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Behind The Supply Curve: Production Function I 1. Production - short run 1. Production - short run –Productive efficiency –The Law of diminishing marginal.

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Presentation on theme: "Behind The Supply Curve: Production Function I 1. Production - short run 1. Production - short run –Productive efficiency –The Law of diminishing marginal."— Presentation transcript:

1 Behind The Supply Curve: Production Function I 1. Production - short run 1. Production - short run –Productive efficiency –The Law of diminishing marginal returns 2. Production - long run 2. Production - long run –isoquants & isocosts –least cost method of production

2 Background Firms seek to maximise profit () Firms seek to maximise profit () = R - C = R - C How do firms produce output and minimise costs (C)? How do firms produce output and minimise costs (C)? What is production? What is production? …production is simply the process of transforming inputs and outputs. …production is simply the process of transforming inputs and outputs. inputs = capital (K) and labour (L) inputs = capital (K) and labour (L)

3 A production function Functional relationship Functional relationship Q = f(K, L, T) Q = f(K, L, T) T changes over time T changes over time At a point in time T is fixed At a point in time T is fixed Productive efficiency Productive efficiency A method of production is efficient if, for a given level of factor inputs, it is impossible to obtain a higher level of output, given the existing state of technology. A method of production is efficient if, for a given level of factor inputs, it is impossible to obtain a higher level of output, given the existing state of technology.

4 The short run Period of time over which one factor is fixed Period of time over which one factor is fixed Capital - machines, factory, etc. Capital - machines, factory, etc. Total and Marginal Physical Product Total and Marginal Physical Product …marginal product is the additional output produced by an additional unit of labour …marginal product is the additional output produced by an additional unit of labour MPP = TPP / L MPP = TPP / L See Figure See Figure

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

6 fig 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)

7 Law of Diminishing Returns Definition Definition …as units of one input are added (with all other inputs held constant), a point will be reached where the resulting additions to output will begin to decrease; that is marginal product will decline. …as units of one input are added (with all other inputs held constant), a point will be reached where the resulting additions to output will begin to decrease; that is marginal product will decline. On figure - between 2 and 3 workers On figure - between 2 and 3 workers

8 2. The Long Run All factors are variable All factors are variable Decisions Decisions Scale Scale Location Location Technique Technique Choice of technique Choice of technique Isoquants Isoquants Isocosts Isocosts

9 Isoquants An isoquant An isoquant …is a contour line which joins together the different combinations of two factors of production that are just physically able to produce a given quantity of a good. …is a contour line which joins together the different combinations of two factors of production that are just physically able to produce a given quantity of a good. Construction, slope and maps Construction, slope and maps

10 fig An isoquant Units of K Units of L Units of labour (L) Units of capital (K)

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

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

13 Isocosts Actual output also depends on costs Actual output also depends on costs isocosts isocosts join combinations of K & L - same cost join combinations of K & L - same cost assuming constant factor prices assuming constant factor prices Construction, slope & map Construction, slope & map

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

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

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

17 Least cost method of production Tangency between isoquant and isocost Tangency between isoquant and isocost Where: Where: Slope of isoquant = slope of isocost Slope of isoquant = slope of isocost Successive points of tangency - scale expansion path Successive points of tangency - scale expansion path


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