MANAGERIAL

ECONOMICS
P R E S E N T E D B Y: PA U L A G E O R G I A B . B A N C A S O
 TOPICS

• La w of
• Production • I nput f a c t or
Di m i ni shi ng
Functions subst i t ut i on
Re t ur ns
• Properties of • Com pe nsa t i on
• Di m i ni shi ng
Production pol i c y
r e t ur n f a c t or
Functions • Eff i c i e nc y wa ge s
• I nput c om bi na t i on
• Total, M arginal,
and Average c hoi c e
Product
PRODUCTION
Prod uction - is a n a ctivity that
transfo rm in p u ts in to o u tpu ts su ch
as good o r se r v ic e.
 • is a mathematical statement used to explain the technical relationship between input and output in
physical terms over a given period of time.
• According to Koutsoyiannis, “ the production function is purely a technical relation which connects
factor inputs and output.”

1 Land
( Na n)y th in g w h ic h is
g ift o f n a tu r e a n d
n o t th e r e su lt o f
h u m a n e ff o rt , e .g .
so il, w a te r, fo r e sts ,
m in e ra ls .
4 FACTORS OF PRODUCTION
2 Labour 3 Capital (K) 4 Entrepreneurship
( Lph)ys i cal or
mental wealth which is used (E
the)ability and action
effort of human for further production to take risk of
bei n gs that undert akes as utilizing all the
t he product ion machine/equipment/in factors of production
process. termediary good. for economic gains.
COBB-DOUGLAS
T h e Co b b – Do u g l as p ro d u ct io n fu n ct i o n i s a
p ar t i cu l ar fu n ct i o n al fo rm o f t h e p ro d u ct i o n
fu n ct i o n , wi d el y u sed t o rep resen t t h e t ech n o l o g i cal
rel at i o n sh i p b et ween t h e amo u n t s o f t wo o r mo re
i n p u t s an d t h e amo u n t o f o u tp u t t h at can b e
p r o d u ced b y t h o se i n p u t s.

Cap i t al an d L ab o u r are th e two " fact o rs o f

p r o d u ct i o n " o f t h e Co b b – Do u g l as p ro d u ct i o n
fu n ct i o n .

Charles W. CObb Paul H. Douglas

I ll ust r ati on
Q = To ta l P r o du ctio n o f I npu ts ( un its )
A = To ta l F a c to r P r od uc tivity ( c o ns ta nt)
L= La b or F or c e ( u nits )
K = P hy s ica l C a pita l ( un its )
α a nd β = O u tp ut ela s tic ity of the I n puts
COBB-DOUGLAS PRODUCTION FUNCTION
G IV E N : A N SWE R :

A=40
K=3 = 4 0 (5 )0 . 3 (3 )0 . 7
L=5 lo g Q = lo g 4 0 + (0 .3 x lo g 5 ) + (0 . 7 x lo g
a=0.3 3)
b=0.7 lo g Q = 1 .6 0 2 0 + (0 .3 x 0 .6 9 8 9 ) + (0 .7 x
0.4771)
FO R MU LA : lo g Q = 1 .6 0 2 0 + 0 . 2 0 9 6 + 0 .3 3 3 9
lo g Q = 2 .1 4 5 5
N o w, w e w ill ta k e th e a n tilo g o f th e
a b o v e to g e t th e v a lu e o f Q .
a n tilo g lo g Q = a n tilo g 2 . 1 4 5 5
Q = 1 3 9 .7 9 7 7
TYPES OF PRODUCTION
FUNCTION
is one whose quantity remains the Examples: Plant, Machinery, Heavy
FIXED same irrespective of the level of Equipment, Factory Building, Land,

FACTORS output. Its quantity cannot be readily

changed in the short run.
etc.

VARIABLE is one whose quantity changes with

the changes in the level of output.
FACTORS
refers to that time period in which
SHORT-RUN supply of certain factors is fixed.
Examples: Labour, Raw Material,
Power, Fuel, etc.
Note: At least one factor input is
fixed, but the other inputs are
variable.

LONG- refers to that time period in which

supply of all factors i.e. fixed and
Note: All factor inputs are variable.

RUN variable is elastic, but not sufficient

to allow a change in technology.
 P R O P E RT I E S O F
PRODUCTION FUNCTION
1 MA R G IN A L PH Y SIC A L PR O D U C T
i s t h e ad d i t i on al o ut p ut t hat can b e p r o d u ced b y emp l o y i n g o n e mo r e u n i t o f t h at
i n p u t whi l e ho l di n g al l o t her i n p u t s co n s t an t .

2 FA C TO R EL A STIC IT Y
i s t h e p er cent age chan ge i n o u t p u t i n r es p o n s e t o an i n f i n i t es i mal p er cen t ag e
ch an g e i n a fact or gi ven t h at al l o t h er f act o r s ar e h el d f i x ed .

3 MA R G IN A L R AT E O F T E CH N IC A L SU B STITU TIO N (MRTS)

s t at es t h at prog ressi vel y red u ci n g t h e amo u n t o f o n e i n p u t wh i l e mai n t ai n i n g a
co n s t an t ou t put l ev el wi l l r eq u i r e p r o g r es s i v el y l arg e i n cr eas es o f t h e o t h er i n p u t .

4 E LA ST IC IT Y O F SU B ST IT U T IO N
i t meas u res t he percen t age ch an g e i n t h e r el at i v e amo u n t o f t h e f act o r s emp l o y ed
r es u l t i n g f rom a g i ven per cen t ag e ch an g e i n t h e r el at i v e marg i n al p r o d u ct s .
 CONCEPT OF PRODUCT
Total Product
(TP)
refer s t o t h e t o t al q u an t i t y / v o l u me o f
g o o d s an d serv i ces p r o d u ced b y a f i r m
d u ri n g a g i v en p eri o d o f t i me.
Average Product Marginal Product
(AP) (MP)
is ou tp ut ( tota l pr o du ct) pe r u nit of de f ine d a s c ha ng e in to ta l
a f a c tor. pr o du ctio n d ue to us e of a n e xtr a
un it of a v a ria ble f a c to r.

E xa m pl e :
• wh e r e L i s q ua nt i t y of a fa c t o r
• AP i s t he a ve ra ge pr o du c t
if th e to ta l p ro d u c t i s 3 0 k g o f w h e a t E xa m pl e :
p ro d u c e d b y 5 la b o u rs (v a r ia b l e i n p u ts ) , if 2 la b o u r s p r o d u c e 6 0 k g o f r ic e a n d 4
• MP i s m a rgi n a l p ro du c t
th e n : la b o u r s p r o d u c e 1 0 0 k g o f r i c e , t h e n M P
E x am p l e : w ill b e :
if 5 lab ou r s p r o d u ce 6 k g o f w h eat, th en : A P= T P/n
= 3 0 /5 M P= T P/n
TP=AP x L
= 6 x 5 = 6kg = 1 0 0 - 6 0 /4 - 2
= 3 0k g = 4 0 /2
= 2 0 u n it s
 LAWS OF PRODUCTION
LAW O F D IMIN I SH IN G R ETU RN S
In simple terms, law of diminishing returns
explains that, if you keep increasing one factor in
the production of goods (such as your labour)
while keeping all other factors the same, it will
reach a point beyond which additional increases
will result in a progressive decline in output. In
other words, there is a point when adding more
inputs will begin to hamper the production
process.
E X A MPL E
For example, take a farmer with a limited number of
acres. If that farmer has too few workers to farm the
land, the farmer won’t be able to produce the maximum
crop the land can yield. Adding more workers will likely
increase the level of production—to a point. But if the
farmer goes beyond this limit, production will begin to
fall, simply because there are too many workers and not
enough land.
 LAWS OF PRODUCTION
D IMIN ISH IN G R ET U R N FA C TO R
(L AW O F R ET U R N TO SC A L E)
Diminishing returns to a factor refers to a situation
in which the total output tends to increase at the
diminishing rate when additional units of the
variable factor is combined with the fixed factors of
production.
E X A MPL E
For example, take a farmer with a 100 hectares of land.
If that farmer has many workers to farm the land and
have enough capital, the farmer will be able to produce
the maximum crop the land can yield. Also, with the help
of another fixed factor (factory building) to produce
crops using machineries and equipment, we can conclude
that if the farmer increases inputs, the outputs will also
increase at a consistent rate.
 INPUT COMBINATION
CHOICE
ISOQUA ISO = EQUAL; QUANT = QUANTITY
NT
It is a curve that represents the different combinations of inputs that can
efficiently be used to produce a given level of output.
Each point on the isoquant represents a different combination of inputs X (L)
and Y (K) that can be used to produce same level of output.

TYPES OF
ISOQUANT
Linear isoquant input-output isoquant
Perfect substituability between Strict complementarity between
factors of production. An output inputs. If a quantity of one input
can be produced by either using is increased there will be no
one or both. change in output.
 PROPERTIES OF
ISOQUANT
isoquants are negatively no two isoquants intersect
sloped
Isoquant do not intersect or touch
They normally slope from left to each other because they represent
right means they are negatively different level of output.
sloped.

higher isoquants represents larger isoquants are convex to the

output origin
In most production processes the
Higher isoquant is one that is
factors of production have
further from the point of origin. substitutuability. Labour can be
substituted for capital and vice
versa.
ISO-COST
This represent the price of the
factor. It defines all possible
combinations of two resources
which can be purchased with a
given outlay of funds.
For example, a producer wants to
spend Rs. 300 on the factors of
production, namely X and Y. The price
of X in the market is Rs. 3 per unit
and price of Y is Rs. 5 per unit.
INPUT SUBSTITUTI
FA C T O R ON
It solves t he problem of “how t o produce?”. It
guides in the determinat ion of l east cost
combinat ion of resources and does explains
fact or-fact or relati onship.

In thi s rel at i onshi p, output is kept constant,

i nput i s vari ed in quant it y t o achi eve gi ven
l evel of out put.

M a r g i n a l R a t e o f Te c h n i c a l
S u b s t i t u t i o n ( M RT S )
Shows amount of one i nput t hat must be
subst it ut ed for anot her to maintain constant
output.
For example, if hand labour costs less relative to cost of
performing the operations by machines, costs may be
lowered by substituting labour for machinery. If machine
costs are low relative to labour, labour should get
substituted with machine operations.
COMPENSATION TYPES OF COMPENSATION

POLICY Basic
Salary
Addition
al
Payment
Addition
al
Benefit
Reconitio
n
Payment
based on
Merit
Is the fixed amount Extra amount after Addition to monetary Provides appreciation Shows the amount of
that an employee gets achieving specific payments like health and motivation to the compensation that
A policy that was used by organizations or cooperation to after performing target like bonus, insurance of employees for good employees get as per
his/her work at incentives, award, employees, work. his/her performance.
compensate their worker or employee if they are in a certain regular intervals. gifts, etc. retirement benefit,
conditions of specific situations. paid holidays, leave
credits, etc.

“Pay for performance” means that employee compensation

closely reflects the amount of value derived from each
employee’s effort.

In economic terms, it is the value derived from employee effort

is measured by net marginal revenue product.

Communicating organization’s
compensation philosophy with
Why Compensation Policy employees help them understand the
Matters? “why” behind decisions that are made.
In an employee’s day-to-day
experience, policies have the most
direct impact.
Framework of Compensation
Policy
A well structured compensation
policy helps the organization in
building a better reward system and
also helps in providing proper
remuneration to the employees.
Philosophy related with Analysis of Market
Compensation Policy Compensation policies need to be
properly analyzed before being framed.
It shows the point of view that the When analyzing the market, an effort is
organization posses while paying the made to learn about industry standards
compensation and designing the and market rates that are relevant to the
compensation structure. compensation that the other
organizations in the market provide to its
employees.
 M A I N TA I N I N G EMPLOYEE
LEGAL ASPECT
EQUALITY AWA R E N E S S
Each count ry has law Organizations should clearly
Organization s hould related with employment communicate with the
ensur e that and compens at ion emp loyee about different
compens at ion given to policy, s tructure of the asp ects/ty pes of
employees s houl d be fair compens at ion s houl d be compensation .
and jus tified and als o fr amed accor ding to the Further, organizations
s houl d be according to applicable laws. sho uld co mmun icate th e
the work. emp loyees requ ired criteria
for gettin g extra benefits,
bonu s, in crements, etc.
E F F I C I E N C Y WA G E S
In labor economics, efficiency wages are a level of
wages paid to workers above the minimum wage to
retain a skilled and efficient workforce. Efficiency
wage theory posits that an employer must pay its
workers high enough so that workers are incentivized
to be productive and that highly skilled workers do
EfficiencynotWage quit. Theory

Paying higher wages will increase the level of

efficiency of employees and make firm develop further.
“Higher wages” in the statement means that employers
pay more wages in comparison to market-clearing level
which is considered as equilibrium level.
(Mankiw, Gregory N. & Taylor, Macroeconomics)
 UNDERSTANDING
EFFICIENCY WAGES

1 8 T H C E N T U RY 2 0 T H C E N T U RY
Notable economist Joseph Stiglitz
Classical political economist
and his work on shirking. Stiglitz
Adam Smith identified a form
proposed that, when employment is
of wage inequality where
high, workers that are dismissed
workers in some industries are
can easily find new employment.
paid more than others based on
However, this condition also makes
the level of trustworthiness
it more likely that workers afraid of
required.
losing their jobs. ("shirking
model").
A D VA N TA G E S
INCREASING QUALITY
OF WORK THROUGH
INCREASING WAGES
Wages play an essential role for employees during work
selection and the main idea in their minds is “high wages lead

SELECT THE BETTER-

better lives”

QUALITY WORKER
AMONG ALL
High-skilled employees themselves have reservation wages
CANDIDATES
and they will just accept wages higher than that level.
Therefore, those positions mostly get the best candidates in

PROTECTION FROM
the market.

UNIONIZATION
Union strikes happen as a result of low welfare and wages. It
poses a serious threat to the firms and it could even result

MOTIVATION
with revolution inside the firm.

This could be the one thing that makes employees to put their
effort into their work. If workers are not compensated well
enough, they would not have a motive to expend their energy
for work and increase employee performance.
 D I S A D VA N TA G E S
geographical
Discrimination
placement
It occurs when workers with
In urban areas, firms pay
similar skills get much more
money than others because of Size of a firm significantly more than the uncertainty
his/her group affiliation. This firms in rural areas.
type of discrimination is
generally related with gender The economy is full of
In comparison to small
and ethnicity. uncertainty and
firms, large firms pay
unforeseeable events such as
remarkably higher wages to
economic downturns, crisis,
comparable employees.
etc. that can affect the
efficiency wage.
T H A N K
YOU