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ECONOMICS
MIDTERM 02
Production.
Transformation of inputs into outputs. Inputs are what a firm buys (i.e.,
productive resources) and outputs are what it sells (i.e., goods and services).
Production is defined as creation of utility and more precisely,
creation/addition of value. Production is creation of utility.
Production Function.
Marginal product.
Output that results from one additional unit of a factor of production (such
as a labor hour or machine hour), all other factors remaining constant is
known as marginal product. Whereas the marginal cost indicates the added
cost incurred in producing an additional unit of output, marginal product
indicates the added output accruing to an additional input.
Marginal product of capital MPk = dQ/dK = AK 1L and
Marginal product of labor MPL = dQ/dL = AKL 1
An economic principle that states that while increasing one input and keeping
other inputs at the same level may initially increase output, further increases
in that input will have a limited effect, and eventually no effect or a negative
effect, on output. The law of diminishing marginal productivity helps explain
why increasing production is not always the best way to increase profitability.
Ten equally skilled and diligent workers are ready to work in a factory
equipped with machines and ready stock of materials. As workers add in, the
output increases and figures on the number of workers, total product,
average product and marginal product can be shown as under:
Producers equilibrium.
What is iso-quant?
Iso-quant represent all these combinations of two resources which give same
level of output. Isoquant is one way of presenting the production function
where two factors of production are shown. It represents all possible input
combinations of the two factors, which are capable of producing the same
level of output. As the production remains the same on the point of this
contour line, it is also called the equal product curve. Isoquants generally
slope downward, are convex to the origin and do not intersect each other.
Let, Q = f (L, K) is the production factor.
L = Labor & K= Capital
This curve indicates that a firm can produce the specified level of output from
input combinations (L 1 , K 1 ), (L 2 , K 2 ), (L 3 , K 3 ), a b c. As we move down
from one point on an isoquant to another, we are substituting one factor for
another while holding output constant.
Budget Line.
Commodity A
5
4
3
2
1
0
Commodity B
0
1
2
3
4
5
Joining these points (as seen below) will result in a straight line called as
Budget Line or Price Line (PL).It is popularly known as 'Price Line'.
Laws of Returns.
There are three laws of returns: Law of diminishing, increasing and constant
returns. However, they are only three aspects of one law viz., the law of
variable proportions.
According to law of diminishing returns applicable in agriculture successive
application of labor and capital to a given area of land must ultimately, other
things remaining the same, yield a less than proportionate increase in
produce.
An industry is subject to law of increasing returns if extra investment in the
industry is followed by more than proportionate returns i.e., the marginal
product increases (with lowering of marginal cost). This may happen by
specialization of machinery and labor.
The Law of constant returns says that increased investment of the labor and
capital results in a proportionate increase in output and whatever the output
or scale of production, the cost per unit remains unaltered.
Returns TO SCALE.
Returns to Scale refers to the effect of doubling, trebling, and quadrupling
and so on of all the inputs on the output of the product, a situation when all
the productive forces are increased or decreased simultaneously in the same
ratio.
Returns to scale answer the question: If labor, capital, and other inputs ALL
increase by the same proportion (say 10 percent) does output increase by
more than, less than, or equal to this proportion (more than 10 percent, less
than 10 percent, or exactly 10 percent)? The answer indicates that returns to
scale can take one of three forms: increasing returns to scale, decreasing
returns to scale, and constant returns to scale.
1.
Laws of returns refer to situations when some factors may be increased
or decreased and at least one factor remains unchanged.
While returns to scale refers to a situation when all factors change
simultaneously in a given proportion.
2.
In laws of returns, the possibility in production expansion is very
limited. It can be expanded until its factor marginal product becomes zero.
The returns to scale, at the other hand, can be expanded at all level because
all factors become variable in the long-run.
Economies of Scale.
Economies Of Scope.
Economies of Scope: An economic theory stating that the average total cost
of production decreases as a result of increasing the number of different
goods produced. For example, McDonalds can produce both hamburgers and
French fries at a lower average cost than what it would cost two separate
firms to produce the same goods. This is because McDonalds hamburgers and
French fries share the use of food storage, preparation facilities, and so forth
during production.