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Click to edit Master title style,Click to edit Master text styles,Second Level,Third Level,Fourth Level,Fifth Level,Slide,*,Chapter 6,Production,1,Topics to be Discussed,The Technology of Production,Isoquants,Production with One Variable Input (Labor),Production with Two Variable Inputs,Returns to Scale,2,Introduction,Our focus is the,supply side,.,The theory of the firm,will address:,How a firm makes cost-minimizing production decisions,How cost varies with output,Characteristics of market supply,Issues of business regulation,3,The Technology of Production,The Production Process,Combining inputs or factors of production to achieve an output,Categories of Inputs (factors of production),Labor,Materials,Capital,4,The Technology of Production,Production Function:,Indicates the highest output that a firm can produce for every specified combination of inputs given the state of technology.,Shows what is,technically feasible,when the firm operates,efficiently,.,5,The Technology of Production,The production function for two inputs:,Q = F(K,L),Q =,Output, K =,Capital,L,= Labor,For a given technology,6,Isoquants,Assumptions,Food producer has two inputs,Labor (,L,) & Capital (,K,),7,Isoquants,Observations:,1) For any level of K, output increases with more L.,2)For any level of L, output increases with more K.,3)Various combinations of inputs produce the same output.,8,Isoquants,Isoquants,Curves showing all possible combinations of inputs that yield the same output,9,Production Function for Food,12040556575,24060758590,3557590100105,46585100110115,57590105115120,Capital Input12345,Labor Input,10,Production with Two Variable Inputs (,L,K,),Labor per year,1,2,3,4,1,2,3,4,5,5,Q,1,=,55,The,isoquants are derived,from the production,function for output of,of 55, 75, and 90.,A,D,B,Q,2,=,75,Q,3,=,90,C,E,Capital,per year,The Isoquant Map,11,Isoquants,The isoquants emphasize how different input combinations can be used to produce the same output.,This information allows the producer to respond efficiently to changes in the markets for inputs.,Input Flexibility,12,Isoquants,Short-run:,Period of time in which quantities of one or more production factors cannot be changed.,These inputs are called,fixed inputs.,The Short Run versus the Long Run,13,Isoquants,Long-run,Amount of time needed to make all production inputs variable.,The Short Run versus the Long Run,14,AmountAmountTotalAverage Marginal,of Labor (,L,)of Capital (,K,)Output (,Q,)ProductProduct,Production withOne Variable Input (Labor),0100-,110101010,210301520,310602030,410802020,510951915,6101081813,710112164,810112140,91010812-4,101010010-8,15,Observations:,1) With additional workers, output (,Q,) increases, reaches a maximum, and then decreases.,Production withOne Variable Input (Labor),16,Observations:,2) The average product of labor (,AP,), or output per worker, increases and thendecreases.,Production withOne Variable Input (Labor),17,Observations:,3) The marginal product of labor (M,P,), or output of the additional worker, increases rapidly initially and then decreases and becomes negative.,Production withOne Variable Input (Labor),18,Total Product,A: slope of tangent = MP (20),B: slope of OB = AP (20),C: slope of OC= MP & AP,Labor per Month,Output,per,Month,60,112,0,2,3,4,5,6,7,8,9,10,1,A,B,C,D,Production withOne Variable Input (Labor),19,Average Product,Production withOne Variable Input (Labor),8,10,20,Output,per,Month,0,2,3,4,5,6,7,9,10,1,Labor per Month,30,E,Marginal Product,Observations:,Left of E: MP AP & AP is increasing,Right of E: MP AP, AP,is increasing,When,MP AP, AP,is decreasing,When,MP = AP, AP,is at its maximum,Production withOne Variable Input (Labor),21,Production withOne Variable Input (Labor),Labor,per Month,Output,per,Month,60,112,0,2,3,4,5,6,7,8,9,10,1,A,B,C,D,8,10,20,E,0,2,3,4,5,6,7,9,10,1,30,Output,per,Month,Labor,per Month,AP =,slope of line from origin to a point on,TP, lines,b, & c.,MP =,slope of a tangent to any point on the,TP,line, lines a & c.,22,As the use of an input increases in equal increments, a point will be reached at which the resulting additions to output decreases (i.e.,MP,declines).,Production withOne Variable Input (Labor),The Law of Diminishing Marginal Returns,23,When the labor input is small,MP,increases due to specialization.,When the labor input is large,MP,decreases due to inefficiencies.,The Law of Diminishing Marginal Returns,Production withOne Variable Input (Labor),24,Can be used for long-run decisions to evaluate the trade-offs of different plant configurations,Assumes the quality of the variable input is constant,The Law of Diminishing Marginal Returns,Production withOne Variable Input (Labor),25,Explains a declining,MP, not necessarily a negative one,Assumes a constant technology,The Law of Diminishing Marginal Returns,Production withOne Variable Input (Labor),26,The Effect ofTechnological Improvement,Labor per,time period,Output,per,time,period,50,100,0,2,3,4,5,6,7,8,9,10,1,A,O,1,C,O,3,O,2,B,Labor productivity,can increase if there,are improvements in,technology, even though,any given production,process exhibits,diminishing returns to,labor.,27,Malthus predicted mass hunger and starvation as diminishing returns limited agricultural output and the population continued to grow.,Why did Malthus prediction fail?,Malthus and the Food Crisis,28,Index of World FoodConsumption Per Capita,1948-1952100,1960115,1970123,1980128,1990137,1995135,1998140,Year Index,29,Malthus and the Food Crisis,The data show that production increases have exceeded population growth.,Malthus did not take into consideration the potential impact of technology which has allowed the supply of food to grow faster than demand.,30,Malthus and the Food Crisis,Technology has created surpluses and driven the price down.,Question,If food surpluses exist, why is there hunger?,31,Malthus and the Food Crisis,Answer,The cost of distributing food from productive regions to unproductive regions and the low income levels of the non-productive regions.,32,Labor Productivity,Production withOne Variable Input (Labor),33,Labor Productivity and the Standard of Living,Consumption can increase only if productivity increases.,Determinants of Productivity,Stock of capital,Technological change,Production withOne Variable Input (Labor),34,Labor Productivity inDeveloped Countries,1960-19734.754.048.302.892.36,1974-19862.101.852.501.690.71,1987-19971.482.001.941.021.09,UnitedUnited,FranceGermanyJapanKingdomStates,Annual Rate of Growth of Labor Productivity (%),$54,507$55,644$46,048$42,630$60,915,Output per Employed Person (1997),35,Trends in Productivity,1) U.S. productivity is growing at a slower rate than other countries.,2)Productivity growth in developed countries has been decreasing.,Production withOne Variable Input (Labor),36,Explanations for Productivity Growth Slowdown,1)Growth in the stock of capital is the primary determinant of the growth in productivity.,Production withOne Variable Input (Labor),37,Explanations for Productivity Growth Slowdown,2)Rate of capital accumulation in the U.S. was slower than other developed countries because the others were rebuilding after WWII.,Production withOne Variable Input (Labor),38,Explanations for Productivity Growth Slowdown,3)Depletion of natural resources,4) Environment regulations,Production withOne Variable Input (Labor),39,Observation,U.S. productivity has increased in recent years,What Do You Think?,Is it a short-term aberration or a new long-run trend?,Production withOne Variable Input (Labor),40,Production withTwo Variable Inputs,There is a relationship between production and productivity.,Long-run production,K& L,are variable.,Isoquants analyze and compare the different combinations of,K & L,and output,41,The Shape of Isoquants,Labor per year,1,2,3,4,1,2,3,4,5,5,In the long run both,labor and capital are,variable and both,experience diminishing,returns.,Q,1,=,55,Q,2,=,75,Q,3,=,90,Capital,per year,A,D,B,C,E,42,Reading the Isoquant Model,1)Assume capital is 3 and labor increases from 0 to 1 to 2 to 3.,Notice output increases at a decreasing rate (55, 20, 15) illustrating diminishing returns from labor in the short-run and long-run.,Production withTwo Variable Inputs,Diminishing Marginal Rate of Substitution,43,Reading the Isoquant Model,2)Assume labor is 3 and capital increases from 0 to 1 to 2 to 3.,Output also increases at a decreasing rate (55, 20, 15) due to diminishing returns from capital.,Diminishing Marginal Rate of Substitution,Production withTwo Variable Inputs,44,Substituting Among Inputs,Managers want to determine what combination if inputs to use.,They must deal with the trade-off between inputs.,Production withTwo Variable Inputs,45,Substituting Among Inputs,The slope of each isoquant gives the trade-off between two inputs while keeping output constant.,Production withTwo Variable Inputs,46,Substituting Among Inputs,The marginal rate of technical substitution equals:,Production withTwo Variable Inputs,47,Marginal Rate ofTechnical Substitution,Labor per month,1,2,3,4,1,2,3,4,5,5,Capital,per year,Isoquants are downward,sloping and convex,like indifference,curves.,1,1,1,1,2,1,2/3,1/3,Q,1,=,55,Q,2,=,75,Q,3,=,90,48,Observations:,1)Increasing labor in one unit increments from 1 to 5 results in a decreasing,MRTS,from 1 to 1/2.,2) Diminishing,MRTS,occurs because of diminishing returns and implies isoquants are convex.,Production withTwo Variable Inputs,49,Observations:,3),MRTS,and Marginal Productivity,The change in output from a change in labor equals:,Production withTwo Variable Inputs,50,Observations:,3),MRTS,and Marginal Productivity,The change in output from a change in capital equals:,Production withTwo Variable Inputs,51,Observations:,3),MRTS,and Marginal Productivity,If output is constant and labor is increased, then:,Production withTwo Variable Inputs,52,Isoquants When Inputs are Perfectly Substitutable,Labor,per month,Capital,per,month,Q,1,Q,2,Q,3,A,B,C,53,Observations when inputs are perfectly substitutable:,1)The MRTS is constant at all points on the isoquant.,Production withTwo Variable Inputs,Perfect Substitutes,54,Observations when inputs are perfectly substitutable:,2) For a given output, any combination of inputs can be chosen (,A, B, or C),to generate the same level of output (e.g. toll booths & musical instruments),Production withTwo Variable Inputs,Perfect Substitutes,55,Fixed-ProportionsProduction Function,Labor,per month,Capital,per,month,L,1,K,1,Q,1,Q,2,Q,3,A,B,C,56,Observations when inputs must be in a fixed-proportion:,1)No substitution is possible.Each output requires a specific amount of each input (e.g. labor and jackhammers).,Fixed-Proportions Production Function,Production withTwo Variable Inputs,57,Observations when inputs must be in a fixed-proportion:,2) To increase output requires more labor and capital (i.e. moving from,A,to,B,to,C,which is technically efficient).,Fixed-Proportions Production Function,Production withTwo Variable Inputs,58,A Production Function for Wheat,Farmers must choose between a capital intensive or labor intensive technique of production.,59,Isoquant Describing theProduction of Wheat,Labor,(hours per year),Capital,(machine,hour per,year),250,500,760,1000,40,80,120,100,90,Output = 13,800 bushels,per year,A,B,Point,A,is more,capital-intensive, and,B,is more labor-intensive.,60,Observations:,1)Operating at,A:,L =,500 hours and,K =,100 machine hours.,Isoquant Describing theProduction of Wheat,61,Observations:,2)Operating at B,Increase L to 760 and decrease K to 90 the MRTS 1:,Isoquant Describing theProduction of Wheat,62,Observations:,3),MRTS, 1, therefore the cost of labor must be less than capital in order for the farmer substitute labor for capital.,4)If labor is expensive, the farmer would use more capital (e.g. U.S.).,Isoquant Describing theProduction of Wheat,63,Observations:,5) If labor is inexpensive, the farmer would use more labor (e.g. India).,Isoquant Describing theProduction of Wheat,64,Returns to Scale,Measuring the relationship between the scale (size) of a firm and output,1),Increasing returns to scale,: output more than doubles when all inputs are doubled,Larger output associated with lower cost (autos),One firm is more efficient than many (utilities),The isoquants get closer together,65,Returns to Scale,Labor (hours),Capital,(machine,hours),10,20,30,Increasing Returns:,The isoquants move closer together,5,10,2,4,0,A,66,Returns to Scale,Measuring the relationship between the scale (size) of a firm and output,2),Constant returns to scale,: output doubles when all inputs are doubled,Size does not affect productivity,May have a large number of producers,Isoquants are equidistant apart,67,Returns to Scale,Labor (hours),Capital,(machine,hours),Constant Returns:,Isoquants are equally spaced,10,20,30,15,5,10,2,4,0,A,6,68,Returns to Scale,Measuring the relationship between the scale (size) of a firm and output,3),Decreasing returns to scale,: output less than doubles when all inputs are doubled,Decreasing efficiency with large size,Reduction of entrepreneurial abilities,Isoquants become farther apart,69,Returns to Scale,Labor (hours),Capital,(machine,hours),Decreasing Returns:,Isoquants get further,apart,10,20,30,5,10,2,4,0,A,70,Returns to Scalein the Carpet Industry,The carpet industry has grown from a small industry to a large industry with some very large firms.,71,Returns to Scalein the Carpet Industry,Question,Can the growth be explained by the presence of economies to scale?,72,Carpet Shipments, 1996,(Millions of Dollars per Year),The U.S. Carpet Industry,1. Shaw Industries$3,2026. World Carpets$475,2. Mohawk Industries1,7957. Burlington Industries450,3. Beaulieu of America1,0068. Collins & Aikman418,4. Interface Flooring8209. Masland Industries380,5. Queen Carpet77510. Dixied Yarns280,73,Returns to Scalein the Carpet Industry,Are there economies of scale?,Costs (percent of cost),Capital - 77%,Labor - 23%,74,Returns to Scalein the Carpet Industry,Large Manufacturers,Increased in machinery & labor,Doubling inputs has more than doubled output,Economies of scale exist for large producers,75,Returns to Scalein the Carpet Industry,Small Manufacturers,Small increases in scale have little or no impact on output,Proportional increases in inputs increase output proportionally,Constant returns to scale for small producers,76,Summary,A,production function,describes the maximum output a firm can produce for each specified combination of inputs.,An,isoquant,is a curve that shows all combinations of inputs that yield a given level of output.,77,Summary,Average product of labor,measures the productivity of the average worker, whereas,marginal product of labor,measures the productivity of the last worker added.,78,Summary,The,law of diminishing returns,explains that the marginal product of an input eventually diminishes as its quantity is increased.,79,Summary,Isoquants always slope downward because the marginal product of all inputs is positive.,The standard of living that a country can attain for its citizens is closely related to its level of productivity.,80,Summary,In long-run analysis, we tend to focus on the firms choice of its scale or size of operation.,81,End of Chapter 6,Production,82,
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