Production

Firm transforms inputs or factors of production (FOPs) into outputs, using technology or the production process. FOPs: capital (K) = long-lived inputs e.g. land, buildings, equipment; labour (L) = all human services; materials (M) = raw materials & processed inputs. Production function: how inputs outputs. q = f (L, K) (q is max output) Cobb-Douglas form: q = AKL e.g. q = 100 K0.5 L0.5 Time & input variability: Short Run Production = period of time so brief that at least one FOP cannot be varied practically = one fixed input.

R/ships among TP, AP & MP: MP is slope of TP (MPL = q/L). AP is slope of a line from 0 to that point on TP (APL = q/L). MP max is at inflection pt A on TP function (where TP changes from increasing at an increasing rate, to increasing at a decreasing rate).

MP intersects AP at max AP. (Whenever MP > AP, AP will be rising; when MP < AP, AP will be falling.) At corresponding pt on TP, slope of (a tangent to) TP & a line from 0 to TP will be identical (MP = AP). MP is 0 at TP max, & negative for employment levels beyond that. (TP, AP, MP all drawn dashed after 11 workers = inefficient.)

Law of Diminishing Marginal Returns (DMR): when increasing amts of the variable input are added to a fixed level of another input (tech constant), a point will be reached where the MP of the variable input will decline. based on real-world production processes dont leave out the marginal! note constant technology assumed (tech progress could MPL indefinitely). Long Run Production = lengthy enough period of time that all inputs can be varied (all variable inputs). LR production: both inputs variable firm can vary both FOPs same Q can be produced in diff ways (different K/L combinations) can substitution between K & L, keeping Q constant. Isoquant (IQ): shows all the efficient combinations of K & L that can produce a given level of output.

IQs also show SR e.g. K fixed at 2 horizontal line. Properties of IQs: (Similar to ICs. Stem from efficiency requirement.) 1. Further from 0 = higher Q. 2. IQs do not cross. 3. IQs slope down. 4. IQs must be thin. Shape of IQ: reflects substitutability between inputs *If hold 1 constant & vary 1 moves from 1 isoquant to another *If increase 1 & decrease the other it moves along a single isoquant

IQ slope: rate at which one input can be substituted for the other, keeping Q constant. Marginal rate of technical substitution: MRTS = K/L always negative - IQ slopes down; diminishing MRTS; MRTS = negative ratio of MPs: Moving down IQ: (MPL x L) + (MPK x K) = 0 - MPL = MPK K L = MRTS

6.5 Returns to scale LR: K & L variable Scale of production defined by K & L input; change in scale = proportionate (=%) changes in both inputs. Constant (CRS): L, K & Q increase by same %, f (2L, 2K) = 2f (L, K) Increasing RS (economies of scale): f (2L, 2K) > 2f (L, K) Decreasing RS (diseconomies): f (2L, 2K) < 2f (L, K).

Sources of IRS: Technologies (cost-effective at high Q; high per unit costs at low Q) Geometric relations (e.g. grain in a silo)

Labour specialization Inventory economies.

Sources of DRS: Managerial diseconomies Transport costs Rising wage costs (one big regional employer). Cobb-Douglas function: Q = AKL = ( + ) <1 =1 >1 e.g. Q = 100 K0.5 L0.5 CRS Q = 10K0.5L0.6 IRS Q = 20K0.5L0.4 DRS. Returns DRS CRS IRS

Productivity & technical change Relative productivity: Some firms are more productive than others. Firms output = q; output the most productive firm could produce using the same inputs = q*. Relative productivity = (q/q*) x 100.

Technical progress: Advances in knowledge allow Q with same level of inputs. e.g. last year: q1 = f (L, K) This year with new tech: q2 = 1.1f (L, K).