1. PRODUCTION AND ESTIMATION CHAPTER # 4

2. Introduction  Production is the name given to that transformation of factors into goods.  Production refers to all of the activities involved in the production of goods and services, from borrowing to setting up or expanding production facilities, to hiring workers, purchasing raw materials, running quality control, cost accounting and so on rather than referring merely to the physical transformation of inputs into outputs of goods and services.

3. Inputs  E.g. land, labour and capital  Fixed inputs: The inputs which cannot be changed readily during the time period under consideration, perhaps at very great expense. E.g. plant and some specialized equipment ( IBM took several years to build a new factory to produce computer chips to go into its own computers).  Variable input: inputs which can be changed on a very short notice e.g, raw material and unskilled labour.

4.  Short run: the time period during which at least one input is fixed is called the short run.  Long run:the time period when all inputs are variable is called long run. The length of the long run depends on the industry. For example for a dry clean business setting up or expansion, the long run may be a few weeks or months but for construction of a new electricity generating plant, it may be many years.

5. Production Table and Production Function  A production table shows the output resulting from various combinations of factors of production or inputs.  Marginal product is the additional output that will be forthcoming from an additional worker, other inputs remaining constant.  Average product is calculated by dividing total output by the quantity of the input.  Production function – a curve that describes the relationship between the inputs (factors of production) and outputs.

6. Production Table Number of workers Total output Marginal product Average product 4 6 7 6 5 3 1 0 -2 -5 1 2 3 4 5 6 7 8 9 10 0 4 5 5.7 5.8 5.6 5.2 4.6 4.0 3.3 2.5 — 4 10 17 23 28 31 32 30 25 0

7. Output 32 30 28 26 24 22 20 18 16 14 12 10 8 6 4 2 0 123456789 Number of workers TP Output per worker 123456789 10 Number of workers 7 6 5 4 3 2 1 0 MP (a) Total product(b) Marginal and average product AP Production Function

8. At first MP rises with workers  Initially, By adding more workers the output increases at a greater rate because of specialization.  MP of each worker added is larger than previous worker.  This is because of law of Increasing Marginal Returns.

9. then, MP falls with more workers  If we keep on increasing number of workers with the same amount of capital, eventually the MP will fall.  MP of next worker will be smaller than MP of previous workers.  This is because of law of decreasing marginal returns

10. The Law of Diminishing Marginal Productivity  Law of diminishing marginal productivity – As more and more of a variable input is added to an existing fixed input, after some point the additional output one gets from the additional input will fall.

11. The Law of Diminishing Marginal Productivity Number of workers Total output Marginal product Average product Increasing marginal returns Diminishing marginal returns Diminishing absolute returns 4 6 7 6 5 3 1 0 -2 -5 1 2 3 4 5 6 7 8 9 10 0 4 5 5.7 5.8 5.6 5.2 4.6 4.0 3.3 2.5 — 4 10 17 23 28 31 32 30 25 0

12. Output Diminishing marginal returns Diminishing absolute returns 32 30 28 26 24 22 20 18 16 14 12 10 8 6 4 2 0 123456789 Increasing marginal returns Number of workers TP Output per worker 123456789 10 Number of workers 7 6 5 4 3 2 1 0 MP Diminishing marginal returns Diminishing absolute returns (a) Total product(b) Marginal and average product AP The Law of Diminishing Marginal Productivity

14.  This law is also called the flower pot law. If it did not hold true, the world’s entire food supply could be grown in a single flower pot.

15. Definition of Iso-quant line (with two variable inputs)  Isoquant/ Equal Product Curve:  “An Isoquant is a curve which shows various combinations of Labor and Capital which can produce a specific level of output.” OR  “Equal product curve is a curve which represents those pairs of two factors like Labor and Capital which produce an equal level of output.”

16. Isoquant line (cont’d):  Here the production depends upon Labor and Capital. Accordingly the production function will be as;Q = f (L, K) Combinations Of factors L K Total output ABCDEABCDE 16 1 500 Meters 12 2 500 Meters 9 3 500 Meters 7 4 500 Meters 6 5 500 Meters

17. Isoquant line (cont’d):  Diagrammatical representation: 12 34 5 3 6 9 12 15 Y X IQ Labor Capital

18. PRINCIPLE OF DIMINISHING MRTS

19. Marginal Rate of Technical substitution (MRTS)  The rate at which the factor can be substituted at the margin without changing the level of output. OR  It can also be stated like “the loss of certain units of Factors X which will just be compensated by an additional units of Factor Y at that point”.

20. Diminishing MRTS CombinationsFactor X(Labor) Factor Y(Capital) MRTSOutput Meters A161------500 B1224:1500 C933:1500 D742:1500 E651:1500

21. ISO-QUANT MAP Y X IQ 1 500m IQ 3 700m IQ 2 600m Labor 0 Capital

22. Isocost line:  Isocost line is a line which shows different combinations of two factors like Labor and Capital which a firm can purchase while the firm’s budget (cost), price of labor (P L ) and price of capital (P K ) are given.

23. Cont`d  The Iso-cost curves are also called outlay lines, price lines or factor cost lines.  Each price line represents the different combinations of two inputs that a firm can buy for a given sum of money at the given prices of each output.

24. example  For example a firm wishes to spend Afs 5000 on the combination of two factors for producing a level of output.  If the price of factor X, say labor is Afs 1000 and second factor Y say Capital has price is Afs 500. then in how much quantity of both factors can b purchased.

25. ISOCOST LINE cont`d Factor Combinations QTY OF (K) QTY OF (L) TOTAL COST A10010(500) + 0(1000) =5000 B81 8(500) + 1(1000) =5000 C62 6(500) + 2(1000) =5000 D43 4(500) + 3(1000) =5000 E24 2(500) + 4(1000) =5000 F05 0(500) + 5(1000) =5000 Prices of factors and total amount to be spent is given as under: Price of Factor K (Capital) Afs 500 Price of Factor L (Labor) Afs 1000 Total amount to be spent Afs 5000

26. Graphical presentation Iso Cost line. Y X 10 8 6 4 2 0 1 2 3 4 5 A B C D E F Iso Cost line Factor K Factor L

27. Example to be solved…??  Suppose you have Maximum $30, and there are two resources, Labor (L) and Capital (K). The money payments to these resources are Wages for labor and Rent for machine.  Rent of machine per hour is $ 3  Wages of labor per hour is $ 6 Find all possible combinations and construct ISO Cost Line.

29. Least Cost Combination for Producer`s Equilibrium.  Least cost combination refers to the combination of factors with which a firm can produce a specific quantity of output at the lowest possible cost.

30. Cont`d  Least cost combination of factors for any level of output is that where the Isoquant curve is tangent to an Isocost curve. For this we have following assumptions 1 There are only two factors X & Y. 2 The prices of factors X & Y are constant. 3 The total money to spend is given.

31.  Producer equilibrium can be obtained at the point where: 1 Iso-quant is tangent to the Isocost line or in other words slopes of both curves are the same, 2Iso-quant must be convex to origin. Producer Equilibrium

32. Least cost combination for producer`s equilibrium. Y X R Capital Labor 0 C S T A B A B C a f Equilibrium point IQ

33. Thanks