Prepared by Robert F. Brooker, Ph.D. Copyright ©2004 by South-Western, a division of Thomson Learning. All rights reserved.Slide 1 Managerial Economics in a Global Economy, 5th Edition by Dominick Salvatore Chapter 6 Production Theory and Estimation

Prepared by Robert F. Brooker, Ph.D. Copyright ©2004 by South-Western, a division of Thomson Learning. All rights reserved.Slide 2 The Organization of Production Inputs –Labor, Capital, Land Fixed Inputs Variable Inputs Short Run –At least one input is fixed Long Run –All inputs are variable

Prepared by Robert F. Brooker, Ph.D. Copyright ©2004 by South-Western, a division of Thomson Learning. All rights reserved.Slide 3 Production Function With Two Inputs Q = f(L, K)

Prepared by Robert F. Brooker, Ph.D. Copyright ©2004 by South-Western, a division of Thomson Learning. All rights reserved.Slide 4 Production Function With Two Inputs Discrete Production Surface

Prepared by Robert F. Brooker, Ph.D. Copyright ©2004 by South-Western, a division of Thomson Learning. All rights reserved.Slide 5 Production Function With Two Inputs Continuous Production Surface

Prepared by Robert F. Brooker, Ph.D. Copyright ©2004 by South-Western, a division of Thomson Learning. All rights reserved.Slide 6 Production Function With One Variable Input Total Product Marginal Product Average Product Production or Output Elasticity TP = Q = f(L) MP L =  TP  L AP L = TP L E L = MP L AP L

Prepared by Robert F. Brooker, Ph.D. Copyright ©2004 by South-Western, a division of Thomson Learning. All rights reserved.Slide 7 Production Function With One Variable Input Total, Marginal, and Average Product of Labor, and Output Elasticity

Prepared by Robert F. Brooker, Ph.D. Copyright ©2004 by South-Western, a division of Thomson Learning. All rights reserved.Slide 8 Production Function With One Variable Input

Prepared by Robert F. Brooker, Ph.D. Copyright ©2004 by South-Western, a division of Thomson Learning. All rights reserved.Slide 9 Production Function With One Variable Input

Prepared by Robert F. Brooker, Ph.D. Copyright ©2004 by South-Western, a division of Thomson Learning. All rights reserved.Slide 10 Optimal Use of the Variable Input Marginal Revenue Product of Labor MRP L = (MP L )(MR) Marginal Resource Cost of Labor MRC L =  TC  L Optimal Use of Labor MRP L = MRC L

Prepared by Robert F. Brooker, Ph.D. Copyright ©2004 by South-Western, a division of Thomson Learning. All rights reserved.Slide 11 Optimal Use of the Variable Input Use of Labor is Optimal When L = 3.50

Prepared by Robert F. Brooker, Ph.D. Copyright ©2004 by South-Western, a division of Thomson Learning. All rights reserved.Slide 12 Optimal Use of the Variable Input

Prepared by Robert F. Brooker, Ph.D. Copyright ©2004 by South-Western, a division of Thomson Learning. All rights reserved.Slide 13 Production With Two Variable Inputs Isoquants show combinations of two inputs that can produce the same level of output. Firms will only use combinations of two inputs that are in the economic region of production, which is defined by the portion of each isoquant that is negatively sloped.

Prepared by Robert F. Brooker, Ph.D. Copyright ©2004 by South-Western, a division of Thomson Learning. All rights reserved.Slide 14 Production With Two Variable Inputs Isoquants

Prepared by Robert F. Brooker, Ph.D. Copyright ©2004 by South-Western, a division of Thomson Learning. All rights reserved.Slide 15 Production With Two Variable Inputs Economic Region of Production

Prepared by Robert F. Brooker, Ph.D. Copyright ©2004 by South-Western, a division of Thomson Learning. All rights reserved.Slide 16 Production With Two Variable Inputs Marginal Rate of Technical Substitution MRTS = -  K/  L = MP L /MP K

Prepared by Robert F. Brooker, Ph.D. Copyright ©2004 by South-Western, a division of Thomson Learning. All rights reserved.Slide 17 Production With Two Variable Inputs MRTS = -(-2.5/1) = 2.5

Prepared by Robert F. Brooker, Ph.D. Copyright ©2004 by South-Western, a division of Thomson Learning. All rights reserved.Slide 18 Production With Two Variable Inputs Perfect Substitutes Perfect Complements

Prepared by Robert F. Brooker, Ph.D. Copyright ©2004 by South-Western, a division of Thomson Learning. All rights reserved.Slide 19 Optimal Combination of Inputs Isocost lines represent all combinations of two inputs that a firm can purchase with the same total cost.

Prepared by Robert F. Brooker, Ph.D. Copyright ©2004 by South-Western, a division of Thomson Learning. All rights reserved.Slide 20 Optimal Combination of Inputs Isocost Lines ABC = $100, w = r = $10 A’B’C = $140, w = r = $10 A’’B’’C = $80, w = r = $10 AB*C = $100, w = $5, r = $10

Prepared by Robert F. Brooker, Ph.D. Copyright ©2004 by South-Western, a division of Thomson Learning. All rights reserved.Slide 21 Optimal Combination of Inputs MRTS = w/r

Prepared by Robert F. Brooker, Ph.D. Copyright ©2004 by South-Western, a division of Thomson Learning. All rights reserved.Slide 22 Optimal Combination of Inputs Effect of a Change in Input Prices

Prepared by Robert F. Brooker, Ph.D. Copyright ©2004 by South-Western, a division of Thomson Learning. All rights reserved.Slide 23 Returns to Scale Production Function Q = f(L, K) Q = f(hL, hK) If = h, then f has constant returns to scale. If > h, then f has increasing returns to scale. If < h, the f has decreasing returns to scale.

Prepared by Robert F. Brooker, Ph.D. Copyright ©2004 by South-Western, a division of Thomson Learning. All rights reserved.Slide 24 Returns to Scale Constant Returns to Scale Increasing Returns to Scale Decreasing Returns to Scale

Prepared by Robert F. Brooker, Ph.D. Copyright ©2004 by South-Western, a division of Thomson Learning. All rights reserved.Slide 25 Empirical Production Functions Cobb-Douglas Production Function Q = AK a L b Estimated using Natural Logarithms ln Q = ln A + a ln K + b ln L

Prepared by Robert F. Brooker, Ph.D. Copyright ©2004 by South-Western, a division of Thomson Learning. All rights reserved.Slide 26 Innovations and Global Competitiveness Product Innovation Process Innovation Product Cycle Model Just-In-Time Production System Competitive Benchmarking Computer-Aided Design (CAD) Computer-Aided Manufacturing (CAM)