Presentation on theme: "Reveals functional relation between factors of input and output."— Presentation transcript:
1 Reveals functional relation between factors of input and output. PRODUCTION FUNCTIONReveals functional relation between factors of input and output.
2 The Technology of Production The Production ProcessCombining inputs or factors of production to achieve an outputCategories of Inputs (factors of production)LandCapitalLaborEntrepreneur
3 The Technology of Production Production Function:Indicates the highest output that a firm can produce for every specified combination of inputs given the state of technology.Shows what is technically feasible when the firm operates efficiently.
4 The Technology of Production The production function for two inputs:Q = F(K,L)Q = Output, K = Capital, L = LaborFor a given technology
5 Short Run vs Long RunS-R is the period of time during which at least one factor of production is fixed - cannot be increased.L-R is the period of time during which all factors of production can be varied.
6 The Short Run / Law of Variable proportions StagesLaw of increasing returnsLaw of diminishing returnsLaw of negative returns
7 Production with One Variable Input (Labor) Amount Amount Total Average Marginalof Labor (L) of Capital (K) Output (Q) Product Product
8 Production with One Variable Input (Labor) Observations:The average product of labor (AP), or output per worker, increases and then decreases.
9 Production with One Variable Input (Labor) Observations:The marginal product of labor (MP), or output of the additional worker, increases rapidly initially and then decreases and becomes negative..
10 Production with One Variable Input (Labor) OutputperMonthABCD112Total ProductB increase at increasing rateB to D incr at diminishing rateD max prd. n then decline in TP6012345678910Labor per Month
11 Production with One Variable Input (Labor) OutputperMonthEMarginal ProductObservations:Left of E: MP > AP & AP is increasingRight of E: MP < AP & AP is decreasingE: MP = AP & AP is at its maximum3020Average Product1012345678910Labor per Month
12 Production with One Variable Input (Labor) Observations:When MP = 0, TP is at its maximumWhen MP > AP, AP is increasing and TP is increasing at increasing rate.When MP < AP, AP is decreasing and TP is increasing at diminishing rate.When MP = AP, AP and TP are at maximum
13 Production with One Variable Input (Labor) AP = slope of line from origin to a point on TP, lines b, & c.MP = slope of a tangent to any point on the TP line, lines a & c.OutputperMonthOutputperMonthD11230CE2060B10ALaborper MonthLaborper Month1234567891012345678910
14 Law of variable output Stage I Stage II Stage III TP in increasing at increasing rate, MP is increasing (reaches it max and then declines somewhere in this stage) and AP is also increasing but less than MP.Stage IITP in increasing at diminishing rate, MP is declining and AP is declining and is higher than MP.Stage IIITP reaches its max and then start to decline, MP is ZERO when TP is max and AP is declining.
15 The Law of Diminishing Marginal Returns Stage of operationThe Law of Diminishing Marginal ReturnsAs the use of an input increases in equal increments, a point will be reached at which the resulting additions to output decreases (i.e. MP declines).
16 Long Run Production Function Returns to Scale Measuring the relationship between the scale (size) of a firm and output1) Increasing returns to scale: output more than doubles when all inputs are doubledUtilizing Economies of Scale
17 Returns to ScaleMeasuring the relationship between the scale (size) of a firm and outputConstant returns to scale: output doubles when all inputs are doubledMoving towards Optimum
18 Returns to ScaleMeasuring the relationship between the scale (size) of a firm and output3) Decreasing returns to scale: output less than doubles when all inputs are doubledDecreasing efficiency with large sizeReduction of entrepreneurial abilitiesDiseconomies of scale