SHORT-RUN THEORY OF PRODUCTION

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Presentation transcript:

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 2

Wheat production per year from a particular farm (tonnes)

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

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

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

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

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

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

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

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

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

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

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 4

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 5

LONG-RUN THEORY OF PRODUCTION Diseconomies of scale External economies and diseconomies of scale Optimum combination of factors MPPa/Pa = MPPb/Pb ... = MPPn/Pn 6

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 7

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

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

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

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

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

An isoquant map Units of capital (K) I1 Units of labour (L)

An isoquant map Units of capital (K) I2 I1 Units of labour (L)

An isoquant map Units of capital (K) I3 I2 I1 Units of labour (L)

An isoquant map Units of capital (K) I4 I3 I2 I1 Units of labour (L)

An isoquant map Units of capital (K) I5 I4 I3 I2 I1 Units of labour (L)

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

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

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

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

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 8

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

Finding the least-cost method of production Units of capital (K) TPP1 Units of labour (L)

Finding the least-cost method of production Units of capital (K) TC = £400 000 r TPP1 Units of labour (L)

Finding the least-cost method of production Units of capital (K) TC = £400 000 r t TPP1 Units of labour (L)

Finding the maximum output for a given total cost Units of capital (K) TPP5 TPP4 TPP3 TPP2 TPP1 O Units of labour (L)

Finding the maximum output for a given total cost Units of capital (K) Isocost TPP5 TPP4 TPP3 TPP2 TPP1 O Units of labour (L)

Finding the maximum output for a given total cost Units of capital (K) TPP5 TPP4 v TPP3 TPP2 TPP1 O Units of labour (L)

Finding the maximum output for a given total cost Units of capital (K) u TPP5 TPP4 v TPP3 TPP2 TPP1 O Units of labour (L)

Finding the maximum output for a given total cost Units of capital (K) t u TPP5 TPP4 v TPP3 TPP2 TPP1 O Units of labour (L)

Finding the maximum output for a given total cost Units of capital (K) t K1 u TPP5 TPP4 v TPP3 TPP2 TPP1 O L1 Units of labour (L)