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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.

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Presentation on theme: "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."— Presentation transcript:

1 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

2 Wheat production per year from a particular farm (tonnes)

3 Wheat production per year from a particular farm Number of farm workers Tonnes of wheat produced per year Number of workers 0 1 2 3 4 5 6 7 8 TPP 0 3 10 24 36 40 42 40

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

5 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

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

7 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

8 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)

9 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)

10 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

11 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

12 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

13 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

14 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

15 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

16 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

17 Units of K 40 20 10 6 4 Units of L 5 12 20 30 50 Point on diagram a b c d e a Units of labour (L) Units of capital (K) An isoquant

18 Units of K 40 20 10 6 4 Units of L 5 12 20 30 50 Point on diagram a b c d e a b Units of labour (L) Units of capital (K) An isoquant

19 Units of K 40 20 10 6 4 Units of L 5 12 20 30 50 Point on diagram a b c d e a b c d e Units of labour (L) Units of capital (K)

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

21 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

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

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

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

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

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

27 An isocost Units of labour (L) Units of capital (K) Assumptions P K = £20 000 W = £10 000 TC = £300 000 a

28 Units of labour (L) Units of capital (K) TC = £300 000 a b Assumptions P K = £20 000 W = £10 000 TC = £300 000 An isocost

29 Units of labour (L) Units of capital (K) TC = £300 000 a b c Assumptions P K = £20 000 W = £10 000 TC = £300 000 An isocost

30 Units of labour (L) Units of capital (K) TC = £300 000 a b c d Assumptions P K = £20 000 W = £10 000 TC = £300 000 An isocost

31 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

32 Finding the least-cost method of production Units of labour (L) Units of capital (K) Assumptions P K = £20 000 W = £10 000 TC = £200 000 TC = £300 000 TC = £400 000 TC = £500 000

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

34 Units of labour (L) Units of capital (K) Finding the least-cost method of production TC = £400 000 r TPP 1

35 Units of labour (L) Units of capital (K) Finding the least-cost method of production TC = £400 000 TC = £500 000 s r t TPP 1

36 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

37 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

38 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

39 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

40 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

41 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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