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SHORT-RUN THEORY OF PRODUCTION Profits and the aims of the firm Long-run and short-run production: – –fixed and variable factors The law of diminishing returns The short-run production function: – –total physical product (TPP) – –average physical product (APP) – –marginal physical product (MPP) – –the graphical relationship between TPP, APP and MPP Profits and the aims of the firm Long-run and short-run production: – –fixed and variable factors The law of diminishing returns The short-run production function: – –total physical product (TPP) – –average physical product (APP) – –marginal physical product (MPP) – –the graphical relationship between TPP, APP and MPP

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Wheat production per year from a particular farm (tonnes)

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Wheat production per year from a particular farm Number of farm workers Tonnes of wheat produced per year Number of workers TPP

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Wheat production per year from a particular farm Number of farm workers Tonnes of wheat produced per year TPP

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Wheat production per year from a particular farm Number of farm workers Tonnes of wheat produced per year TPP a b Diminishing returns set in here

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Wheat production per year from a particular farm Number of farm workers Tonnes of wheat produced per year TPP a b d Maximum output

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Wheat production per year from a particular farm Number of farm workers (L) Tonnes of wheat per year TPP Tonnes of wheat per year Number of farm workers (L) TPP = 7 L = 1 MPP = TPP / L = 7

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Wheat production per year from a particular farm Tonnes of wheat per year TPP Tonnes of wheat per year MPP Number of farm workers (L) Number of farm workers (L)

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Wheat production per year from a particular farm Tonnes of wheat per year TPP Tonnes of wheat per year APP MPP APP = TPP / L Number of farm workers (L) Number of farm workers (L)

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Wheat production per year from a particular farm Tonnes of wheat per year TPP Tonnes of wheat per year APP MPP b Diminishing returns set in here Number of farm workers (L) Number of farm workers (L) b

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Wheat production per year from a particular farm Tonnes of wheat per year TPP Tonnes of wheat per year APP MPP b d d Number of farm workers (L) Number of farm workers (L) Maximum output b

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Wheat production per year from a particular farm Tonnes of wheat per year TPP Tonnes of wheat per year APP MPP b b d d Number of farm workers (L) Number of farm workers (L) Slope = TPP / L = APP c c

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LONG-RUN THEORY OF PRODUCTION All factors variable in long run The scale of production: – –constant returns to scale – –increasing returns to scale – –decreasing returns to scale All factors variable in long run The scale of production: – –constant returns to scale – –increasing returns to scale – –decreasing returns to scale

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LONG-RUN THEORY OF PRODUCTION Economies of scale – –specialisation & division of labour – –indivisibilities – –container principle – –greater efficiency of large machines – –by-products – –multi-stage production – –organisational & administrative economies – –financial economies – –economies of scope Economies of scale – –specialisation & division of labour – –indivisibilities – –container principle – –greater efficiency of large machines – –by-products – –multi-stage production – –organisational & administrative economies – –financial economies – –economies of scope

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LONG-RUN THEORY OF PRODUCTION Diseconomies of scale External economies and diseconomies of scale Optimum combination of factors MPPa/Pa = MPPb/Pb... = MPPn/Pn Diseconomies of scale External economies and diseconomies of scale Optimum combination of factors MPPa/Pa = MPPb/Pb... = MPPn/Pn

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ISOQUANT- ISOCOST ANALYSIS Isoquants – –their shape – –diminishing marginal rate of substitution – –isoquants and returns to scale – –isoquants and marginal returns Isocosts – –slope and position of the isocost – –shifts in the isocost Isoquants – –their shape – –diminishing marginal rate of substitution – –isoquants and returns to scale – –isoquants and marginal returns Isocosts – –slope and position of the isocost – –shifts in the isocost

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Units of K Units of L Point on diagram a b c d e a Units of labour (L) Units of capital (K) An isoquant

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Units of K Units of L Point on diagram a b c d e a b Units of labour (L) Units of capital (K) An isoquant

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Units of K Units of L Point on diagram a b c d e a b c d e Units of labour (L) Units of capital (K)

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Units of labour (L) g h K = 2 L = 1 isoquant MRS = 2 MRS = K / L Diminishing marginal rate of factor substitution

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Units of capital (K) Units of labour (L) g h j k K = 2 L = 1 K = 1 L = 1 Diminishing marginal rate of factor substitution isoquant MRS = 2 MRS = 1 MRS = K / L

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An isoquant map Units of capital (K) Units of labour (L) I1I1

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I2I2 Units of capital (K) Units of labour (L) An isoquant map I1I1

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I2I2 I3I3 Units of capital (K) Units of labour (L) An isoquant map I1I1

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I2I2 I3I3 I4I4 Units of capital (K) Units of labour (L) An isoquant map I1I1

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I1I1 I2I2 I3I3 I4I4 I5I5 Units of capital (K) Units of labour (L) An isoquant map

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An isocost Units of labour (L) Units of capital (K) Assumptions P K = £ W = £ TC = £ a

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Units of labour (L) Units of capital (K) TC = £ a b Assumptions P K = £ W = £ TC = £ An isocost

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Units of labour (L) Units of capital (K) TC = £ a b c Assumptions P K = £ W = £ TC = £ An isocost

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Units of labour (L) Units of capital (K) TC = £ a b c d Assumptions P K = £ W = £ TC = £ An isocost

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ISOQUANT- ISOCOST ANALYSIS Least-cost combination of factors for a given output – –point of tangency – –comparison with marginal productivity approach Highest output for a given cost of production Least-cost combination of factors for a given output – –point of tangency – –comparison with marginal productivity approach Highest output for a given cost of production

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Finding the least-cost method of production Units of labour (L) Units of capital (K) Assumptions P K = £ W = £ TC = £ TC = £ TC = £ TC = £

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Units of labour (L) Units of capital (K) Finding the least-cost method of production TPP 1

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Units of labour (L) Units of capital (K) Finding the least-cost method of production TC = £ r TPP 1

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Units of labour (L) Units of capital (K) Finding the least-cost method of production TC = £ TC = £ s r t TPP 1

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Finding the maximum output for a given total cost TPP 1 TPP 2 TPP 3 TPP 4 TPP 5 Units of capital (K) Units of labour (L) O

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O Isocost Units of capital (K) Units of labour (L) TPP 1 TPP 2 TPP 3 TPP 4 TPP 5 Finding the maximum output for a given total cost

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O r v Units of capital (K) Units of labour (L) TPP 1 TPP 2 TPP 3 TPP 4 TPP 5 Finding the maximum output for a given total cost

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O s u Units of capital (K) Units of labour (L) TPP 1 TPP 2 TPP 3 TPP 4 TPP 5 r v Finding the maximum output for a given total cost

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O t Units of capital (K) Units of labour (L) TPP 1 TPP 2 TPP 3 TPP 4 TPP 5 r v s u Finding the maximum output for a given total cost

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O K1K1 L1L1 Units of capital (K) Units of labour (L) TPP 1 TPP 2 TPP 3 TPP 4 TPP 5 r v s u t Finding the maximum output for a given total cost

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