CHAPTER 6 * Productive Capacity is determined by the size and quality of the labor force, by the quantity and quality

of capital stock, by the nations technical knowledge along with the ability to use that knowledge, and by the nature of public and private institutions. BASIC CONCEPTS The production function specifies the maximum output that can be produced with a given quantity of inputs. It is defined for a given state of engineering and technical knowledge. Relationship between the amount of input required and the ampint of output that can be obtained. Useful way of describing the productive capabilities of a firm.

Total product Designates the total amount of output produced

Marginal Product Extra output produced by 1 additional unit of that input while other inputs are held constant.

Average Product Equals total output divided by total units of input.

The Law of Diminishing Returns Holds that we will get less and less extra output when we add additional doses of an input while holding other inputs fixed. o The marginal product of each unit of input will decline as the amount of that input increases, holding all other inputs constant. o As more of an input such as labor is added to a fixed amount of land, machinery, and other inputs the labor has less and less of the other factors to work with. o Marginal product curve declines as labor inputs increase

Returns to Scale Effects of scale increases of inputs on the quantity produced. (What is the effect when all inputs are increased) o Constant returns to scale- case where change in all inputs leads to a proportional change in output.

o Increasing returns to scale (economies of scale)- arise when an increase in all inputs leads to a more-than-proportional increase in the level of output. o Decreasing returns to scale- occur when a balanced increase of all inputs leads to a less-than-proportional increase in total output. o Scaling up may eventually reach a point beyond which inefficiencies set in. SHORT RUN and LONG RUN Short run Period in which firms can adjust production by changing variable factors such as materials and labor but cannot change fixed factors such as capital. Only variable factors can be adjusted, fixed factors(i.e. plant and equipment) cannot be fully modified or adjusted.

Long run Period sufficiently long that all factors including capital can be adjusted. Period of time over which all inputs, fixed and variable, can be adjusted.

Variable factors- factors which are increased in the short run Fixed factors- those that cannot be changed in the short run because of physical condition or legal contracts. Technological change Improves productivity and raises living standards. o A process of innovation is equivalent to a shift in the production function

*When there are market failures, technological regress might occur even in a market economy. Productivity Concept measuring the ratio of total output to a weighted average input o Labor productivity- calculates the amount of output per unit labor o Total factor productivity- measures output per unit of total inputs (typically of capital and labor).

economies of scale and mass production have been important elements of productivity growth over the last century if increasing returns prevailed, the larger scale of inputs and production would lead to greater productivity Aggregate Production Function

 total output to the quantity of inputs (like labor, capital and land) and to
toal productivity. Business firms

Are specialized organizations devoted to managing the process of

production. They exploit economies of mass production, raise funds and organize factors of production. Production is organized in firms because efficiency generally requires largescale production, the raising of significant financial resources and careful management and monitoring of ongoing activities. * read summary