1. Reveals functional relation between factors of input and output.
PRODUCTION FUNCTION
Reveals functional relation between factors of input and output.

2. The Technology of Production
The Production Process
Combining inputs or factors of production to achieve an output
Categories of Inputs (factors of production)
Land
Capital
Labor
Entrepreneur

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.

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

5. Short Run vs Long Run
S-R is the period of time during which at least one factor of production is fixed - cannot be increased.
L-R is the period of time during which all factors of production can be varied.

6. The Short Run / Law of Variable proportions
Stages
Law of increasing returns
Law of diminishing returns
Law of negative returns

7. Production with One Variable Input (Labor)
Amount Amount Total Average Marginal
of Labor (L) of Capital (K) Output (Q) Product Product

8. Production with One Variable Input (Labor)
Observations:
The average product of labor (AP), or output per worker, increases and then decreases.

9. Production with One Variable Input (Labor)
Observations:
The marginal product of labor (MP), or output of the additional worker, increases rapidly initially and then decreases and becomes negative..

10. Production with One Variable Input (Labor)
Output
per
Month A B C D
112
Total Product
B increase at increasing rate
B to D incr at diminishing rate
D max prd. n then decline in TP 60 1 2 3 4 5 6 7 8 9 10
Labor per Month

11. Production with One Variable Input (Labor)
Output
per
Month 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 30 20
Average Product 10 1 2 3 4 5 6 7 8 9 10
Labor per Month

12. Production with One Variable Input (Labor)
Observations:
When MP = 0, TP is at its maximum
When MP > AP, AP is increasing and TP is increasing at increasing rate.
When MP < AP, AP is decreasing and TP is increasing at diminishing rate.
When MP = AP, AP and TP are at maximum

13. Production with One Variable Input (Labor)
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.
Output
per
Month
Output
per
Month D
112 30 C E 20 60 B 10 A
Labor
per Month
Labor
per Month 1 2 3 4 5 6 7 8 9 10 1 2 3 4 5 6 7 8 9 10

14. Law of variable output Stage I Stage II Stage III
TP in increasing at increasing rate, MP is increasing (reaches it max and then declines somewhere in this stage) and AP is also increasing but less than MP.
Stage II
TP in increasing at diminishing rate, MP is declining and AP is declining and is higher than MP.
Stage III
TP reaches its max and then start to decline, MP is ZERO when TP is max and AP is declining.

15. The Law of Diminishing Marginal Returns
Stage of operation
The Law of Diminishing Marginal Returns
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).

16. Long Run Production Function 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
Utilizing Economies of Scale

17. Returns to Scale
Measuring the relationship between the scale (size) of a firm and output
Constant returns to scale: output doubles when all inputs are doubled
Moving towards Optimum

18. 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
Diseconomies of scale