Microeconomics

Claudia Vogel

EUV

Winter Term 2009/2010

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Production

Lecture Outline

Part II Producers, Consumers, and Competitive Markets

6 Production
The Technology of Production
Production with One Variable Input (Labor)
Production with Two Variable Inputs
Returns to Scale
Summary

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 Production

Production

The theory of the rm describes how a rm makes cost-minimizing production
decisions and how the rm's resulting cost varies with its output.

The Production Decisions of a rm

The production decisions of rms are analogous to the purchsing decisions of
consumers, and can likewise be understood in three steps:
1 Production Technology
2 Cost Constraints
3 Input Choices

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Production The Technology of Production

The Production Function

factors of production: Inputs into the production process (e.g., labor,

capital, and materials)
production function: Function showing the highest output that a rm can
produce for every specied combination of inputs.

q = F (K , L)

Production functions describe what is technically feasible when the rm operates
eciently.

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 Production The Technology of Production

The Short Run versus the Long Run

short run: Period of time in which quantities of one or more production

factors cannot be changed.

xed input: Production factor that cannot be varied.

long run: Amount of time needed to make all production inputs variable.

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Production Production with One Variable Input (Labor)

Production with one Variable Input

Amount Amount Total Average Marginal

of Labor (L) of Capital (K ) Output (q ) Product( q/L) Product (4q /4L)
0 10 0 - -

1 10 10 10 10

2 10 30 15 20

3 10 60 20 30

4 10 80 20 20

5 10 95 19 15

6 10 108 18 13

7 10 112 16 4

8 10 112 14 0

9 10 108 12 - 4

10 10 100 10 - 8

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 Production Production with One Variable Input (Labor)

Average and Marginal Product

average product: Output per unit of

a particular input.
marginal product:Additional output
produced as an input is increased by
one unit.

Average product of labor = q /L

Marginal product of labor = 4q /4L

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Production Production with One Variable Input (Labor)

The Law of Diminishing Marginal Returns

law of diminishing marginal returns: Principle that as the use of an input

increases with other inputs xed, the resulting additions to output will
eventually decrease.

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 Production Production with One Variable Input (Labor)

Example: Malthus and the Food Crisis

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Production Production with One Variable Input (Labor)

Labor Productivity
labor productivity: Average product of labor for an entire industry or for the
economy as a whole.

Example: Labor Productivity and the Standard of Living

United United
States Japan France Germany Kingdom
Real Output per Employed Person (2006)
$82 158 $57 721 $72 949 $60 692 $65 224

Years Annual Rate of Growth of Labor Productivity (%)

1960-1973 2.29 7.86 4.70 3.98 2.84
1974-1982 0.22 2.29 1.73 2.28 1.53
1983-1991 1.54 2.64 1.50 2.07 1.57
1992-2000 1.94 1.08 1.40 1.64 2.22
2001-2006 1.78 1.73 1.02 1.10 1.47
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 Production Production with Two Variable Inputs

Isoquants
isoquant: Curve showing all possible combinations of inputs that yield the
same output
isoquant map: Graph combining a number of isoquants, used to describe a
production function.

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Production Production with Two Variable Inputs

Substitution Among Inputs

marginal rate of technical substitution (MRTS): Amount by which the

quantity of one input can be reduced when one extra unit of another input is
used, so that output remains constant.

MRTS = − 44KL =
MPL )
(
MPK )
(

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 Production Production with Two Variable Inputs

Special Cases

isoquants of perfect substitutes xed-proportions production function

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Production Production with Two Variable Inputs

Example: A Production Function for Wheat

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 Production Returns to Scale

Returns to Scale

returns to scale: Rate at which output increases as inputs are increased

proportionally
increasing returns to scale: Situation in which output more than doubles
when all inputs are doubled.
constant returns to scale: Situation in which output doubles when all
inputs are doubled.
decreasing returns to scale: Situation in which output less than doubles
when all inputs are doubled.

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Production Returns to Scale

Describing Returns to Scale

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 Production Summary

Summary 1/2

A production function describes the maximum output a rm can produce for
each specied combination of inputs.
An isoquant is a curve that shows all combinations of inputs that yield a
given level of output. A rm's production function can be represented by a
series of isoquants associated with dierent levels of output.
In the short run, one or more inputs to the production process are xed. In
the long run, all inputs are potentially variable.
Production with one variable input, labor, can be usefully described in terms
of the average product of labor (which measures output per unit of labor
input), and the marginal product of labor (which measures the additional
output as labor is increased by 1 unit).
According to the law of diminishing marginal returns, when one or more
inputs are xed, a variable input is likely to have a marginal product that
eventually diminished as the level of input increases.

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Production Summary

Summary 2/2

Isoquants always slope downward because the marginal product of all inputs
is positive. The shape of each isoquant can be described by the marginal rate
of technical substitution at each point of the isoquant. The marginal rate of
technical substitution of labor for capital (MRTS) is the amount by which
the input of capital can be reduced when one extra unit of labor is used so
that output remains constant.
The possibilities for substitution among inputs in the production process
range from a production function in which inputs are perfect substitutes to
one in which the proportions of inputs to be used are xed (a
xed-proportions production function).
In long-run analysis, we tend to focus on the rm's choice of its scale or size
of operation. Constant returns to scale means that doubling all inputs leads
to doubling output. Increasing returns to scale occurs when output more
than doubles when inputs are doubled; decreasing returns to scale applies
when output less than doubles.

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 Exerxises 5

Problem 1

1 What is a production function? How does a long-run production function

dier from a short-run production function?
2 What is the dierence between a production function and an isoquant?
3 Isoquants can be convex, linear, or L-shaped. What does each of these
shapes tell you about the nature of the production function? What does each
of these shapes tell you about the MRTS?
4 Can a rm have a production function that exhibits increasing returns to
scale, constant returns to scale, and decreasing returns ro scale as output
increases? Discuss.

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Exerxises 5

Problem 2
Suppose a chair manufacturer is producing in the short run (with its existing plant
and equipment). The manufacturer has observed the following levels of
production corresponding to dierent numbers of workers:
Number of chairs Number of workers

1 10
2 18
3 24
4 28
5 30
6 28
7 25

1 Calculate the marginal and average product of labor for this production
function.
2 Does this production function exhibit diminishing returns to labor? Explain.
3 Explain intuitively what might cause the marginal product of labor to become
negative.
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 Exerxises 5

Problem 3

For each of the following examples, draw a representative isoquant. What can you
say about the marginal rate of technical substitution in each case?
1 A rm can hire only full-time employees to produce its output, or it can hire
some combination of full-time and part-time employees. For each full-time
worker let go, the rm must hire an increasing number of temporary
employees to maintain the same level of output.
2 A rm nds that it can always trade two units of labor for one unit of capital
and still keep output constant.
3 A rm requires exactly two full-time workers to operate each piece of
machinery in the factory.

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Exerxises 5

Problem 4

Do the following functions exhibit increasing, constant, or decreasing returns to

scale? What happens to the marginal product of each individual factor as that
factor is increased and the other factor is held constant?
1 q = 3L + 2K
2 q = (2L + 2K ) 1
2

3 q = 3LK 2
4 q=L K 1
2
1
2

5 q = 4L + 4K1
2

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 Exerxises 5

Problem 5

The production function for the personal computers of DISK, Inc., is given by
q = 10K 0.5 L0.5 , where q is the number of computers produced per day, K is the
hours of machine time, and L is hours of labor input. DISK's competitor,
FLOPPY, Inc., is using the production function q = 10K 0.6 L0.4 .
1 If both companies use the same amounts of capital and labor, which will
generate more output?
2 Assume that capital is limited to 9 machine hours, but labor is unlimited in
supply. In which company is the marginal product of labor greater? Explain.

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