Theory of Production

-->

Theory of Production

In the previous blog posts the utility and demand of the consumer were analysed. But in a microeconomic model, there is not only a consumer who exercises a demand – there is also a producer. The producers supply goods and services to the consumers. The first economic assumption is maximum profit. The motive of the producer is to make a profit! This motive is valid for the farmer, the shoe-producer, the pharmacists, the hairdresser and any other producer of goods and services.

Watch this video to get a better  perspective on Theory of Production.

Utility in a nutshell

After watching the video of utility it should be clear to you that it is all about consumer demand theory according to the utility approach. The satisfaction or use that a consumer receives from the consumption of a product was investigated. This implies that a saturation point and a budget constraint exists, which should also be taken into regard on the demand side. Utility can also be negative due to storage requirements or other problems with shortages - too much of something good is usually bad

Pay special attention to:

• What is meant with utility
• We prefer to rank utility ordinal, which means we determine what is being preferred more that something else, according to one’s ranking order of preference, because it is difficult to measure utility. Now it is much easier to say I prefer this one above that and another one even more.
• Total utility increases as more of a product is being consumed
• Marginal utility is very important, and make sure you are able to calculate marginal utility from total utility given in the table (or schedule). “Marginal” means additional or extra. It is every time the extra use that you would obtain by consuming an additional unit of that product.        

               (

\MU₂ = TU₂ –TU₁   and   TU₂ = TU₁ + MU₂)

Note the Law of Diminishing Marginal Utility. As one uses more of a product the extra value that you get out of it is becoming constantly less.

Here is a summary on how to calculate MU, TU and weighted marginal utility. 

NUT

Wat is nut?

Elastisiteite in 'n "nutshell"

In hierdie hoofstuk is eerstens aandag gegee aan die pryselastisiteit van vraag. Dit kan gedefinieer word as die persentasieverandering in die hoeveelheid van die produk gevra relatief tot die persentasieverandering in die prys van die produk. Daar is aangedui dat die pryselastisiteit van vraag gewoonlik negatief (-) sal wees, alhoewel slegs die positiewe waarde daarvan (of die absolute waarde) in ag geneem word.

In die meting daarvan is onderskei tussen punt- en boog-elastisiteit. Punt-elastisiteit meet die elastisiteit van ’n sekere punt op die vraagkromme, terwyl boog-elastisiteit die elastisiteit tussen twee punte op die vraagkromme meet.

Die nut van die pryselastisiteits-koëffisiënt is ondersoek en daar is tussen vyf pryselastisiteitskoëffisiënte onderskei, naamlik totale onelastisiteit (oneindige), onelastisiteit, eenheidselastisiteit, elastisiteit en totale (oneindige) elastiese vraag. ’n Waarde groter as 1 is relatief elasties en ’n waardekleiner as 1 is relatief onelasties of ongevoelig vir prysveranderinge.

Daar is verder aangedui dat die totale inkomste van ’n besigheid ’n by elastiese vraag sal toeneem indien die prys van die produk afneem, terwyl die totale inkomste by prysonelastiese vraag sal verhoog wanneer die prys van die produk styg. Indien die pryselastisiteit van vraag eenheidselasties is, sal die totale inkomste onveranderd bly, met ’n toename of afname in die prys van die produk.

Bron: Mohr en Fourie, Ekonomie vir Suid Afrikaanse studente

 Die faktore wat die pryselastisiteit van vraag beïnvloed, is ook geïdentifiseer en bespreek. Aandag is ook geskenk aan kruiselastisiteit wat aantoon tot watter mate die vraag na produkte styg of daal indien die pryse van substitute en komplimente verander.

Die gedeelte is afgesluit deur die pryselastisiteit van aanbod te bestudeer, wat gedefinieer word as die persentasieverandering in die hoeveelheid van ’n produk aangebied relatief tot (m.a.w. gedeel deur) die persentasieverandering in die prys van daardie produk. Daar is aangedui dat die pryselastisiteit van aanbod ’n positiewe (+) waarde het. Die koëffisiënte kan in vyf kategorieë verdeel word, naamlik, totale (oneindige) onelastiese, onelastiese, eenheidselastiese, elastiese en totale (oneindige) elastiese aanbod. Hierdie leergedeelte is afgesluit met faktore wat die pryselastisiteit van aanbod beïnvloed.

Elasticity: Point ad Arc formula / Punt en Boog Formule

To recap:

We looked at the term elasticity.  What does it mean?? 

It measures the sensitivity of a change in price.  If Mango airlines decided to increase the price of airline tickets how will consumers react to this price change?  Will they be sensitive to the change in price or not? And will Mango make a profit now since the price for tickets increased?
  

In order to determine price sensitivity we need to calculate the price elasticity.
 

First we look at the Price Elasticity of Demand:

Price Elasticity of Demand can be calculated according to the Point or Arc formula.  By using the point formula it means that you calculate the elasticity of demand on a specific point on the demand curve.  When you use the arc formula you calculate the elasticity from one point TO another point on the demand curve.
  

Here is an example:
 

Imagine that at a price of R160, 1 000 pairs of jeans are sold (demanded). If the price declines to R140, then 2 000 pairs of jeans will be demanded. Calculate the point elasticity before the price decrease by making use of the point formula. 

Thus if we fill in the table below it looks like this:

-->

	P	Q
Point A	160	1000
Point B	140	2000
▲AB	P A- P B 160 -140 = 20	QA-QB 1000 -2000 = -1000
ΣAB	P A+ P B 160 +140 = 300	QA+QB 1000 +3000 = 4000

 

Point

E_d   =          (-1000/20) * (160/1000)

        =          -8

        =          8 Relative elastic since the elasticity value is > than 1.

It it were asked to calculate elasticity by making use of the arc formula the calculation will look like this:

Arc

 

       E_d        =         (-1000/20) * (300/3000)

                   =          -5

                   =          5 Relative elastic since the elasticity value is > than 1. 

Next time: Income elaticity

Introduction to elasticity of demand

Let me ask you ‘n question:  If a business wants to generate more revenue should it increase the price of its products or decrease its price of its products?

What do you think?

Well – It depends.  If Eskom wants to generate more revenue it will increase the price of electricity.  If South African Airlines quickly wants to generate more revenue it will reduce ticket prices.  So... Which one is correct?  Well, they both are.  It all depends on the sensitivity of buyers.  How sensitive will buyers be to a change in prices. 

Elasticity is about the sensitivity that buyers and sellers have for changes in price.

Elasticity of demand is defined as the percentage change in the quantity, relative to the percentage that the price of that product has changed.

 

There are four types of elasticity’s:

1) Elasticity of Demand = E_d

2) Elasticity of Supply = E_s

3) Income Elasticity = E_y

4) Cross Price Elasticity = E_xp

If a buyer is very sensitive to a change in price it means that the buyer’s sensitivity to price is relative elastic.  If a buyer is not very sensitive to a change in price it means the buyer the buyer’s price sensitivity is relative inelastic. 

When you calculate the calculations you always interpret the values.  (See flow diagram below). 

Check out the video of elasticities under video's. 

Next week: Examples of calculations

Elasticity of Demand