we are focusing on "supply" rather than "demand".  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. In this Lecture 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 make only temporary changes to its operation.  In a sporting contest, the “short run” would be 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 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 a factory, and the equipment inside, cannot be altered.  '''''Fixed costs can be easily identified 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.

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 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.

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 to exceed the marginal revenue from new customers coming into the store at night.

===The Short Run: Marginal Product===

===The Short Run: Marginal Product===

1.  The Lecture mentioned how a prior student in this course is working her way through college by working as a waitress in a fancy Manhattan restaurant.  Suppose her boss tells her one day, "We were profitable last month.  To double our profits this month, I'm going to doubt our number of waitresses so that we can be double the number of people we serve!"  But our former economics student told him that his plan would fail because there is _____________ returns of scale in the restaurant: more waitresses would result in more wasted time talking to each other, and waitresses getting in the way of each other.

1.  Fixed costs can be easily identified by seeing what the total costs are when output is _______.

2. The difference between total revenue and explicit costs is what kind of profit? Economic profit? Taxable profit? Or some other kind of profit?

2. The Lecture mentioned how a prior student in this course is working her way through college by working as a waitress in a fancy Manhattan restaurant. Suppose her boss tells her one day, "We were profitable last month. To double our profits this month, I'm going to doubt our number of waitresses so that we can be double the number of people we serve!" But our former economics student told him that his plan would fail because there is _____________ returns of scale in the restaurant: more waitresses would result in more wasted time talking to each other, and waitresses getting in the way of each other.

3.  Explain what "marginal product" is.

3. The difference between total revenue and explicit costs is what kind of profit?  Economic profit?  Taxable profit? Or some other kind of profit?

4.  Do you think the returns to scale from the world's population is increasing, constant or decreasing?  There is no correct answer but you will be graded on your explanation.

4.  Explain what "marginal product" is.

5.  Give an example of a "short run" cost for a firm, and give an example of a "long run" cost. It can be any type of firm.

5.  Do you think the returns to scale from the world's population is increasing, constant or decreasing? There is no correct answer but you will be graded on your explanation.

6.  Earlier in this course we learned that someone who obtains a college degree earns, over the course of his life, about $500,000 more than someone who does not.  How can you explain this fact in terms of the advantages of "long run" costs over "short run" costs?

6.  Give an example of a "short run" cost for a firm, and give an example of a "long run" cost.  It can be any type of firm.

7.  (challenging problem, try at least to earn partial credit)  Recall from the last Lecture that a firm increases its output as long as its marginal revenue exceeds its marginal cost.  Suppose there is an increase in market price for the firm's widget, such that its marginal revenue is greater than its marginal cost.  The firm will hire more employees to produce more output until the value of its marginal product of labor equals _____________.

7.  Earlier in this course we learned that someone who obtains a college degree earns, over the course of his life, about $500,000 more than someone who does not.  How can you explain this fact in terms of the advantages of "long run" costs over "short run" costs?

 

===Honors===

===Honors===

Answer question 8 and then a brief essay about one of the other questions.

Answer questions 8 and 9, and then write a brief essay about one of the other questions.

 

8.  (challenging problem, try at least to earn partial credit)  Recall from the last Lecture that a firm increases its output as long as its marginal revenue exceeds its marginal cost.  Suppose there is an increase in market price for the firm's widget, such that its marginal revenue is greater than its marginal cost.  The firm will hire more employees to produce more output until the value of its marginal product of labor equals _____________.

8.  Answer and discuss:  Your firm seeks to produce a certain level of output in the most efficient way (the lowest cost).  It should use its resources in which of the following ways:

9.  Answer and discuss:  Your firm seeks to produce a certain level of output in the most efficient way (the lowest cost).  It should use its resources in which of the following ways:

(a) use materials that generate the highest marginal product

(a) use materials that generate the highest marginal product

<br>(d) use resources such that their marginal products per unit cost are equal

<br>(d) use resources such that their marginal products per unit cost are equal

9.  Explain the following from the lecture: 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.

10.  Explain the following from the lecture: 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.

10.  Charity, revisited:  Sloan's charitable efforts (Sloan-Kettering) have lasted longer than his business efforts (General Motors).  Is this just by chance, or are there reasons why charity lasts longer than business?  Feel free to revisit the issue of the interplay between the free market and charity.

11.  Charity, revisited:  Sloan's charitable efforts (Sloan-Kettering) have lasted longer than his business efforts (General Motors).  Is this just by chance, or are there reasons why charity lasts longer than business?  Feel free to revisit the issue of the interplay between the free market and charity.

11.  Are "long run" average costs lower than "short run" average costs and, if so, why?

12.  Are "long run" average costs lower than "short run" average costs and, if so, why?

=== Extra Credit for Anyone ===

=== Extra Credit for Anyone ===

12.  The most efficient division of labor in the world is ... traditional marriage between a man and woman.

13.  The most efficient division of labor in the world is ... traditional marriage between a man and woman.

== References ==

== References ==