270 PART THREE. Praciction and Cost An months or weeks. For others, such asthe construction of a new electicity-generating plant, it may be many years. In the short run, a firm can increase output ony by using more ofthe variable inputs (Sy, labor andraw materials) together withthe fixed inputs (plant and equip- ment In the long run, the came inereace in output could likely be obtained more efficiently by also expanding the firm’s production facilites (plant and equipmen). Thus, we say that the firm operates inthe short run and plans increases or reductions in its scale of operation in te long run. In the long ran, technology usually improves, s0 that more output can be ‘obigned from a given quantity of inputs, or the same output from less inputs The Production Function Just as demand theory centers on the concept of the demand function, production theory revolves around the concept ofthe production function. A production function is an equa- tion, table, or graph showing the maximum output ofa commodity that a firm can produce per period of time with each set of inputs. Both inputs and outputs are measured in physi- cal rather than in monetary units, Technology is assumed to remain constant during the period ofthe analysis. For simplicity we assume here that a frm produces only one type of output (commod- ity or service) with two inputs, labor (E) and capital (K). Thus, the general equation ofthis simple production function is O=fl.K) oy ‘Equation 7-1 reads: the quantity of output is a function of, or depends on, the quantity ‘of labor and capital used in production. Output refers to the numberof units ofthe com- ‘modity ay, automobiles) produced, labor refers to the numberof workers employed, and capital refers tothe amount ofthe equipment used in production. We assume that all units of Land K are homogeneous or identical, An explicit production function would indicate precisely the quantity of output thatthe firm would produce with each particular set of Inputs of labor and capital. Although our discussion will be in terms of a single output produced with only two inpus, the priniples that we will develop are general and apply to cases in which the firm uses more than two inputs and produces more than one output (the usual situation). ‘Table 7-1 gives a hypotitical production function that shows the outputs (the Q's) ‘that the frm can produce with various combinations of labor (L) and capital (K), The table ciate)“CHAPTER 7 Production Theory and Estimation 271 shows that by using I unit of labor (LZ) and I unit of apital (12), the firm would produce 3 units of output (30), With 21 and 1X, output is 80; with 3L’and 1K, output is 120; with 32 and 2K, output is 280; with 4Z and 2K, output is 300. and so on. Note also that labor and capital can be substituted foreach other in productior. For example, 120 can be produced either with 32 and 1K or with IL and 4K." Input prices will determine which of these two combinations of Isbor and capital is cheaper. The ouput thatthe fim will want to produce isthe one that maximizes its total profits. These questions will be examined and answered later inthe chapter. ‘The production relationships given in Table 7-1 are shown graphically in Figure 7-1, Which is three-dimensional In Figure 7-, the height of the bers refers to the maximum FIGURE 7-1. Discrete Production Surface The height of the bars refers to the ‘maximum output (@) that can be preduced with each combination of labor (L) and capital 06) shown on the axes. Thus, the tone of al te Bars form the production surface for the frm ‘Tag coal als be predoes with 1K and Linstead of 1K ad 3 (se he aster in th stow fhe table), bt he fem wold certainly not want se his combination of abr a ep. Silay 120 oul be produced wih IL and eter aK oe SK, bute firm would at want ss the later np eombiaton272 PART THREE Production and Cost Analysis output that can be produced with each combination of labor and capital shown on the axes, ‘Tus, the tps ofall the bars form the production surface fo the firm. If-we assume that inputs and outputs are continuously or infinitesimally divisible (eather than being measured in discrete unis), we Would have aa infaite numberof out- ‘buts, each resulting from one ofthe infinite number of combinations of labor and capital that could be used in production. This is shown in Figure 72, in which the axes forming the base ofthe figure meastre the labor and capital inputs, while the height ofthe surface tives the (maximum) level of ourput resulting from each input combination, all assumed tobe continuously divisible For example, by keeping the quantity of capital used at K, in Figure 7-2 and increasing the quantity of labor used from zero to Z, units (Go that we are inthe short run, the firm ‘generates the output shown by the height of cross section K,AB¥ (with base parallel to the labor axis), On the other hand, by increasing the emount of labor used from zero to, units but keeping cepital constan at K, rather than K, (0 that we are still in the short un), the firm generates the output sown by the top of cross section K,CD. If instead the frm kept labor constant at L, and increased the quantity of capital used from zero to K, units, the firm's output would be the one shown by the top of toss section L EF (with base parallel ‘o the capital axis). With labor constant at L, onthe other hand, the firms output generated by changing the quantity of capital used from zero to K, units would be the one shown by the height of cross section L,CD. output Labor FIGURE 7-2 Continuous Production Surface The horizontal and inclined axes measure, respectively the labor and capital inputs, while the vertical ans measures the height of the surface or the maximum lave of utaut resulting from each input ombination~al assumed to be continuously divisible, The outnut generated by holding capital constant at, and increasing labor from zera to L, unit ls givan by the height lof eross section K/Ad (with base paralel to the labor axis)