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Production Theory
Production theory describes efficient combinations of inputs (L,K) which contribute maximum output (Q) or with least cost combination. The firms production function relates its output Q to labor L, capital K, and other inputs. If L and K are the main inputs Q=F(L,K). In the short run firms find it costly to change capital stock so Q depends mostly on L, the more flexible input.
are two types with respect to time Short Run Production Function
is that production function in which one input is fixed (K) and other is variable (L)
Long
It
is that production function in which both inputs (K) and (L) are variable
Production Function
It means that production function in which there is no effect of efficiency of Q = f ( K , L, R, S , , ) inputs and no effect of technology has been introduced. In Cobb Douglas both parameters have been taken Care.
Q =A * LK
Definition
The
Law of Increasing Return If each additional unit of labor with fixed capital gives more production as compare to previous unit, it means that production follows Law of Increasing Return Law of Constant Return If each additional unit of labor with fixed capital gives same production as compare to previous unit, it means that production follows Law of Constant Return Law of Diminishing Return If each additional unit of labor with fixed capital gives less output as compare to previous unit of labor, it means that production follows Law of Diminishing Return
Rationale
(3) (1) Marginal Product Units of the (MP), (2) Variable Resource Total Product Change in (2)/ (Labor) Change in (1) (TP) 0 1 2 3 4 5 6 7 8 0 10 25 45 60 70 75 75 70
Tabular
Example
(3) Average Product (AP), (2)/(1) 10.00 12.50 15.00 15.00 14.00 12.50 10.71 8.75
] ] ] ] ] ] ] ]
10 15 20 15 10 5 0 -5
Graphical
Total Product, TP 30 20 10 0 Marginal Product, MP
Portrayal
TP
10 1 2 3 4 5 6 7
AP 8 9 MP
the long run the adjustment costs of capital loom less large and capital becomes a variable input. Table 2 illustrates this situation. Notice that as L and K increase in equal proportion along the diagonal, Q increases in the same proportion. This is Constant Returns to Scale, CRS.
can have both CRS and diminishing returns for the same production functionlike table 2. Hold K=4 and you get diminishing returns to labor. Vary L and K in proportion along the diagonal and you get CRS.
both inputs are variable then with an increase in both inputs at what proportion the output is increasing, It depends upon Laws of Returns to scale Types of Laws of Returns to Scale
Law of Increasing Return to scale Law of Diminishing Return to scale Law of constant Return to scale
ISO Quant It is an aggregation of those combinations of inputs (K,L) which are giving same level of output ISO Cost It means that combination of inputs (K,L) on which same cost has been occurred
Sloping DMRTS( Diminishing Marginal Rate of Technical Substitution Higher is better Never intersect each other
slope of the isoquant is the additional capital K required per unit of labor L given up that maintains output. We call this slope the marginal rate of technical substitution or MRTS. This varies along the isoquant.
Definition:
The MRTS is the slope of the isoquant or trade-off between two inputs, holding output constant.
In terms of Figure 6,
(1 ) K MRTS = , L
This is the units of capital required per unit of labor sacrificed along the isoquant.
is
ratio terms in (4) are the marginal products of each input, which hold the other input constant. Thus,
(1 )
Inserting
F F MP , MP L K L K
(1 )
Then
MRTS
(8).
Equilibrium Condition
MRTS