Professional Documents
Culture Documents
PGP-I
Session 6
Key Concepts
Productive resources, such as labor and capital
equipment, that firms use to manufacture goods and
services are called inputs or factors of production.
The amount of goods and services produces by the firm is
the firms output.
Production transforms a set of inputs into a set of
outputs
Technology determines the quantity of output that is
feasible to attain for a given set of inputs.
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Key Concepts
The production function tells us the maximum possible
output that can be attained by the firm for any given
quantity of inputs.
Production Function:
Q = output
K = Capital
L = Labor
Q f ( L, K )
Production Function
Q = f(L)
Production Set
L
7
L g (Q)
Example:
LQ
Q L
10
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Total Product
Total Product Function: A single-input production
function. It shows how total output depends on the
level of the input
Increasing Marginal Returns to Labor: An increase
in the quantity of labor increases total output at an
increasing rate.
Diminishing Marginal Returns to Labor: An
increase in the quantity of labor increases total output
but at a decreasing rate.
Diminishing Total Returns to Labor: An increase in
the quantity of labor decreases total output.
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Total Product
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Definition:
The law of diminishing marginal
returns states that marginal products (eventually)
decline as the quantity used of a single input increases.
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APL
MPL
30
12
96
11
18
162
11
24
192
30
150
-7
16
TP
TPLL maximized
maximized where
where
MP
MPLL isis zero.
zero. TP
TPLL falls
falls
where
where MP
MPLL isis negative;
negative;
TP
TPLL rises
rises where
where MP
MPLL isis
positive.
positive.
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18
Q
MPL
L
K is held const
Q
MPK
K
K is held const
L is held const
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Isoquants
Definition: An isoquant traces out
all the combinations of inputs
(labor and capital) that allow that
firm to produce the same quantity
of output
And
And
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Isoquants
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Isoquants
K
All
Allcombinations
combinationsof
of(L,K)
(L,K)along
alongthe
the
isoquant
isoquantproduce
produce20
20units
unitsof
ofoutput
output..
Example:
Q = 20
Slope=K/L
Q = 10
L
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23
Therefore
Therefore
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Isoquants
Isoquants
MPK < 0
Example:
Example: The
The Economic
Economic and
and the
the
Uneconomic
Regions
of
Uneconomic
Regions
of
Production
Production
Q = 20
MPL < 0
Q = 10
0
L
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Q (K ) MU K (L) MU L
Q
MPK
K
L is held const
Q
MPL
L
K is held const
MPL
MRTS L , K
MPK
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Elasticity of Substitution
A measure of how easy is it for a firm to
substitute labor for capital.
It is the percentage change in the capitallabor ratio for every one percent change in
the MRTSL,K along an isoquant.
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Elasticity of Substitution
Definition:
Definition: The
The elasticity
elasticity of
of substitution,
substitution, ,
, measures
measures how
how
the
the capital-labor
capital-labor ratio,
ratio, K/L,
K/L, changes
changes relative
relative to
to the
the change
change in
in
the
.
theMRTS
MRTSL,K
L,K.
%MRTS L , K
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Elasticity of Substitution
K
"The
"The shape
shape of
of the
the isoquant
isoquant
indicates
indicates the
the degree
degree of
of
substitutability
of
the
substitutability
of
the
inputs"
inputs"
=0
=1
= 5
=
0
L
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Returns to Scale
%(quantity of output)
Returns to Scale
%(quantity of all inputs)
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Returns to Scale
Let represent the amount by which both inputs, labor
and capital, increase.
Q f (L, K ) for 1
Let represent the resulting proportionate increase in
output, Q
Increasing returns:
Decreasing returns:
Constant Returns:
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Returns to Scale
How much will output increase when ALL inputs increase by a
particular amount?
RTS = [%Q]/[% (all inputs)]
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.
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Returns to Scale
K
2K
Q = Q1
K
Q = Q0
0
2L
L
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Returns to Scale
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