1. Slide -- 1 Production Analysis ·Production is an activity where resources are altered or changed and there is an increase in the ability of these resources to satisfy wants. ·Transformation of input into output.. ·change in physical characteristics ·change in form ·change in space ·change in time

2. Slide -- 2 Production Function ·Production is a technical relationship between a set of inputs or resources and a set of outputs or goods. Q X = f( inputs [land, labour, capital], technology,... )

3. Slide -- 3 Normal Profit ·In economics, all costs should be included: ·wages represent the cost of labour ·interest represents the cost of Capital ·rent represents the cost of land ·“normal profit [  ]” represents the cost of entrepreneurial activity ·normal profit includes risk

4. Slide -- 4 Production Function ·A production function expresses the relationship between a set of inputs and the output of a good or service. ·The relationship is determined by the nature of the good and technology. ·A production function is “like” a recipe for cookies; it tells you the quantities of each ingredient, how to combine and cook, and how many cookies you will produce.

5. Slide -- 5 Q X = f(L, K, R, technology,... ) Q X = quantity of output L = labour input K = Capital input R = natural resources [land] Decisions about alternative ways to produce good X require that we have information about how each variable influences Q X. One method used to identify the effects of each variable on output is to vary one input at a time. The use of the ceteris paribus convention allows this analysis. The time period used for analysis also provides a way to determine the effects of various changes of inputs on the output.

6. Slide -- 6 Technology ·The production process is divided up into various time periods; ·the “long run” is a period sufficiently long enough that technology used in the production process changes. ·In shorter time periods technology is a constant.

7. Slide -- 7 Short Run ·The short run is a period in which at least one of the inputs has become a constant and at least one of the inputs is a variable. ·If Capital [K] and land [R] are fixed or constant in the short run, labour [L] is the variable input. Output is changed by altering the labour input. Q X = f(L) Technology, K and R are fixed or constant.

8. Slide -- 8 Production in the Short Run Consider a production process where K, R and technology are fixed: As L is changed, the output changes, Q X = f(L) L = labour input TP L = Q X = output of good X AP L = average product [TP/L] MP L = Marginal product [  TP/  L] Production of Good X LAP L MP L TP L 0 AP L = TP L L 0 -- 14 AP L = TP L L 4 MP L =  TP L LL 4 2 10 AP L = TP L L 5 MP L =  TP L LL 6 3 20 6.67 10 425 6.25 5 5 6 7 9 8 29 32 34 35 5.8 5.3 4.87 4.37 3.89 4 3 2 1 0 AP L = TP L L = output input = Efficiency Maximum of AP L is at the 3 input of labour.

9. Production in the Short Run AP L = TP L L = output input Efficiency of labour = Production of Good X LAP L MP L TP L 0 5 6 7 9 8 00 -- 14 4 4 2 10 5 6 3 20 6.67 10 425 6.25 5 29 32 34 35 5.8 5.3 4.87 4.37 3.89 4 3 2 1 0 Notice that the AP L increases as the first three units of labour are added to the fixed inputs of K and R. The maximum efficiency of Labour or maximum AP L, given our technology, plant and natural resources is with the third worker. As additional units of labour are added beyond the third worker the output per worker [AP L ] declines.

10. Slide -- 10 L 0 5 6 7 9 8 1 2 3 4 TP L 0 4 10 20 25 29 32 34 35 1 2 3 4 5 6 7 8 9 Labour Output, Q X 5 10 15 20 25 30 35 Graphically TP L can be shown:.......... TP L TP L initially increases at an increasing rate; it is convex from below. After some point it then increases at a decreasing rate and reaches a maximum level of output, Maximum output and declines

11. Slide -- 11 1 2 3 4 5 6 7 8 9 Labour 2 4 6 8 10 Given the TP, the AP L can calculated: AP L = TP L L = output input Efficiency of labour = L 0 5 6 7 9 8 1 2 3 4 TP L 0 4 10 20 25 29 32 34 35 AP L 0 4 5 6.67 6.25 5.8 5.3 4.87 4.37 3.89 AP L..........

12. Slide -- 12 1 unit of L produces 4Q, 4 AP L is 4/1 = 4 or the slope of line 0H. H rise/run = 4 2 units of L produces 10Q, AP L is 10/2 = 5 or the slope of line 0M. M rise/run = 5 3 units of L produces 20Q,. AP L is 20/3 = 6.67 or the slope of line 0Z. Z 4 units of L produces 25Q,. AP L is 25/4 = 6.25 or the slope of line 0W. W As additional units of L are added, the AP falls.... 1 2 3 4 5 6 7 8 9 Labour Output, Q X 5 10 15 20 25 30 35 1 2 3 4 5 6 7 8 9 Labour 2 4 6 8 10 TP L... AP L Graphically the relationship between AP L and TP L can be shown: 0 AP L The AP L is the slope of a ray from the origin to the TP L. The maximum AP is where the ray with the greatest slope is tangent to the TP. Z............

13. Slide -- 13 4.... 1 2 3 4 5 6 7 8 9 Labour Output, Q X 5 10 15 20 25 30 35 1 2 3 4 5 6 7 8 9 Labour 2 4 6 8 10 TP L... AP L 0............ Given TP L, the AP L was calculated and graphed. AP L 0 4 5 6.67 6.25 5.8 5.3 4.87 4.37 3.89 TP L 0 4 10 20 25 29 32 34 35 MP L was calculated as the change in TP L given a change in L. MP L -- 4 6 10 5 4 3 2 1 0 The first unit of labour added 4 units of output. 4-0. Remember: MP is graphed at “between” units of L. “ Between” the 1st and 2cd units of labour, Q increases by 6......... MP L Note: Where MP L = AP L, AP L is a maximum. MP L = AP L

14. Slide -- 14 4.... 1 2 3 4 5 6 7 8 9 Labour Output, Q X 5 10 15 20 25 30 35 1 2 3 4 5 6 7 8 9 Labour 2 4 6 8 10 TP L... AP L 0..................... MP L Useful things to notice: 1. MP L is the slope of TP L. 2. When TP L increases at an increasing rate, MP L increases. At the inflection point in the TP L, MP L is a maximum. When TP L increases at a decreasing rate, MP L is decreasing. 3. The AP L is a maximum when: a. MP L = AP L, b. the slope of the ray from origin is tangent to TP L. 4. When MP L > AP L the AP L is increasing. When MP L < AP L the AP L is decreasing. 5. When MP L is 0, the slope of TP L is 0, and TP is a maximum. Z

15. Slide -- 15 Summary: TP L, MP L and AP L MP L AP L TP L L L In many production processes Q initially increases at an increasing rate. This is due to division of labour and a “better” mix of the variable input with the fixed inputs. TP L As Q [ TP L ] increases at an increasing rate, MP increases. As Q [ TP L ] increases at a decreasing rate, MP L decreases. MP L At the inflection point Diminishing marginal product MP L is a max Where 0Z is tangent to TP L, AP L is a maximum; AP L = MP L. 0 Z AP L When TP L is a maximum, MP L is zero. Whe n TP L is decreasing, MP L is negative. {MP> AP, AP rises} {MP< AP, AP falls} L1L1 L2L2 L3L3

16. Slide -- 16 PRODUCTION LABOURKAPITALOUTPUT MPAP 050 158 2523 3542 4557 5567 6574 7579 8582 9583 10582 0 8.0 11.5 14.0 14.25 13.4 12.33 11.28 10.25 9.22 8.2 8 15 19 15 10 7 5 3 1 As L is added to production process, output per worker [AP] increases. to a maximum “efficiency” [output/input which occurs at L = 4. MP increases to a max between the 2cd & 3rd units of L. When MP > AP the output per worker is increasing. Division of Labour and a more efficient mix of L, K & R causes AP to increase. Output per worker decreases after the 4th worker. “Too many” workers for K, R & tech, MP< AP. Diminishing Marginal Productivity begins with the 4th unit of L.