# Welcome back

## Find a book, put up your feet, stay awhile

Sign in with Facebook

Sorry, we are unable to log you in via Facebook at this time. Please try again later.

or

Welcome to Scribd, the world's digital library. Read, publish, and share books and documents. See more

Download

Standard view

Full view

of .

Look up keyword

Like this

Share on social networks

2Activity

×

0 of .

Results for: No results containing your search query

P. 1

ch06HandoutsRatings: (0)|Views: 34|Likes: 2

Published by RAJAT SHARMA

See more

See less

https://www.scribd.com/doc/36453226/ch06Handouts

09/17/2010

text

original

1

1. Motivation

2. The Production Function

•Marginal and Average Products

•Isoquants

•The Marginal Rate of Technical Substitution

3. Returns to Scale

4. Technological Progress

5. Some Special Functional Forms

2

When deciding about factory design, e.g. the right

combination of machines and workers, need to

know the trade-offs

• to which degree can one be replaced by the

other?

• the optimal combination has to take relative costs

into account (next chapter)

3

Inputs(also known as “factors of production”) are

resources, such as labor and capital equipment, that a firm

uses to produce goods and services.

Outputsare the goods and services produced by a firm.

Productiontransforms a set of inputs into a set of outputs.

Technologydetermines the quantity of output that is

feasible to attain for a given set of inputs.

Production functionstates the maximum amount of

output that can be produced for any given amount of inputs.

Example:

Q = f(L,K,M) where L: labor, K: capital, M: materials

Q = f(L,F,A) where L: labor, F: fertilizer, A: land area

4

• The production set is the set of technically feasible

combinations of inputs and outputs

•A firm istechnically efficient if it produces the

maximum possible output given the inputs, i.e. operates

at the boundary of the production set

The analysis of production functions follows that of

utility functions.

•Think of a utility function as a production

function for “happiness”

•Difference: since production function measures

real output, production function is cardinal.

5

The Production Function and Technical Efficiency

for one input

production function

Q = f(L)

L

Q

•

•

•

•

C

D

A

B

area of technically inefficient production

area of technically not

achievable production

technically efficient production

is on the production function

6

•The variables in the production function areflows (the

amount of the input used per unit of time), notstocks (the

absolute quantity of the input).

ðExample: stock of capital is the total factory installation;

flow of capital is the machine hours used per unit of time in

production (including depreciation).

•Capital refers tophysical capital

(goods that are themselves produced goods) and not

financial capital(the money required to start or maintain

production).

7

Average productof an input resource is the average

amount of output produced per unit of the input.

average product of labor

APL = Q/L

average product of capital

APK = Q/K

Marginal productof an input resource is the rate at which

total output changes as the amount of the input is changed.

marginal product of labor

MPL = dQ/dL

marginal product of capital

MPK = dQ/dK

Law of diminishing marginal returns

The marginal product of an input eventually decreases as its

usage is increased, while holding all other inputs constant.

8

Total, Average, and Marginal Products

L

APL

MPL

Q

L

MPL maximized

APL maximized

TPL maximized

where MPL is zero.

TPL falls where MPL

is negative.

TPL rises where MPL

is positive.

Q(L)

MPL = dQ(L)/dL

APL = Q(L)/L

9

Note:

•When the marginal product is positive, the total product

is increasing

•When the marginal product is larger than the average

product, the average product is increasing (why? Because

the added unit adds more to the total then the previous

units on average, so it drives the average up)

•When the marginal product is smaller than the average

product, the average product is decreasing

•The average product is maximal where it is equal to the

marginal product

•The same holds for total, average and marginal for all

magnitudes, such as cost, utility, revenue, etc

10

Anisoquant traces all combinations of inputs that allow

a firm to produce thesame quantity of output.

e.g. Q = K1/2L1/2, then isoquant for Q = 20 is given by

K1/2L1/2 = 20, hence KL = 400, and K = 400/L

•Marginal rate of technical substitution MRTSL,K

is the rate at which the capital input K must be decreased

(increased) to keep output level constant after the labor

input L is increased (decreased) by one unit.

MRTSL,K

= –∆K/∆L

(negative slope of the isoquant)

= MPL/MPK

(ratio of the marginal products)

along an isoquant we have MPL(∆L) + MPK(∆K) = 0,

thus MPL/MPK = -∆K/∆L = MRTSL,K

11

L

K

Q = 10

Q = 20

All combinations of (L,K) along the

isoquant produce 20 units of output.

0

Slope=∆K/∆L

Example: Isoquants

12

•If both marginal products are positive, the slope of

the isoquant is negative

•If we have diminishing marginal returns, we also

have adiminishing marginal rate of technical

substitution(but not the other way around)

For many production functions,

marginal products eventually

become negative. We can ignore

the upward-sloping part of the

isoquants in a graph because

these regions are uneconomic.

13

Example: The Economic and the

Uneconomic Regions of Production

L

K

Q = 10

Q = 20

0

MPK < 0

MPL < 0

Isoquants

economic region

uneconomic regions

14

Consumer’s Choice

Firms’ Choice

marginal rate of substitution

MRS

marginal rate of technical

substitution MRTS

indifference curve

isoquant

marginal utility of X (MUX)

marginal product of X (MPX)

ordinal

cardinal

derived from preferences

derived from technologies

utility from consumption

output from inputs

15

TheElasticity of substitutionσ measures the percent

change in the capital-labor ratio K/L for each one

percent change inMRTSL,K. It hence measures the degree

of substitutability between different inputs

σ=

∆(K/L)/(K/L)

∆MRTSL,K/MRTSL,K

=

(∆(K/L)/∆MRTSL,K)(MRTSL,K/(K/L))

=

∆(K/L)

MRTS

L,K

∆MRTSL,K (K/L)

16

The shape of the isoquant

indicates the degree of

substitutability of the

inputs

Example: The Elasticity of

Substitution

L

K0

σ=0

σ=1

σ=5

σ= ∞

17

Returns to scale RTS

measure the relative increase in output, when ALL

input quantities increase by a given amount

RTS = %∆Q / %∆(all inputs)

•increasing returns to scale

a 1% increase in all inputs results in a more than 1%

increase in output

•constant returns to scale

a 1% increase in all inputs results in an equally 1%

increase in output

•decreasing returns to scale

a 1% increase in all inputs results in a less 1%

increase in output

18

Calculating the returns to scale

Production function Q1 = AL1αKβ1

Increase all inputs by the scale factorλ:

Q2 = A(λL1)α(λK1)β

=λα+β AL1αKβ1 =λα+βQ1

so the scale will depend on the value ofα+β.

• constant returns to scale:

α+β=1

• decreasing returns to scale:

α+β<1

• increasing returns to scale:

α+β>1

Note:The marginal product of a single factor may

diminish while the returns to scale do not

• Can there really be decreasing returns to scale?

They reflect that we do not increase all inputs or not in

the same quality

- Read and print without ads
- Download to keep your version
- Edit, email or read offline

© Copyright 2015 Scribd Inc.

Language

Choose the language in which you want to experience Scribd:

Sign in with Facebook

Sorry, we are unable to log you in via Facebook at this time. Please try again later.

or

Password Reset Email Sent

Join with Facebook

Sorry, we are unable to log you in via Facebook at this time. Please try again later.

or

By joining, you agree to our

read free for two weeks

Unlimited access to more than

one million books

one million books

Personalized recommendations

based on books you love

based on books you love

Syncing across all your devices

Join with Facebook

or Join with emailSorry, we are unable to log you in via Facebook at this time. Please try again later.

Already a member? Sign in.

By joining, you agree to our

to download

Unlimited access to more than

one million books

one million books

Personalized recommendations

based on books you love

based on books you love

Syncing across all your devices

Continue with Facebook

Sign inJoin with emailSorry, we are unable to log you in via Facebook at this time. Please try again later.

By joining, you agree to our

Are you sure?

This action might not be possible to undo. Are you sure you want to continue?

CANCEL

OK

You've been reading!

NO, THANKS

OK

scribd