Chapter 6 Production

Chapter 6Slide 2 The Technology of Production The Production Process Combining inputs or factors of production to achieve an output Categories of Inputs (factors of production) Labor Materials Capital

Chapter 6Slide 3 The Technology of Production Production Function: Indicates the highest output that a firm can produce for every specified combination of inputs given the state of technology. Shows what is technically feasible when the firm operates efficiently.

Chapter 6Slide 4 The Technology of Production The production function for two inputs: Q = F(K,L) Q = Output, K = Capital, L = Labor For a given technology

Chapter 6Slide 5 Production Function for Food Capital Input12345 Labor Input

Chapter 6Slide 6 Isoquants Curves showing all possible combinations of inputs that yield the same output

Chapter 6Slide 7 Production with Two Variable Inputs (L,K) Labor per year Q 1 = 55 The isoquants are derived from the production function for output of of 55, 75, and 90. A D B Q 2 = 75 Q 3 = 90 C E Capital per year The Isoquant Map

Chapter 6Slide 8 Isoquants Short-run: Period of time in which quantities of one or more production factors cannot be changed. These inputs are called fixed inputs. The Short Run versus the Long Run

Chapter 6Slide 9 Isoquants Long-run Amount of time needed to make all production inputs variable. The Short Run versus the Long Run

Chapter 6Slide 10 AmountAmountTotalAverage Marginal of Labor (L)of Capital (K)Output (Q)ProductProduct Production with One Variable Input (Labor)

Chapter 6Slide 11 Total Product A: slope of tangent = MP (20) B: slope of OB = AP (20) C: slope of OC= MP & AP Labor per Month Output per Month A B C D Production with One Variable Input (Labor)

Chapter 6Slide 12 Average Product Production with One Variable Input (Labor) Outpu t per Month Labor per Month 30 E Marginal Product Observations: Left of E: MP > AP & AP is increasing Right of E: MP < AP & AP is decreasing E: MP = AP & AP is at its maximum

Production with One Variable Input (Labor) Labor per Month Output per Month A B C D 8 20 E Output per Month Labor per Month AP = slope of line from origin to a point on TP, lines b, & c. MP = slope of a tangent to any point on the TP line, lines a & c.

Chapter 6Slide 14 As the use of an input increases in equal increments, a point will be reached at which the resulting additions to output decreases (i.e. MP declines). Production with One Variable Input (Labor) The Law of Diminishing Marginal Returns

Chapter 6Slide 15 When the labor input is small, MP increases due to specialization. When the labor input is large, MP decreases due to inefficiencies. The Law of Diminishing Marginal Returns Production with One Variable Input (Labor)

Chapter 6Slide 16 Can be used for long-run decisions to evaluate the trade-offs of different plant configurations Assumes the quality of the variable input is constant The Law of Diminishing Marginal Returns Production with One Variable Input (Labor)

Chapter 6Slide 17 Explains a declining MP, not necessarily a negative one Assumes a constant technology The Law of Diminishing Marginal Returns Production with One Variable Input (Labor)

Chapter 6Slide 18 The Effect of Technological Improvement Labor per time period Output per time period A O1O1 C O3O3 O2O2 B Labor productivity can increase if there are improvements in technology, even though any given production process exhibits diminishing returns to labor.

Chapter 6Slide 19 Production with Two Variable Inputs Long-run production K& L are variable. Isoquants analyze and compare the different combinations of K & L and output

Chapter 6Slide 20 The Shape of Isoquants Labor per year In the long run both labor and capital are variable and both experience diminishing returns. Q 1 = 55 Q 2 = 75 Q 3 = 90 Capital per year A D B C E

Chapter 6Slide 21 Substituting Among Inputs The slope of each isoquant gives the trade- off between two inputs while keeping output constant. Production with Two Variable Inputs

Chapter 6Slide 22 Substituting Among Inputs The marginal rate of technical substitution equals: Production with Two Variable Inputs

Chapter 6Slide 23 Marginal Rate of Technical Substitution Labor per month Capital per year Isoquants are downward sloping and convex like indifference curves /3 1/3 Q 1 =55 Q 2 =75 Q 3 =90

Chapter 6Slide 24  The change in output from a change in labor equals: Production with Two Variable Inputs

Chapter 6Slide 25  The change in output from a change in capital equals: Production with Two Variable Inputs

Chapter 6Slide 26  If output is constant and labor is increased, then: Production with Two Variable Inputs

Chapter 6Slide 27 Isoquants When Inputs are Perfectly Substitutable Labor per month Capital per month Q1Q1 Q2Q2 Q3Q3 A B C

Chapter 6Slide 28 Fixed-Proportions Production Function Labor per month Capital per month L1L1 K1K1 Q1Q1 Q2Q2 Q3Q3 A B C

Chapter 6Slide 29 A Production Function for Wheat Farmers must choose between a capital intensive or labor intensive technique of production.

Chapter 6Slide 30 Isoquant Describing the Production of Wheat Labor (hours per year) Capital (machine hour per year) Output = 13,800 bushels per year A B Point A is more capital-intensive, and B is more labor-intensive.

Chapter 6Slide 31 Returns to Scale Measuring the relationship between the scale (size) of a firm and output 1)Increasing returns to scale: output more than doubles when all inputs are doubled  Larger output associated with lower cost (autos)  One firm is more efficient than many (utilities)  The isoquants get closer together

Chapter 6Slide 32 Returns to Scale Labor (hours) Capital (machine hours) Increasing Returns: The isoquants move closer together A

Chapter 6Slide 33 Returns to Scale Measuring the relationship between the scale (size) of a firm and output 2)Constant returns to scale: output doubles when all inputs are doubled  Size does not affect productivity  May have a large number of producers  Isoquants are equidistant apart

Chapter 6Slide 34 Returns to Scale Labor (hours) Capital (machine hours) Constant Returns: Isoquants are equally spaced A 6

Chapter 6Slide 35 Returns to Scale Measuring the relationship between the scale (size) of a firm and output 3)Decreasing returns to scale: output less than doubles when all inputs are doubled  Decreasing efficiency with large size  Reduction of entrepreneurial abilities  Isoquants become farther apart