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Production Function2
Production Function2
Production Function Total Production, Marginal Production and Average Production Law of Diminishing Marginal Returns Isoquant- Isoquant Schedule, Map Marginal Rate of Technical Substitution Isocost Optimal Combination of Inputs Expansion path Returns to Scale
Production Function
The firms production function for a particular good (q) shows the maximum amount of the good that can be produced using alternative combinations of capital (k) and labor (l)
Example: Q = f (L, K)
Short run- One factor is variable and others are constant Q = f (L, K*) Long run- All the factors are variable Q = f (L, K)
Production Set
The marginal product of an input is the change in output that results from a small change in an input holding the levels of all other inputs constant.
MPL = Q/L (holding constant all other inputs) MPK = Q/K (holding constant all other inputs)
The average product of an input is equal to the total output that is to be produced divided by the quantity of the input that is used in its production: APL = Q/L APK = Q/K
Average Product [AP] [3] 43 80 117 150 175 192 196 192
Marginal Product [MP] [4] 43 117 191 249 275 277 220 164
9
10 11 12
1656
1750 1815 1860
184
175 165 155
120
94 65 45
300 TP 250
AP
MP 50
4 labour
10
12
4 6 Labour
10
12
The law of diminishing marginal returns states that marginal products (eventually) decline as the quantity used of a single input increases. 2 k kk 11 2
Stages of Production
Three stages. First stage- when we vary one factor of production, there is increasing average returns to the factor of production. i.e. MPL> APL ( Marginal product is greater than average product. Second stage: When average product is decreasing marginal product is also decreasing but marginal product is positive. i.e. APL> MPL Third stage: When average product is decreasing but marginal product is negative. i.e. MPL<0
ISOQUANT
Labor Input Capital Input 1
1
2 3 4 5
2
40
60 75 85 90
3
55
75 90 100 105
4
65
85 100 110 115
5
75
90 105 115 120
20
40 55 65 75
5
4 3 2
E The isoquants are derived from the production function for output of 55, 75, and 90. A B C
Q3 = 90 1 1 2 3
D
Q2 = 75 Q1 = 55 4 5
Labor per year
The isoquants emphasize how different input combinations can be used to produce the same output. This information allows the producer to respond efficiently to changes in the markets for inputs.
Marginal rate of technical substitution (RTS): the amount by which one input can be reduced when one more unit of another input is added while holding output constant (i.e. negative of the slope of an isoquant). It is the rate that capital can be reduced, holding output constant, while using one more unit of labor.
Rate of Technical Substitution (of labour for capital) =RTS (of L for K) = - (slope of isoquants) = - (change in capital inputs)/ (change in labour inputs) RTS (of L for K) = MPK/MPL
B D A IQ
5 Labor
10
B D A 220,000 unit
5 Labor
10
Line
Given
Budget lines
Isocost
ISOCOST lines are the combination of inputs for a given cost,
Capital 360 J
K 0 Labour 40
The objective is to minimize cost for a given output Minimize production cost
Optimal where:
Cost minimization
450
360 Capital 270 225 J A Rs. 450,000
T
Rs. 360,000 240,000 unit
Rs. 270,000
0 15 B 30 Labours K 40 50
All relevant output levels Production indifference curves Budget lines Output Total cost
Tangency points
E S
Capital
B S
T
300,000 units
220,000 units
E 0
Rs. 270,000 B
10 15
Capital
T E 240,000 units
K Labor
Returns to Scale
Output Elasticity and Returns to Scale Output elasticity is Q = Q/Q Xi/Xi where Xi is all
inputs (labor, capital, etc.) Q > 1 implies increasing returns. Q = 1 implies constant returns. Q < 1 implies decreasing returns.
Returns To Scale
If a 1% increase in all inputs results in a greater than 1% increase in output, then the production function exhibits increasing returns to scale.
If a 1% increase in all inputs results in exactly a 1% increase in output, then the production function exhibits constant returns to scale. If a 1% increase in all inputs results in a less than 1% increase in output, then the production function exhibits decreasing returns to scale.
Returns to scale
Capital
(a)
Capital
(b)
Capital
(c)
B p1 6 4
12
Constant returns to scale. Increasing returns to scale. Doubling the levels of both Doubling the levels of inputs more than doubles labor (from 3 to 6) and capital (from 2 to 4) also the output level doubles the level of output (from 4 to 8)
Decreasing returns to scale. Doubling the levels of both inputs less than doubles the output level
C B
100
O3
Labor productivity can increase if there are improvements in technology, even though any given production process exhibits diminishing returns to labor.
A
50 O2 O1
Labor per time period
0 1
2 3
5 6
7 8
10