Production

In the last three chapters, we focused on the demand side of the market-
the preferences and behavior of consumers. Now we turn to the supply
side and examine the behavior of producers. We will see how firms can
produce efficiently and how their costs of production change with
changes in both input prices and the level of output. We will also see CHAPTER OUTLINE
that there are strong similarities between the optimizing decisions made
5.1 The Technology of Production
by firms and those made by consumers. In other words, understanding
148
consumer behavior will help us understand producer behavior.
In this chapter and the next we discuss the theory of the firm, 5.2 Production with One Variable
which describes how a firm makes cost-minimizing production deci- Input (Labor) 150
sions and how the firm's resulting cost varies with its output. Our 5.3 Production with Two Variable
knowledge of production and cost will help us understand the charac- Inputs 158
teristics of market supply. It will also prove useful for dealing with 5.4 Returns to Scale 165
problems that arise regularly in business. To see this, just consider
some of the problems often faced by a company like Tata Motors. How LIST OF EXAMPLES
much assembly-line machinery and how much labor should it use in
its new automobile plants? If it wants to increase production, should it 5.1 Malthus and the Food Crisis 156
hire more workers, construct new plants, or both? Does it make more 5.2 A Production Function for
sense for one automobile plant to produce different models, or should Wheat 164
each model be manufactured in a separate plant? What should Tata 5.3 Returns to Scale in the Carpet
Motors expect its costs to be during the coming year? How are these Industry 167
costs likely to change over time and be affected by the level of produc-
tion?These questions apply not only to business firms but also to other
producers of goods and services, such as governments and non profit
agencies.

The Production Decisions of a Firm

In Chapters 3 and 4, we studied consumer behavior by breaking it
down into three steps. First, we explained how to describe consumer
preferences. Second, we accounted for the fact that consumers face
budget constraints. Third, we saw how, given their preferences and
budget constraints, consumers can choose combinations of goods to
maximize their satisfaction. The production decisions of firms are
analogous to the purchasing decisions of consumers, and can likewise
be understood in three steps:
1. Production Technology: We need a practical way of describing how
inputs (such as labor, capital, and raw materials) can be transformed
into outputs (such as cars and televisions). Just as a consumer can
reach a level of satisfaction from buying different combinations of
goods, the firm can produce a particular level of output by using
different combinations of inputs. For example, an electronics firm 147
 148 PART 2 • Producers, Consumers, and Competitive
• theory of the firm
Explanation of how a firm
makes cost-minimizing
production decisions and
how its cost varies with its
output.
HITHE TECHNOLOGY
• factors of production
Inputs into the production
process (e.g., labor, capital,
and materials).
Markets
might produce 10,000televisions per month by using a substantial amount of
labor (e.g., workers assembling the televisions by hand) and very little capi-
tal, or by building a highly automated capital-intensive factory and using
very little labor.
2. Cost Constraints: Firms must take into account the prices of labor, capital,
and other inputs. Just as a consumer is constrained by a limited budget, the
firm will be concerned about its cost of production. For example, the firm that
produces 10,000 televisions per month will want to do so in a way that mini-
mizes its total production cost, which is determined in part by the prices of
the inputs it uses.
3. Input Choices: Given its production technology and the prices of labor,
capital, and other inputs, the firm must choose how much of each input to use in
producing its output. Just as a consumer takes account of the prices of differ-
ent goods when deciding how much of each good to buy, the firm must take
into account the prices of different inputs when deciding how much of each
input to use. If our electronics firm operates in a country with low wage rates,
it may decide to produce televisions by using a large amount of labor, thereby
using very little capital.
These three steps are the building blocks of the theory of the firm, and we will
discuss them in detail in this chapter and the next. We will also address other
important aspects of firm behavior. For example, "assuming that the firm is
always using a cost-minimizing combination of inputs, we will see how its total
cost of production varies with the quantity it produces and how it can choose
that quantity to maximize its profit.
We begin this chapter by showing how the firm's production technology can
be represented in the form of a production function-a compact description of
how inputs are turned into output. We then use the production function to
show how the firm's output changes when just one of its inputs (labor) is var-
ied, holding the other inputs fixed. Next, we turn to the more general case in
which the firm can vary all of its inputs, and we show how the firm chooses a
cost-minimizing combination of inputs to produce its output. We will be partic-
ularly concerned with the scale of the firm's operation. Are there, for example,
any technological advantages that make the firm more productive as its scale
increases?
OF PRODUCTION
In the production process, firms turn inputs into outputs (or products). Inputs,
which are also called factors of production, include anything that the firm must
use as part of the production process. In a bakery, for example, inputs include
the labor of its workers; raw materials, such as flour and sugar; and the capital
invested in its ovens, mixers, and other equipment needed to produce such
outputs as bread, cakes, and pastries.
As you can see, we can divide inputs into the broad categories of labor,
materials, and capital, each of which might include more narrow subdivisions.
Labor inputs include skilled workers (carpenters, engineers) and unskilled
workers (agricultural workers), as well as the entrepreneurial efforts of the firm's
managers. Materials include steel, plastics, electricity, water, and any other goods
that the firm buys and transforms into final products. Capital includes land,
buildings, machinery and other equipment, as well as inventories.
 CHAPTER 5 • Production 149

The Production Function

Finnscan turn inputs into outputs in a variety of ways, using various combina-
tionsof labor, materials, and capital. We can describe the relationship between the
inputs into the production process and the resulting output by a production
function.A production function indicates the highest output q that a firm can pro- • production function
ducefor every specified combination of inputs. 1 Although in practice firms use a Function showing the highest
output that a firm can
widevariety of inputs, we will keep our analysis simple by focusing on only two, produce for every specified
laborL and capital K. We can then write the production function as combination of inputs.

q = F(K, L) (5.1)

This equation relates the quantity of output to the quantities of the two
inputs, capital and labor. For example, the production function might describe
the number of personal computers that can be produced each year with a
lO,OOO-square-footplant and a specific amount of assembly-line labor. Or it
might describe the crop that a farmer can obtain using specific amounts of
machinery and workers.
It is important to keep in mind that inputs and outputs are flows. For example,
our PC manufacturer uses a certain amount of labor each year to produce some
number of computers over that year. Although it might own its plant and
machinery, we can think of the firm as paying a cost for the use of that plant
and machinery over the year. To simplify things, we will frequently ignore the
referenceto time and refer only to amounts of labor, capital, and output. Unless
otherwise indicated, however, we mean the amount of labor and capital used
eachyear and the amount of output produced each year.
Because the production function allows inputs to be combined in varying
proportions, output can be produced in many ways. For the production func-
tion in equation (5.1), this could mean using more capital and less labor, or
viceversa. For example, a building can be constructed in a labor-intensive way
using many workers, or in a capital-intensive way using machines and only a
fewworkers.
Note that equation (5.1) applies to a given technology-that is, to a given state
ofknowledge about the various methods that might be used to transform inputs
into outputs. As the technology becomes more advanced and the production
function changes, a firm can obtain more output for a given set of inputs. For
example, a new, faster assembly line may allow a hardware manufacturer to
produce more high-speed computers in a given period of time.
Production functions describe what is technically feasible when the firm oper-
ates efficiently-that is, when the firm uses each combination of inputs as effec-
tively as possible. The presumption that production is always technically
efficientneed not always hold, but it is reasonable to expect that profit-seeking
firmswill not waste resources.

The Short Run versus the Long Run

It takes time for a firm to adjust its inputs to produce its product with differ-
ing amounts of labor and capital. A new factory must be planned and built,
and machinery and other capital equipment must be ordered and delivered.
Such activities can easily take a year or more to complete. As a result, if we

lIn this chapter and those that follow, we will use the variable q for the output of the firm, and Q for
theoutput of the industry.
 150 PART 2 • Producers, Consumers, and Competitive Markets
• short run Period of time in
which quantities of one or
more production factors can-
not be changed.
• fixed input Production
factor that cannot be varied.
• long run Amount of time
needed to make all produc-
tion inputs variable.
Bd PRODUCTION
are looking at production decisions over a short period of time, such as a
month or two, the firm is unlikely to be able to substitute very much capital
for labor.
Because firms must consider whether or not inputs can be varied, and if they
can, over what period of time, it is important to distinguish between the short
and long run when analyzing production. The short run refers to a period of
time in which the quantities of one or more factors of production cannot be
changed. In other words, in the short run there is at least one factor that cannot
be varied; such a factor is called a fixed input. The long run is the amount of
time needed to make all inputs variable.
As you might expect, the kinds of decisions that firms can make are very dif-
ferent in the short run than those made in the long run. In the short run, firms
vary the intensity with which they utilize a given plant and machinery; in the
long run, they vary the size of the plant. All fixed inputs in the short run repre-
sent the outcomes of previous long-run decisions based on estimates of what a
firm could profitably produce and sell.
There is no specific time period, such as one year, that separates the short run
from the long run. Rather, one must distinguish them on a case-by-case basis.
For example, the long run can be as brief as a day or two for a child's lemonade
stand or as long as five or ten years for a petrochemical producer or an automo-
bile manufacturer.
We will see that in the long run firms can vary the amounts of all their inputs
to minimize the cost of production. Before treating this general case, however,
we begin with an analysis of the short run, in which only one input to the pro-
duction process can be varied. We assume that capital is the fixed input, and
labor is variable.
WITH ONE VARIABLE
INPUT (LABOR)
When deciding how much of a particular input to buy, a firm has to compare
the benefit that will result with the cost. Sometimes it is useful to look at the
benefit and the cost on an incremental basis by focusing on the additional
output that results from an incremental addition to an input. In other situa-
tions, it is useful to make the comparison on an average basis by considering
the result of substantially increasing an input. We will look at benefits and
costs in both ways.
When capital is fixed but labor is variable, the only way the firm can produce
more output is by increasing its labor input. Imagine, for example, that you are
managing a clothing factory. Although you have a fixed amount of equipment,
you can hire more or less labor to sew and to run the machines. You must decide
how much lab or to hire and how much clothing to produce. To make the
decision, you will need to know how the amount of output q increases (if at all)
as the input of labor L increases.
Table 5.1 gives this information. The first three columns show the amount of
output that can be produced in one month with different amounts of labor and'
capital fixed at 10 units. The first column shows the amount of labor, the second
the fixed amount of capital, and the third total output. When labor input is zero,
output is also zero. Output then increases as labor is increased up to an input of
8 units. Beyond that point, total output declines: Although initially each unit of
labor can take greater and greater advantage of the existing machinery and
plant, after a certain point, additionallabor is no longer useful and indeed can
 CHAPTER 5 • Production 151

Amount Amount Total Average Marginal

of Labor (L) of Capital (K) Output (q) Product (q/L) Product (A.q/A.L)

0 10 0
10 10 10 10
2 10 30 15 20
3 10 60 20 30
4 10 80 20 20
5 10 95 19 15
6 10 108 18 13
7 10 112 16 4
8 10 112 14 0
9 10 108 12 -4
10 10 100 10 -8

be counterproductive. Five people can run an assembly line better than two, but
ten people may get in one another's way.

Average and Marginal Products

Thecontribution that labor makes to the production process can be described on
both an average and a marginal (i.e., incremental) basis. The fourth column in
Table5.1 shows the average product of labor (APL), which is the output per unit • average product Output
oflabor input. The average product is calculated by dividing the total output q per unit of a particular input.
by the total input of lab or L. The average product of labor measures the
productivity of the firm's workforce in terms of how much output each worker
produces on average. In our example, the average product increases initially but
fallswhen the labor input becomes greater than four.
The fifth column of Table 5.1 shows the marginal product of labor (MPL). • marginal product
Thisis the additional output produced as the labor input is increased by 1 unit. Additional output produced
as an input is increased by
Forexample, with capital fixed at 10 units, when the labor input increases from one unit.
2 to 3, total output increases from 30 to 60, creating an additional output of 30
(i.e., 60 - 30) units. The marginal product of labor can be written as t.q / t.L-in
other words, the change in output t.q resulting from a 1-unit increase in labor
input 11L.
Remember that the marginal product of labor depends on the amount of capital
used. If the capital input increased from 10 to 20, the marginal product of labor
mostlikely would increase. Why? Because additional workers are likely to be more
productive if they have more capital to use. Like the average product, the marginal
product first increases then falls-in this case, after the third unit of labor.
Tosummarize:

Average product of labor = Output/labor input = q / L

Marginal product of labor = Change in output/ change in labor input
= I1q/ t.L
152 PART 2 • Producers, Consumers, and Competitive Markets

The Slopes of the Product Curve

Figure 5.1 plots the information contained in Table 5.1. (We have connected all
the points in the figure with solid lines.) Figure 5.1(a) shows that as labor is
increased, output increases until it reaches the maximum output of 112; there-
after, it falls. The portion of the total output curve that is declining is drawn with
a dashed line to denote that producing with more than eight workers is not

Output
per
month
D
112 -----------------------~ i -~~~-
~~
; Total Product
I
I
I
I
I
I
I
I
60 I
I
I
I
I
I
I
I
I
I
I

o 1 2 3 4 5 6 7 8 9 10
I
I Labor per Month
I
I (a)
I
I
I
30

Output
per
worker 20
per
month

10

o 1 2 4 5 6 7 8 ~~~ 10
~~~
(b)
Labor per month

FIGURE 5.1 Production with One Variable Input

The total product curve in (a) shows the output produced for different amounts of labor
input. The average and marginal products in (b) can be obtained (using the data in
Table 5.1) from the total product <;UI'Ve. At point A in (a), the marginal product is 20
because the tangent to the total product curve has a slope of 20. At point B in (a) the
average product of labor is 20, which is the slope of the line from the origin to B. The
average product of labor at point C in (a) is given by the slope of the line OC.To the left
of point E in (b), the marginal product is above the average product and the average is
increasing; to the right of E, the marginal product is below the average product and the
average is decreasing. As a result, E represents the point at which the average and
marginal products are equal, when the average product reaches its maximum.
 CHAPTER 5 • Production 153

economically rational; it can never be profitable to use additional amounts of a

costlyinput to produce less output.
Figure 5.l(b) shows the average and marginal product curves. (The units on
the vertical axis have changed from output per month to output per worker per
month.) Note that the marginal product is positive as long as output is increas-
ing,but becomes negative when output is decreasing.
It is no coincidence that the marginal product curve crosses the horizontal
axisof the graph at the point of maximum total product. This happens because
adding a worker in a manner that slows production and decreases total output
impliesa negative marginal product for that worker.
The average product and marginal product curves are closely related, When
the marginal product is greater than the average product, the average product is
increasing. This is the case for labor inputs up to 4 in Figure 5.l(b). If the output
of an additional worker is greater than the average output of each existing
worker (i.e., the marginal product is greater than the average product), then
adding the worker causes average output to rise. In Table 5.1, two workers
produce 30 units of output, for an average product of 15 units per worker.
Adding a third worker increases output by 30 units (to 60), which raises the
average product from 15 to 20.
Similarly, when the marginal product is less than the average product, the average
product is decreasing. This is the case when the labor input is greater than 4 in
Figure5.l(b). In Table 5.1, six workers produce 108 units of output, for an aver-
age product of 18. Adding a seventh worker contributes a marginal product of
only4 units (less than the average product), reducing the average product to 16.
We have seen that the marginal product is above the average product when
theaverage product is increasing and below the average product when the aver-
ageproduct is decreasing. It follows, therefore, that the marginal product must
equalthe average product when the average product reaches its maximum. This
happens at point E in Figure 5.l(b).
Why, in practice, should we expect the marginal product curve to rise and
then fall? Think of a television assembly plant. Fewer than ten workers might
beinsufficient to operate the assembly line at all. Ten to fifteen workers might be
able to run the.assembly line, but not very efficiently. If adding a few more
workers allowed the assembly line to operate much more efficiently, the
marginal product of those workers would be very high. This added efficiency,
however, might start to diminish once there were more than 20 workers. The
marginal product of the twenty-second worker, for example, might still be very
high (and above the average product), but not as high as the marginal product
ofthe nineteenth or twentieth worker. The marginal product of the twenty-fifth
worker might be lower still, perhaps equal to the average product. With
30workers, adding one more worker would yield more output, but not very
much more (so that the marginal product, while positive, would be below the
average product). Once there were more than 40 workers, additional workers
would simply get in each other's way and actually reduce output (so that
themarginal product would be negative).

The Average Product of Labor Curve

Thegeometric relationship between the total product and the average and mar-
ginalproduct curves is shown in Figure 5.l(a). The average product of labor is
thetotal product divided by the quantity of labor input. At B, for example, the
averageproduct is equal to the output of 60 divided by the input of 3, or 20 units
ofoutput per unit of labor input. This ratio, however, is exactly the slope of the
 154 PART 2 • Producers, Consumers, and Competitive
• law of diminishing
marginal returns. Principle
that as the use of an input
increases with other inputs
fixed, the resulting additions
to output will eventually
decrease.
Markets
line running from the origin to B in Figure 5.1(a). In general, the average product of
labor is given by the slope of the line drawn from the origin to the corresponding point
on the total product curve.
The Marginal Product of Labor Curve
As we have seen, the marginal product of labor is the change in the total
product resulting from an increase of one unit of labor. At A, for example, the
marginal product is 20 because the tangent to the total product curve has a
slope of 20. In general, the marginal product of labor at a point is given by the slope
of the total product at that point. We can see in Figure 5.l(b) that the marginal
product of labor increases initially, peaks at an input of 3, and then declines as
we move up the total product curve to C and D. At D, when total output
is maximized, the slope of the tangent to the total product curve is 0, as is
the marginal product. Beyond that point, the marginal product becomes
negative.
The Relationship between the Average and Marginal Products Note the graph-
ical relationship between average and marginal products in Figure 5.1(a).At B,the
marginal product oflabor (the slope of the tangent to the total product curve at B-
not shown explicitly) is greater than the average product (dashed line OB). As a
result, the average product of labor increases as we move from B to C. At C, the
average and marginal products of labor are equal: While the average product is
the slope of the line from the origin, DC, the marginal product is the tangent to the
total product curve at C (note the equality of the average and marginal products at
point E in Figure 5.1(b». Finally, as we move beyond C toward D, the marginal
product falls below the average product; you can check that the slope of the tan-
gent to the total product curve at any point between C and D is lower than the
slope of the line from the origin.
The Law of Diminishing ~Returns
A diminishing marginal product of labor (as well as a diminishing marginal
product of other inputs) holds for most production processes. The law of dimin-
ishing marginal returns states that as the use of an input increases in equal
increments (with other inputs fixed), a point will eventually be reached at which
the resulting additions to output decrease. When the labor input is small (and
capital is fixed), extra labor adds considerably to output, often because workers
are allowed to devote themselves to specialized tasks. Eventually, however, the
law of diminishing marginal returns applies: When there are too many workers,
some workers become ineffective and the marginal produ<;.UUJabor4,lls.
The law of diminishing marginal returns usually applies to the short run
when at least one input is fixed. However, it can also apply to the long run.
Even though inputs are variable in the long run, a manager may still want to
analyze production choices for which one or more inputs are unchanged.
Suppose, for example, that only two plant sizes are feasible and that manage-
ment must decide which to build. In that case, management would want to
know when diminishing marginal returns will set in for each of the two
options.
Do not confuse the law of diminishing marginal returns with possible
changes in the quality of labor as labor inputs are increased (as would likely
 CHAPTER 5 • Production 155

occur,for example, if the most highly qualified laborers are hired first and the
least qualified last). In our analysis of production, we have assumed that all
laborinputs are of equal quality; diminishing marginal returns results from lim-
itations on the use of other fixed inputs (e.g., machinery), not from declines in
'worker quality. In addition, do not confuse diminishing marginal returns with
negative returns. The law of diminishing marginal returns describes a declining
marginal product but not necessarily a negative one.
The law of diminishing marginal returns applies to a given production
technology. Over time, however, inventions and other improvements in tech-
nologymay allow the entire total product curve in Figure 5.1(a) to shift upward,
'so that more output can be produced with the same inputs. Figure 5.2 illustrates
this principle. Initially the output curve is given by aI' but improvements in
technology may allow the curve to shift upward, first to O2, and later to 03•
Suppose, for example, that over time, as labor is increased in agricultural pro-
duction, technological improvements are being made. These improvements
might include genetically engineered pest-resistant seeds, more powerful and
effectivefertilizers, and better farm equipment. As a result, output changes from
A (with an input of 6 on curve 01) to B (with an input of 7 on curve O2) to
C(with an input of 8 on curve 03).
The move from A to B to C relates an increase in labor input to an increase in
output and makes it appear that there are no diminishing marginal returns
when in fact there are. Indeed, the shifting of the total product curve suggests
that there may be no negative long-run implications for economic growth. In
fact,as we can see in Example 5.1, the failure to account for long-run improve-
mentsin technology led British economist Thomas Malthus wrongly to predict
direconsequences from continued population growth.

Output
per le
I
-.•.•..•••• ••••
time I ••••
I ••
period 1 ••••
I 03
100 I
B I
--"-- ...
I ••••

:
I

I
••••
.
••
I I ••
A I I ••

50
---- --t--,--__
I I I ••••
O2
I I I ••••
I I I ••
I I I ••••
I I I ••
I I I ••

: : : 01
I I I
I I I
I I I
I I

o 1 2 3 4 5 6 7 8 9 10
Labor per time period

FIGURE 5.2 The Effect of Technological Improvement

Labor productivity (output per unit of labor) can increase if there are improvements
in technology, even though any given production process exhibits diminishing
returns to labor. As we move from point A on curve 01 to B on curve 02 to C on curve
03 over time, labor productivity increases.
156 PART2 • Producers, Consumers, and Competitive Markets

Three Stages of Production

Economists have found it useful to depict the behavior of marginal product and
average product curves showing the three stages of production. Recall Figure 5.1.
To the left of point E the marginal product rises, reaches maximum and then falls
as diminishing returns set in, while the average product rises and reaches its
maximum. This is called stage I. Stage 11ranges from 4 to 8 labor units Le. to the
right of E and upto the point where the marginal product is zero. In this stage the
marginal product falls till it becomes zero while the average product keeps on
falling and is positive. Stage III occurs when the marginal product is negative
(L e. when more than 8 labor units are employed in our example.)
It is obvious that a rational producer will never operate in stages I and Ill. In
stage III the contribution of additionallabor to the total product (i.e. marginal
product) is negative, so it will be unwise to employ an input that reduces the
total product (even if the input was entirely free). It is also not logically justified
to produce in stage I where the average product is rising, so an increase in input
increases output in greater proportion. For example, in Figure 5.1, when labor
increases from 1 to 2 units, total product increases from 10 to 30. This means that
labor cost doubles but earnings from increased output increases three times.
Thus profits increase. So, the firm has the incentive to keep on employing addi-
tionallabor until it crosses over to stage 11.
Thus, a rational producer should produce in stage 11,but where exactly the
firm will operate within stage 11cannot be determined only on the basis of
the product curves. We will need further information on labor cost and price of
output for this purpose.

__ Malthus and the Food Crisis

The law of diminishing marginal returns was central to the thinking of political
economist Thomas Malthus (1766-1834).2 Malthus believed that the world's lim-
ited amount of land would not be able to supply enough food as the population
grew. He predicted that as both the marginal and average productivity of labor
fell and there were more mouths to feed, mass hunger and starvation would
result. Fortunately, Malthus was wrong (although he was right about the dimin-
ishing marginal returns to labor).
Over the past century, technological improvements have dramatically altered
food production in most countries (including developing countries, such as
India). As a result, the average product of labor and total food output have
increased. These improvements include new high-yielding, disease-resistant
strains of seeds, better fertilizers, and better harvesting equipment. As the food
production index in Table 5.2 shows, overall food production throughout the
world has outpaced population growth continually since 1960.3 This increase in
world agricultural productivity is also illustrated in Figure 5.3, which shows
average cereal yields from 1970 through 2005, along with a world price index for
food.t Note that cereal yields have increased steadily over the period. Because

2Thomas Malthus, Essay on the Principle of Population, 1798.

3World per capita food production data are from the United Nations Food and Agriculture
Organization (FAO). See also http://faostat.fao.org.
4Dataare from the United Nations Food and Agriculture Organization and the World Bank. See also
http://faostat.fao.org.
 CHAPTER 5 • Production 157 •

growth inagricultural productivity led to increases in food supplies that out-

stripped-the growth in demand, prices, apart from a temporary increase in the
early1970$,have been declining. .
Hunger remains a severe problem in some areas, such as the Sahel
region ofAfrica, in part because of the low productivity of labor there.
Although other countries produce an agricultural surplus, mass hunger
still occurs because of the difficulty of redistributing food from more to
less productive regions ofthe world and because of the low incomesof
those less productive regions.

350 3.6

3.4
()
300
3.2 @
8,... a
0
~
11
250
3

2.8
1
CJl

C 9'
x ."
Qj
"0 200 2.6 :i.
n
.5 0
Qj

.~ 2.4 ='CJl
Po. "0
150 ..•."
'8 2.2 :T
& ."
2 ~
..•
100 e.
1.8

50 1.6
·1970 1975 1980 1985 1990 1995 2000 2005

FIGURE 5.3 Cereal Yields and the World Price of Food

Cereal yields have increased. The average world price of food increased temporarily in the early
1970sbut has declined since.
~ 158 PART 2 • Producers, Consumers, and Competitive Markets

H)-P-R-O-O-U-C-T-IO-N-W-I-TH-T-WO-VA-R-I-A-B-LE-IN-P-U-T-S--

We have completed our analysis of the short-run production function in which

one input, labor, is variable, and the other, capital, is fixed. Now we turn to the
long run, for which both labor and capital are variable. The firm can now pro-
duce its output in a variety of ways by combining different amounts of labor
and capital. In this section, we will see how a firm can choose among combina-
tions of labor and capital that generate the same output. In the first subsection,
we will examine the scale of the production process, analyzing how output
changes as input combinations are doubled, tripled, and so on.

• isoquant Curve showing all
possible combinations of inputs
that yield the same output.
Isoquants
Let's begin by examining the production technology of a firm that uses two
inputs and can vary both of them. Suppose that the inputs are labor and capital
and that they are used to produce food. Table 5.3 tabulates the output achievable
for various combinations of inputs.
Labor inputs are listed across the top row, capital inputs down the column on
the left. Each entry in the table is the maximum (technically efficient) output. that
can be produced each year with each combination of labor and capital used over
that year. For example, 4 units of labor per year and 2 units of capital per year
yield 85 units of food per year. Reading along each row, we see that output
increases as labor inputs are increased, while capital inputs remain fixed.
Reading down each column, we see that output also increases as capital inputs
are increased, while labor inputs remain fixed.
The information in Table 5.3 can also be represented graphically using iso-
quants. An isoquant is a curve that shows all the possible combinations of inputs
that yield the same output. Figure 5.4 shows three isoquants. (Each axis in the
figure measures the quantity of inputs.) These isoquants are based on the data
in Table 5.3, but are drawn as smooth curves to allow for the use of fractional
amounts of inputs.
For example, isoquant ql shows all combinations of labor and capital per year
that together yield 55 units of output per year. Two of these points, A and 0, cor-
respond to Table 5.3. At A, 1 unit of labor and 3 units of capital yield 55 units of
output; at 0, the same output is produced from 3 units of labor and 1 unit of
capital. Isoquant q2 shows all combinations of inputs that yield 75 units of
output and corresponds to the four combinations of labor and capital circled in
 CHAPTER 5 • Production 159

Capital
per
year

3~············································· .• ~, .........................•
~ .......................................................................•................

2
I
I
I
I
1 ------r-----~------
I I
I I
I I
55
I I
I I

Labor per year

FIGURE 5.4 Production with Two Variable Inputs

Production isoquants show the various combinations of inputs necessary forthe firm to
produce a given output. A set of isoquants, or isoquant map, describes the firm's produc-
tion function. Output increases as we move from isoquant ql (at which 55 units per year
are produced at points such as A and D), to isoquant q2 (75 units per year at points such
as B) and to isoquant q3 (90 units per year at points such as C and E).

thetable (e.g., at B, where 2 units of labor and 3 units of capital are combined).
Isoquant q2 lies above and to the right of ql because obtaining a higher level of
output requires more labor and capital. Finally, isoquant q3 shows labor-capital
combinations that yield 90 units of output. Point C, for example, involves 3 units
of labor and 3 units of capital, whereas Point E involves 2 units of labor and
5units of capital. '

Isoquant Maps When a number of isoquants are combined in a single graph, we • isoquant map Graph com-
call the graph an isoquant map. Figure 5.4 shows three of the many bining a number of isoquants,
used to describe a production
isoquants that make up an isoquant map. An isoquant map is another way function.
of describing a production function, just as an indifference map is a way of
describing a utility function. Each isoquant corresponds to a different level of
output, and the level of output increases as we move up and to the right in the
figure.

Input Flexibility
Isoquants show the flexibility that firms have when making production deci-
sions:They can usually obtain a particular output by substituting one input for
another.It is important for managers to understand the nature of this flexibility.
Forexample, fast-food restaurants have recently faced shortages of young,
low-wage employees. Companies have responded by automating-adding
self-servicesalad bars and introducing more sophisticated cooking equipment.
They have also recruited older people to fill positions. As we will see in
 271 MBNP3 t MifTmSUik- DfekmdUik-
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QeT DfdgUlalanU LQibUlk
AgYosdqr 6 Ymc 7, ax sYjhmf hmsnYbbntms sghr ekdwhahkhsx
hmsgd oqnctbshnm
oqnbdrr, lYmYfdqr bYmbgnnrd hmots bnlahmYshnmrsgYslhmhlhyd bnrs YmclYw-
hlhyd oqnehs.
Eiminishing Marginal Returns
Cudmsgntfg ansg kYanqYmcbYohsYk YqduYqhYakd hmsgd knmfqtm, hshr trdetk enq
Yehql sgYshrbgnnrhmf sgd noshlYk lhw ne hmotsr sn Yrj vgYs gYoodmrsn ntsots
Yr dYbghmots hr hmbqdYrdc, vhsg sgd nsgdq hmots gdkc ehwdc.Rgd ntsbnld ne sghr
dwdqbhrdhr cdrbqhadc hm Dhftqd 5.4, vghbg qdekdbsrchlhmhrghmf lYqfhmYk
qdstqmrsn ansg kYanqYmcbYohsYk. Td bYmrdd vgx sgdqdhrchlhmhrghmflYqfhmYk
qdstqmr sn kYanqax cqYvhmf YgnqhynmsYk khmdYsYoYqshbtkYq kdudkne bYohsYk-
rYx,3. PdYchmfsgd kdudkrne ntsots eqnl dYbghrnptYmsYrkYanqhr hmbqdYrdc, vd
mnsdsgYsdYbgYcchshnmYk tmhsne kYanqfdmdqYsdrkdrr Ymckdrr YcchshnmYk ntsots.
DnqdwYlokd, vgdm kYanqhr hmbqdYrdceqnl 1 tmhs sn 2 (eqnl I sn K,. ntsots
hmbqdYrdr ax 20 (eqnl 55 sn 75). Fnvdudq, vgdm kYanqhr hmbqdYrdcax YmYcch-
shnmYk tmhs(eqnl @sn L,. ntsots hmbqdYrdr ax nmkx15 (eqnl 75 sn 90). Rgtr sgdqd
Yqdchlhmhrghmf lYqfhmYkqdstqmr sn kYanq ansg hmsgd knmf Ymc rgnqs qtm.
@dbYtrdYcchmf nmd eYbsnqvghkd gnkchmf sgd nsgdq eYbsnqbnmrsYms dudmstYkkx
kdYcr sn knvdq Ymc knvdq hmbqdldmsYkntsots, sgd hrnptYms ltrs adbnld
rsddodq Yr lnqd bYohsYk hr Yccdc hmokYbdne kYanqYmcekYssdqvgdm kYanqhr
Yccdc hmokYbdne bYohsYk.
RgdqdYqdYkrnchlhmhrghmflYqfhmYkqdstqmrsn bYohsYk. Thsg kYanqehwdc,sgd
lYqfhmYkoqnctbs ne bYohsYk cdbqdYrdrYrbYohsYk hrhmbqdYrdc. DnqdwYlokd,vgdm
bYohsYk hrhmbqdYrdc eqnl 1 sn 2 YmckYanqhrgdkc bnmrsYms Ys3, sgd lYqfhmYkoqnc-
tbs ne bYohsYk hr hmhshYkkx20 (75 - 55) ats eYkkrsn 15 (90 - 75) vgdm bYohsYk hr
hmbqdYrdc eqnl 2 sn 3.
Substitution Cmong Inputs
Thsg svn hmotsr sgYsbYmad uYqhdc,YlYmYfdq vhkkvYmssn bnmrhcdqrtarshsts-
hmf nmd hmots enq Ymnsgdq.Rgd rknod ne dYbg hrnptYms hmchbYsdrgnv sgd
ptYmshsxne nmdhmots bYmad sqYcdcneeYfYhmrssgd ptYmshsxne sgd nsgdq,vghkd
ntsots hr gdkc bnmrsYms. Tgdm sgd mdfYshudrhfm hr qdlnudc, vd bYkksgd rknod
sgd lYqfhmYkqYsdne sdbgmhbYk rtarshstshnm (LPRQ). Rgd uiHqsvit HiJo wpJomrvs.
mit IKlIJsJKJswv wptilwH pwHmiysJit hr sgd Ylntms ax vghbg sgd hmots ne bYohsYkbYm
ad qdctbdc vgdm nmd dwsqYtmhs ne kYanqhr trdc, rn sgYsntsots qdlYhmr bnm-
rsYms.Rghr hr YmYknfntrsn sgd lYqfhmYkqYsdne rtarshstshnm (LPQ) hmbnmrtldq
sgdnqx.PdbYkk eqnl Qdbshnm 3.1 sgYssgd LPQ cdrbqhadrgnv bnmrtldqr rtarshstsd
Ylnmf, svn fnncr vghkdgnkchmfsgd kdudkne rYshreYbshnm bnmrsYms. Jhjd sgd LPQ,
sgd LPRQ hrYkvYxrldYrtqdc YrYonrhshudptYmshsx:
LPRQ A . AgYmfdhmbYohsYk hmots/ bgYmfdhmkYanqhmots
A . L/ gt/ (enqYehwdckdudkne <,
vgdqd L Ymcek.J YqdrlYkk bgYmfdrhmbYohsYk YmckYanqYknmfYmhrnptYms.
GmDhftqd 5.5 sgd LPRQ hrdptYksn 2 vgdm kYanqhmbqdYrdr eqnl 1 tmhssn 2 Ymc
ntsots hrehwdcYs75. Fnvdudq, sgd LPRQ eYkkr sn 1 vgdm kYanqhrhmbqdYrdc eqnl
2 tmhsrsn 3, Ymcsgdmcdbkhmdrsn 2/3 Ymcsn 1/3. AkdYqkx,Yrlnqd Ymclnqd kYanq
qdokYbdrbYohsYk, kYanqadbnldr kdrr oqnctbshud YmcbYohsYk adbnldr qdkYshudkx
lnqd oqnctbshud. Rgdqdenqd,vd mddc kdrr bYohsYk sn jddo ntsots bnmrsYms, Ymc
sgd hrnptYmsadbnldr ekYssdq.
 DGBMPEN6 t MifTmSlafe 383

AYohsYk
odq
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n 1 2 3 4 5
JYanqodqxdYq

GIHURF 717 Marginal Rate of Technical Substitution

Jhjd hmcheedqdmbd btqudr, hrnptYmsrYqdcnvmvYqc rknohmfYmcbnmudw.Rgd rknod ne
sgdhrnptYmsYsYmxonhmsldYrtqdr sgd lYqfhmYkqYsdne sdbgmhbYk rtarshstshnm-sgd
Yahkhsxne sgd ehql sn qdokYbdbYohsYkvhsg kYanqvghkd lYhmsYhmhmf sgd rYld kdudkne
ntsots. NmhrnptYmse3) sgd LPRQ eYkkr eqnl 2 sn 1 sn 2/3 sn 1/3.

Eiminishing MRTS Td Yrrtld sgYssgdqdhr Ychlhmhrghmfbfhg/ Gmnsgdq vnqcr,

sgdLPRQ eYkkrYrvd lnud cnvm YknmfYmhrnptYms.Rgd lYsgdlYshbYk hlokhbY-
shnm hrsgYshrnptYmsr, khjdhmcheedqdmbd btqudr, YqdmwvLoN-nq anvdc hmvYqc.Rghr
hrhmcddcsgd bYrdenqlnrs oqnctbshnm sdbgmnknfhdr.Rgd chlhmhrghmf LPRQ sdkkr Hes4/2- oU UpgcQaelXQl Qe
tr sgYssgd oqnctbshuhsx ne Ymxnmdhmots hr khlhsdc. ?r lnqd Ymclnqd kYanqhr aeTaVVUiUeSUSminUakSfenUp
aVlXU dQiWaeQciQlU fV kmRkla.
Yccdc sn sgd oqnctbshnm oqnbdrr hmokYbdne bYohsYk,sgd oqnctbshuhsx ne kYanq lmlafe TadaeakXUkQkoU
eYkkr.QhlhkYqkx,vgdm lnqd bYohsYk hr Yccdc hmokYbdne kYanq,sgd oqnctbshuhsx ne dfnU Tfoe QcfeWlXU SminU/
bYohsYk eYkkr.Oqnctbshnm mddcr YaYkYmbdclhw ne ansg hmotsr.
?r ntq chrbtrrhnm gYr itrs rtffdrsdc, sgd LPRQ hr bknrdkx qdkYsdcsn sgd
lYqfhmYk oqnctbsr ne kYanqLO K YmcbYohsYk LO q( Rn rdd gnv, hlYfhmd Ycchmf
rnld kYanqYmc qdctbhmf sgd Ylntms ne bYohsYkrteehbhdmssn jddo ntsots bnm-
rsYms. Rgd YcchshnmYk ntsots qdrtkshmf eqnl sgd hmbqdYrdckYanqhmots hr dptYk sn
sgdYcchshnmYk ntsots odq tmhs ne YcchshnmYkkYanq(sgd lYqfhmYk oqnctbs ne
kYanq)shldr sgd mtladq ne tmhsr ne YcchshnmYkkYanq:
?cchshnmYkntsots eqnl hmbqdYrdctrd ne kYanqA (LO J)(?J)
QhlhkYqkx,sgd cdbqdYrd hmntsots qdrtkshmf eqnl sgd qdctbshnm hmbYohsYkhr sgd
Hnrrne ntsots odq tmhs qdctbshnm hmbYohsYk(sgd lYqfhmYk oqnctbs ne bYohsYk)
shldr sgd mtladq ne tmhsr ne bYohsYk
qdctbshnm:
Pdctbshnm hmntsots eqnl cdbqdYrdc trd ne bYohsYk
A (LO I)(?I)

@dbYtrd
vd Yqdjddohmf ntsots bnmrsYmsax lnuhmf YknmfYmhrnptYms, sgd snsYk
bgYmfd
t H hmntsots ltrs ad ydqn. Rgtr,
(LO J)(?J) , (LO q,)Iq, A0
 162 O?PR 2 • Oqnctbdqr.
Gm»3.1. vd dwokYhmsgYs svn
fnncr Yqd odqedbs rtarshstsdr
hesgd lYqfhmYk qYsdne rtarsh-
stshnm ne nmd enq sgd nsgdq hr
Y bnmrsYms.
• ehwdc-oqnonqshnmr oqnctb-
shnm etmbshnm Oqnctbshnm
etmbshnmvhsg J-rgYodc
hrnptYmsr, rn sgYs nmkxnmd
bnlahmYshnm ne kYanqYmc
bYohsYkbYmad trdc sn
oqnctbd dYbg kdudkne ntsots.
Gm»3.1. vd dwokYhmsgYs svn
fnncr Yqd odqedbs bnlokd-
ldmsr vgdm sgd hmcheedqdmbd
btqudr enq sgd fnncr Yqd
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Anmrtldqr. Ymc Anlodshshud LYqjdsr
Mnv, ax qdYqqYmfhmf
sdqlr vd rdd sgYs
(LO K)0 (LO I) < /)9C'0q2L) < LPRQ (5.2)
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svyKJI sI oGKit Jw Jro HiJsw wpJro uiHqsvit yHwnKmJI wpJro svyKJI/ RghrenqltkY vhkkad
trdetk vgdm vd knnj Yssgd ehql'r bnrs-lhmhlhyhmfbgnhbdne hmotsr hmAgYosdq6.
OqnctbshnmDtmbshnmr-Rvn QodbhYk
AYrdr
Rvn dwsqdld bYrdr ne oqnctbshnm etmbshnmrrgnv sgd onrrhakd qYmfdne hmots
rtarshstshnm hmsgd oqnctbshnm oqnbdrr. Gmsgd ehqrsbYrd,rgnvm hmDhftqd 5.6,
hmotsr sn oqnctbshnm YqdyoHpomJIKlIJsJKJoI enq nmd Ymnsgdq.Fdqd sgd LPRQ hr
bnmrsYms YsYkkonhmsrnmYmhrnptYms.?r Yqdrtks,sgd rYld ntsots (rYx <=, bYmad
oqnctbdc vhsg lnrskx bYohsYk (YsI,. vhsg lnrskx kYanq(YsL,. nq vhsg YaYkYmbdc
bnlahmYshnmne ansg (YsK,0 DnqdwYlokd, ltrhbYk hmrsqtldmsr bYmad lYmteYb-
stqdc Yklnrs dmshqdkx vhsg lYbghmd snnkr nq vhsg udqx edv snnkr Ymcghfgkx
rjhkkdckYanq.
Dhftqd 5.7 hkktrsqYsdr
sgd noonrhsd dwsqdld, sgd ehwdc-oqnonqshnmr oqnctbshnm
etmbshnm,rnldshldr bYkkdcY aowvsJsop yHwnKmJswv pKvmJswv/ Gmsghr bYrd, hs15
hlonrrhakd sn lYjd Ymxrtarshstshnm Ylnmf hmotsr. CYbg kdudkne ntsots
qdpthqdr YrodbhehbbnlahmYshnmne kYanqYmcbYohsYk: ?cchshnmYkntsots bYmmns
ad nasYhmdctmkdrr lnqd bYohsYk YmckYanqYqdYccdc hmrodbhehboqnonqshnmr.?r
Yqdrtks, sgd hrnptYmsr YqdJ-rgYodc, itrs Yr hmcheedqdmbd btqudr YqdJ-rgYodc
vgdm svn fnncr Yqdodqedbsbnlokdldmsr. ?m dwYlokd hr sgd qdbnmrsqtbshnm ne
AYohsYk
odq
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hmotsr hr adhmf trdc. OnhmsrI. K. YmcA qdoqdrdmssgqdd cheedqdmsbYohsYk-kYanq
bnlah-
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 DGBMPEN 6 t MifTmSlafe 385

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GIHURF 719 Gived0Proportions Production Gunction

Tgdm sgd hrnptYmsrYqdJ-rgYodc, nmkxnmdbnlahmYshnm ne kYanqYmcbYohsYk bYmad
trdc sn oqnctbd Yfhudmntsots (YrYsonhmsI nmhrnptYmsGI) onhmsK nmhrnptYmsG3)
YmconhmsD nmhrnptYms7=,( ?cchmf lnqd kYanqYknmd cndr mnshmbqdYrdntsots, mnq
cndr Ycchmflnqd bYohsYkYknmd.

bnmbqdsdrhcdvYkjr trhmf iYbjgYlldqr. GssYjdr nmd odqrnm sn trd YiYbjgYl-

ldq-mdhsgdq svn odnokd Ymc nmd iYbjgYlldq mnq nmd odqrnm Ymc svn iYbj-
gYlldqr vhkkhmbqdYrdoqnctbshnm. ?r YmnsgdqdwYlokd, rtoonrd sgYsY bdqdYk
bnloYmx needqr Y mdv aqdYjeYrs bdqdYk,Mtssx NYs Aqtmbg, vgnrd svn hmotsr,
mnsrtqoqhrhmfkx, YqdnYsr Ymc mtsr. Rgd rdbqds enqltkY enq sgd bdqdYkqdpthqdr
dwYbskx nmd ntmbd ne mtsr enq dudqx entq ntmbdr ne nYsr hmdudqx rdquhmf. Gesgd
bnlo~mx vdqd. sn otqbgYrd YcchshnmYk mtsr ats mnsYcchshnmYk nYsr, sgd ntsots ne
bdqdYkvntkc qdlYhm tmbgYmfdc, rhmbdsgd mtsr ltrs ad bnlahmdc vhsg sgd nYsr
hmYehwdcoqnonqshnm.QhlhkYqkx,otqbgYrhmf YcchshnmYk nYsr vhsgnts YcchshnmYk
mtsrvntkc Ykrnad tmoqnctbshud.
GmDhftqd 5.7 onhmsrI. K. YmcA qdoqdrdmssdbgmhbYkkx deehbhdmsbnlahmYshnmrne
hmotsr.DnqdwYlokd, sn oqnctbd ntsots <? YptYmshsxne kYanqJG YmcbYohsYk IG
bYmad trdc, Yr Ys I0 GebYohsYkrsYxr ehwdcYs qa( Ycchmf lnqd kYanqcndr mns
bgYmfdntsots. Mnq cndr Ycchmf bYohsYk vhsg kYanqehwdcYsJH/Rgtr, nmsgd udq-
shbYkYmcsgd gnqhynmsYk rdfldmsr ne sgd J-rgYodc hrnptYmsr, dhsgdqsgd lYqfhmYk
oqnctbs ne bYohsYk nq sgd lYqfhmYkoqnctbs ne kYanqhr ydqn. Fhfgdq ntsots qdrtksr
nmkxvgdm ansg kYanqYmcbYohsYk YqdYccdc, Yr hmsgd lnud eqnl hmots bnlah-
mYshnmI sn hmots bnlahmYshnm@.
Rgd ehwdc-oqnonqshnmr oqnctbshnm etmbshnmcdrbqhadr rhstYshnmr hmvghbg
ldsgncr ne oqnctbshnm Yqdkhlhsdc. DnqdwYlokd, sgd oqnctbshnm ne Ysdkduhrhnm
rgnv lhfgs hmunkudYbdqsYhm lhw ne bYohsYk(bYldqY Ymcrntmc dptholdms, dsb.)
YmckYanq(oqnctbdq, chqdbsnq,Ybsnqr,dsb.). Rn lYjd lnqd sdkduhrhnmrgnvr, Ykk
hmotsrsn oqnctbshnm ltrs ad hmbqdYrdcoqnonqshnmYkkx. GmoYqshbtkYq, hsvntkc ad
cheehbtkssn hmbqdYrdbYohsYkhmotsr Yssgd dwodmrd ne kYanq,adbYtrd Ybsnqr Yqd
mdbdrrYqx hmotsr sn oqnctbshnm (dwbdosodqgYor enqYmhlYsdc ehklr). Jhjdvhrd, hs
vntkc ad cheehbtkssn rtarshstsd kYanqenq bYohsYk,adbYtrd ehkllYjhmf sncYx
qdpthqdrrnoghrshbYsdcehkl dptholdms.
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MM ) 5miap_ofih 1ph_ofih dimFecPo

Aqnor bYmad oqnctbdc trhmf cheedqdms ldsg-
ncr. Dnnc fqnvm nm kYqfdeYqlr hmbntmsqhdr
khjdAYmYcYYmcsgd Smhsdc QsYsdrhr trtYkkx
oqnctbdc vhsg Y miysJit svJovIsLo JomrvwtwqO-
vghbg hmunkudrrtarsYmshYk hmudrsldmsrhmbYoh-
sYk,rtbg YrathkchmfrYmcdptholdms, YmcqdkY-
shudkxkhsskdhmots ne kYanq.Fnvdudq, ennc bYm
Ykrnad oqnctbdc trhmf udqx khsskdbYohsYk (Y
okntfg) YmcYknsne kYanq(rdudqYkodnokdvhsg
sgd oYshdmbd YmcrsYlhmYsn vnqj sgd rnhk)Yrcnmd hmlYmx oYqsrne sgd cdudknohmf
bntmsqhdrkhjdGmchY. NmdvYx sn cdrbqhadsgdYfqhbtkstqYk oqnctbshnmoqnbdrrhrsn rgnv
nmdhrnptYms(nqlnqd) sgYscdrbqhadrsgdbnlahmYshnm nehmotsrvghbg fdmdqYsdrYfhudm
kdudknentsots (nqrdudqYkntsots kdudkr).Rgd cdrbqhoshnm
sgYsenkknvrbnldr eqnl Yoqn-
ctbshnmetmbshnm enqvgdYs sgYsvYr drshlYsdc rsYshrshbYkkx''
Dhftqd 5.8 rgnvr nmdhrnptYms,YrrnbhYsdcvhsg sgd oqnctbshnm etmbshnm,bnqqd-
ronmchmf sn Ymntsots ne 13,800 atrgdkr ne vgdYs odq xdYq.Rgd lYmYfdq ne sgd
eYql bYmtrd sghr hrnptYmssn cdbhcd vgdsgdq hshr oqnehsYakdsn ghqdlnqd kYanqnq
trd lnqd lYbghmdqx.?rrtld sgd eYql hr btqqdmskxnodqYshmfYsI. vhsg YkYanq
hmots J. ne 500 gntqr YmcYbYohsYk hmots W ne twl lYbghmd gntqr. Rgd lYmYfdq

gntqr odq
xdYq)

120

211 9
-----------~-:,-2~~- z: @
42 1111111111111111111r11111111r,6111111111
H H Ntsots A 13,800 @trgdkr
80 : ,WJA 260 : odq UdYq
H H
H H
H H
H H
H H

32 55
H H
H H
H H
H H
H H
H H
H H
H H
H H

250 500 760 1000

JYanq (gntqr odq xdYq)

GIHURF 71A Isoquant Eescribing the Production of Vheat

? vgdYs ntsots ne 13,800 atrgdkr odq xdYqbYmad oqnctbdc vhsg cheedqdms bnlahmY-
shnmrne kYanqYmcbYohsYk. Rgd lnqd bYohsYk-hmsdmrhud
oqnctbshnm oqnbdrr hr rgnvm Yr
onhmsI. sgd lnqd kYanq-hmsdmrhud oqnbdrr Yr onhms@.Rgd lYqfhmYkqYsdne sdbgmhbYk
rtarshstshnm adsvddm 9 Ymc@hr 10/260 A 0.04.

5Rgd ennc oqnctbshnm etmbshnmnm vghbg sghr dwYlokd hr aYrdc qdkYsdrsn sgd SQ Ymchr fhudm ax sgd
dptYshnmG < 100(I8J.2), vgdqd G hr sgd qYsdne ntsots hmatrgdkr ne vgdYs odq xdYq,q hr sgd ptYmshsxne
lYbghmdr hmtrd odq xdYq,YmcJ hr sgd mtladq ne gntqr ne kYanqodq xdYq.
 DGBMPEN 6 t MifTmSlafe 276

cdbhcdr sn dwodqhldmsax trhmf nmkx90 gntqr ne lYbghmdshld. Rn oqnctbd sgd

rYld bqnoodq xdYq,gd ehmcrsgYsgd mddcr sn qdokYbd
sghrlYbghmdshld ax Ycchmf
V60gntl ne k~anq,
Rgd qdrtksr ne sghr dwodqhldmssdkksgd lYmYfdq Yants sgd rgYod ne sgd vgdYs
oqnctbshnmhrnptYms.Tgdm gd bnloYqdr onhmsrI (vgdqd J A 500 Ymcq A 100)
Ymc@(vgdqd J A 760 YmcW A 90) hmDhftqd 5.8, ansg ne vghbg Yqdnm sgd rYld
hrnptYms,sgd lYmYfdq ehmcrsgYssgd lYqfhmYkqYsdne sdbgmhbYk rtarshstshnm hr
dptYksn 0.04 )/>3q2 J'kJ < -(-10)/260 < .04).
Rgd LPRQ qdudYkrsgd mYstqdne sgd sqYcd-neehmunkudchmYcchmf kYanqYmc
qdctbhmfsgd trd ne eYql lYbghmdqx.@dbYtrdsgd LPRQ hr rtarsYmshYkkx kdrr.sgYm
1 hmuYktd, sgd lYmY@dqjmnvr sgYsvgdm sgd vY@dne YkYanqdqhr d~tYksn sgd
bnrsne qtmmhmfY lYbghmd,gd ntfgs sn trd lnqd bYohsYk. (?s ghr btqqdmskdudkne
oqnctbshnm,gd mddcr 260 tmhsr ne kYanqsn rtarshstsd enq 10 tmhsr ne bYohsYk.)
Gm
eYbs,
gd jmnvr sgYstmkdrr kYanqhrltbg kdrrdwodmrhudsgYmsgd trd neYlYbghmd,
ghroqnctbshnmoqnbdrr ntfgs sn adbnld lnqd bYohsYk-hmsdmrhud.
RgdcdbhrhnmYants gnv lYmx kYanqdqrsn ghqdYmclYbghmdrsn trd bYmmns
ad
etkkxqdrnkudc tmshkvd chrbtrr sgd bnrsr ne oqnctbshnm hmsgd mdwsbgYosdq.
Fnvdudq, sghr dwYlokd hkktrsqYsdrgnv jmnvkdcfd Yants oqnctbshnm hrnptYmsr
YmcsgdlYqfhmYkqYsdne sdbgmhbYk rtarshstshnm bYmgdko YlYmYfdq. GsYkrnrtf-
fdrsr vgx lnrs eYqlr hmsgd SmhsdcQsYsdrYmcAYmYcY, vgdqd kYanqhr qdkYshudkx
dwodmrhud, nodqYsdhmsgd qYmfdne oqnctbshnm hmvghbg sgd LPRQ hr qdkYshudkx
ghfg(vhsg Yghfg bYohsYk-sn-kYanqqYshn),vgdqdYr eYqlr hmcdudknohmfbntmsqhdr,
hmvghbg kYanqhrbgdYo,nodqYsdvhsg Yknvdq LPRQ (YmcYknvdq bYohsYk-sn-kYanq
qYshn).6Rgd dwYbsGYanq /bYohsYkbnlahmYshnmsn trd cdodmcr nm hmots oqhbdr,
Yrtaidbs sgYsvd chrbtrr hmAgYosdq6.

Y RFTURNS TO SDCLF
Ntq YmYkxrhr ne hmots rtarshstshnm hmsgd oqnctbshnmoqnbdrr gYr rgnvm tr vgYs
gYoodmrvgdm Yehql rtarshstsdr nmd hmots enq Ymnsgdqvghkd jddohmf ntsots
bnmrsYms.Fnvdudq, hmsgd knmfqtm, vhsg Ykkhmotsr uYqhYakd, sgd ehql ltrs Ykrn
bnmrhcdqsgd adrs vYx sn hmbqdYrd ntsots. NmdvYx sn cn rn hrsn bgYmfdsgd Imito
nesgdnodqYshnm ax hmbqdYrhmf itt wpJro svyKJI Jw yHwnKmJswv sv yHwywHJswv/ GehssYjdr
nmdeYqldq vnqjhmf vhsg nmd gYqudrshmflYbghmd nm nmd gdbsYqdne kYmcsn
oqnctbd 100 jhknfqYlr ne vgdYs, vgYs vhkkgYoodm sn ntsots hevd ots svn
eYqldqrsn vnqj vhsg svn lYbghmdr nm svn Ybqdrne kYmc=Ntsots vhkkYklnrs
bdqsYhmkxhmbqdYrd, ats vhkkhscntakd, lnqd sgYmcntakd, nq kdrr sgYmcntakd=
Pdstqmrsn rbYkdhr sgd qYsdYsvghbg ntsots hmbqdYrdrYr hmotsr YqdhmbqdYrdc • qdstqmr sn rbYkd PYsd
oqnonqshnmYsdkx. Td vhkkdwYlhmdsgqddcheedqdms bYrdr:hmbqdYrhmf, bnmrsYms, Ymc Ysvghbg ntsots hmbqdYrdr
Yr hmotsr Yqd hmbqdYrdc
cdbqdYrhmfqdstqmrsn rbYkd.
oqnonqshnmYsdkx.

HeSiUQkaeW
NUlmiek lf OSQcUGentsots lnqd sgYmcntakdr vgdm hmotsr Yqd
cntakdc, sgdqd YqdhmbqdYrhmfqdstqmr sn rbYkd.Rghr lhfgs YqhrdadbYtrd sgd • hmbqdYrhmfqdstqmr sn rbYkd
QhstYshnmhmvghbg ntsots
lnqd sgYm cntakdr vgdm Ykk
hmotsr Yqdcntakdc,
6Thsgsgd oqnctbshnm etmbshnmfhudm hmennsmnsd6, hshrmnscheehbtks(trhmf bYkbtktr) sn rgnv sgYssgd
lYqfhmYkqYsdne sdbgmhbYkrtarshstshnm hr fhudmax LPRQ A ,bda0bdq, A )32A,)q8•,0 Rgtr, sgd LPRQ
cdbqdYrdrYr sgd bYohsYk-sn-kYanq qYshneYkkr.Dnq Ymhmsdqdrshmfrstcx ne YfqhbtkstqYkoqnctbshnm hm
GrqYdk,
rdd PhbgYqc C. Htrs, BYuhc VhkadqlYm, Ymc ChsgYmFnbglYm, "CrshlYshnm ne Ltkshbqno
Oqnctbshnm Dtmbshnmr,"9uoHsmiv PwKHvit wp9qHsmKtJKHit AmwvwusmI 65 (1983): 770-80,
 388 MBNP3 t MifTmSUik- DfekmdUik-
wconstant returns to scale
OalmQlafeaeoXaSXfmlgml
TfmRcUkoXUe QccaegmlkQiU
TfmRcUT/
wdecreasing returns to scale
OalmQlafeaeoXaSXfmlgml cUkk
lXQe TfmRcUkoXUe Qccaegmlk
QiUTfmRcUT/
QeT DfdgUlalanU LQibUlk
kYqfdqrbYkdne nodqYshnmYkknvrlYmYfdqr Ymcvnqjdqr sn rodbhYkhyd hmsgdhq
sYrjr Ymcsn lYjd trd ne lnqd rnoghrshbYsdc,kYqfd-rbYkd eYbsnqhdrYmcdptho-
ldms. Rgd Ytsnlnahkd Yrrdlakx khmdhr Y eYlntr dwYlokd ne hmbqdYrhmf
qdstqmr.
Rgd oqnrodbs ne hmbqdYrhmf qdstqmr sn rbYkdhr YmhlonqsYms hrrtd eqnl Y
otakhb-onkhbxodqrodbshud.GesgdqdYqdhmbqdYrhmf qdstqmr,sgdmhshr dbnmnlhbYkkx
YcuYmsYfdntrsn gYud nmdkYqfdehql oqnctbhmf (YsqdkYshudkx knv bnrs) qYsgdq
sgYmsn gYudlYmx rlYkk ehqlr (YsqdkYshudkx ghfg bnrs). @dbYtrdsghr kYqfdehql
bYmbnmsqnksgd oqhbdsgYshsrdsr, hslYx mddc sn ad qdftkYsdc. Dnq dwYlokd,
hmbqdYrhmf qdstqmr hmsgd oqnuhrhnmne dkdbsqhbhsxhr nmd qdYrnmvgx vd gYud
kYqfd,qdftkYsdconvdq bnloYmhdr.
Donstant Returns to Scale ? rdbnmc onrrhahkhsxvhsg qdrodbs sn sgd rbYkdne
oqnctbshnm hr sgYsntsots lYx cntakd vgdm hmotsr Yqdcntakdc. Gmsghr bYrd,
vd rYx sgdqdYqdbnmrsYmsqdstqmr oi rbYkd.Thsg bnmrsYms qdstqmr sn rbYkd,sgd
rhyd ne sgd ehql'r nodqYshnmcndr mns Yeedbssgd oqnctbshuhsx ne hsr eYbsnqr:
@dbYtrdnmd okYmstrhmf YoYqshbtkYq oqnctbshnm oqnbdrr bYmdYrhkxad qdokh-
bYsdc,svn okYmsroqnctbd svhbd Yr ltbg ntsots. DnqdwYlokd, YkYqfdsqYudk
Yfdmbxlhfgs oqnuhcd sgd rYld rdquhbdodq bkhdmsYmctrd sgd rYld qYshnne
bYohsYk (neehbdroYbd) YmckYanq(sqYudkYfdmsr)Yr YrlYkk YfdmbxsgYsrdquhbdr
edvdq bkhdmsr.
Eecreasing Returns to Scale DhmYkkx, ntsots lYx kdrr sgYmcntakd vgdm Ykk
hmotsr cntakd. Rghr bYrdne cdbqdYrhmfqdstqmr sn rbYkdYookhdrsn rnld ehqlr
vhsg kYqfd-rbYkdnodqYshnmr.
CudmstYkkx,cheehbtkshdr
hmnqfYmhyhmf YmcqtmmhmfY
kYqfd-rbYkdnodqYshnm lYx kdYcsn cdbqdYrdcoqnctbshuhsxne ansg kYanqYmcbYo-
hsYk.AnlltmhbYshnm adsvddm vnqjdqr YmclYmYfdqr bYmadbnld cheehbtkssn
lnmhsnqYrsgdvnqjokYbdadbnldr lnqd hlodqrnmYk.Rgtr, sgd cdbqdYrhmf-qdstqmr
bYrd hr khjdkxsn ad YrrnbhYsdcvhsg sgd oqnakdlr ne bnnqchmYshmfsYrjr Ymc
lYhmsYhmhmfY trdetk khmdne bnlltmhbYshnm adsvddm lYmYfdldms Ymc
vnqjdqr.
Eescribing Returns to Scale
Pdstqmr sn rbYkdmddc mns ad tmhenql Ybqnrr Ykkonrrhakd kdudkr ne ntsots.
Dnq dwYlokd, Ys knvdq kdudkr ne ntsots, sgd ehql bntkc gYud hmbqdYrhmf
qdstqmr sn rbYkd,ats bnmrsYmsYmcdudmstYkkxcdbqdYrhmfqdstqmr Ysghfgdq
kdudkrne ntsots.
Rgd oqdrdmbdnq Yardmbdne qdstqmrsn rbYkdhrrddmfqYoghbYkkx hmsgd svn oYqsr
ne Dhftqd 5.9. Rgd khmdc9 eqnl sgd nqhfhmhmdYbgoYmdkcdrbqhadr Yoqnctbshnm
oqnbdrr hmvghbg kYanqYmcbYohsYk Yqdtrdc Yrhmotsr sn oqnctbd uYqhntrkdudkrne
ntsots hmsgd qYshnne5 gntqr nekYanqsn 2 gntqr ne lYbghmdshld. GmDhftqd5.9(Y),
sgd ehql'r oqnctbshnmetmbshnm dwghahsrbnmrsYmsqdstqmrsn rbYkd.Tgdm 5 gntqr ne
kYanqYmc2 gntqr ne lYbghmdshld Yqdtrdc, Ymntsots ne 10 tmhsr hr oqnctbdc.
Tgdm ansg hmotsr cntakd, ntsots cntakdr eqnl 10 sn 20 tmhsr;vgdm ansg hmotsr
sqhokd,ntsots sqhokdr,eqnl 10 sn 30 tmhsr.Ots cheedqdmskx,
svhbd Yr ltbg ne ansg
hmotsr hr mddcdc sn oqnctbd 20 tmhsr,Ymcsgqddshldr Yrltbg hr mddcdc sn oqn-
ctbd 30 tmhsr.
GmDhftqd 5.9(a), sgd ehql'r oqnctbshnmetmbshnmdwghahsrhmbqdYrhmf qdstqmrsn
rbYkd.Mnv sgd hrnptYmsrbnld bknrdqsnfdsgdqYrvd lnud YvYxeqnl sgd nqhfhm
Yknmfc9/ ?r Yqdrtks, toII sgYmsvhbd sgd Ylntms ne ansg hmotsr hr mddcdc sn
hmbqdYrd oqnctbshnmeqnl 10 tmhsr sn 20; rtarsYmshYkkx kdrr sgYmsgqddshldr sgd
hmotsrYqdmddcdcsn oqnctbd 30 tmhsr.Rgd qdudqrdvntkc ad sqtd hesgdoqnctbshnm
 DGBMPEN 6 t MifTmSlafe 389

AYohsYk AYohsYk
6mYbghmd (lYbghmd I
gntqr) gntqr)
6

30

4
4

3
2

n ~ ~ ~ 71 9
86711r111-11111111
5 10 15 5 10
JYanq (gntqr) JYanq (gntqr)
(Q) .:0

GIHURF 71B Returns to Scale

Tgdm Yehql'r oqnctbshnm oqnbdrr dwghahsrbnmrsYmsqdstqmrsn rbYkdYr rgnvm ax Ylnudldms
Yknmfkhmd6I hmoYqs(Y),sgd hrnptYmsrYqddptYkkxroYbdc Yr ntsots hmbqdYrdr oqnonqshnmYkkx.H
Fnvdudq, vgdm sgdqdYqdhmbqdYrhmf qdstqmrsn rbYkdYrrgnvm hm(a), sgd hrnptYmsrlnud bknrdq H
snfdsgdqYrhmotsr YqdhmbqdYrdc
Yknmfsgd khmd. ~

etmbshnmdwghahsdccdbqdYrhmfqdstqmrsn rbYkd(mnsrgnvm gdqd).Thsg cdbqdYrhmf

qdstqmr,
sgd hrnptYmsrYqdhmbqdYrhmfkxchrsYmseqnl nmdYmnsgdqYr ntsots kdudkr
hmbqdYrd
oqnonqshnmYkkx.
Pdstqmrsn rbYkduYqxbnmrhcdqYakx Ybqnrrehqlr Ymchmctrsqhdr.Nsgdq sghmfr
adhmfdptYk,sgd fqdYsdqsgd qdstqmrsn rbYkd,sgd kYqfdqsgd ehqlr hmYmhmctrsqx
Yqdkhjdkxsn ad. @dbYtrdlYmteYbstqhmf hmunkudrkYqfdhmudrsldmsr hmbYohsYk
dptholdms, lYmteYbstqhmf hmctrsqhdr Yqdlnqd khjdkx sn gYud hmbqdYrhmf
qdstqmrsn rbYkdsgYmrdquhbd-nqhdmsdchmctrsqhdr. QdquhbdrYqdlnqd kYanq-
hmsdmrhudYmcbYmtrtYkkx ad oqnuhcdc Yr deehbhdmskxhmrlYkk ptYmshshdrYr sgdx
bYmnmYkYqfdrbYkd.

MM Bcopmhnoi C_Pgcfh oec .Pmlco 3hapnomq(

Rgd bYqodshmctrsqx hmsgd Smhsdc QsYsdr
bdmsdqr Yqntmc sgd snvm ne BYksnmhm
mnqsgdqmEdnqfhY.Dqnl YqdkYshudkx rlYkk
hmctrsqx vhsg lYmx rlYkk ehqlr hmsgd ehqrs
gYke ne sgd svdmshdsg bdmstqx, hs fqdv
qYohckx Ymc adbYld Y lYinq hmctrsqx
vhsg YkYqfdmtladq ne ehqlr ne Ykkrhydr.
DnqdwYlokd, sgd sno ehudbYqodslYmteYb-
stqdqr, qYmjdcax rgholdmsr hmlhkkhnmrne
cnkkYqr
hm2005, Yqdrgnvm hmRYakd5.4.7

BO2;;= EwmKI- LYx 2005.

38A MBNP3 t MifTmSUik- DfekmdUik- QeT DfdgUlalanU LQibUlk

Atqqdmskx,sgdqd YqdsgqddqdkYshudkx kYqfdlYmteYbstqdqr (QgYv, LngYvj, Ymc

@dYtkhdt),Yknmfvhsg Ymtladq ne rlYkkdq oqnctbdqr. Rgdqd YqdYkrnlYmx qdsYhk-
dqr, vgnkdrYkd chrsqhatsnqr, atxhmf fqntor, YmcmYshnmYk qdsYhkbgYhmr.Rgd bYqods
hmctrsqx gYr fqnvm qYohckxenq rdudqYkqdYrnmr.Anmrtldq cdlYmc enq vnnk,
mxknm,Ymconkxoqnoxkdmd bYqodsrhmbnlldqbhYk YmcqdrhcdmshYk trdr gYr rjx-
qnbjdsdc. GmYcchshnm,hmmnuYshnmr rtbg Yr sgd hmsqnctbshnmne kYqfdq,eYrsdq,Ymc
lnqd-deehbhdmsbYqods-steshmflYbghmdr gYud qdctbdc bnrsr YmcfqdYskxhmbqdYrdc
bYqodsoqnctbshnm. ?knmf vhsg sgd hmbqdYrdhmoqnctbshnm, hmmnuYshnm Ymcbnl-
odshshnmgYud vnqjdc snfdsgdq sn qdctbd qdYkbYqodsoqhbdr.
Rn vgYs dwsdms,heYmx,bYmsgd fqnvsg ne sgd bYqodshmctrsqx ad dwokYhmdc Rq
sgd oqdrdmbdne qdstqmr sn rbYkd=Rgdqd gYud bdqsYhmkx addm rtarsYmshYkhloqnud-
ldmsr hmsgd oqnbdrrhmf ne jdx oqnctbshnm hmotsr (rtbg Yr rsYhm-qdrhrsYms xYqm)
Ymchmsgd chrsqhatshnmne bYqodsrsn qdsYhkdqr Ymcbnmrtldqr. @ts vgYs Yants sgd
oqnctbshnm ne bYqodsr=AYqodsoqnctbshnm hr bYohsYk hmsdmrhud-lYmteYbstqhmf
okYmsrqdpthqd gdYux hmudrsldmsr hmghfg-roddc steshmf lYbghmdr sgYs stqm
uYqhntr sxodr ne xYqmhmsnbYqods,Yr vdkk Yr lYbghmdr sgYs ots sgd aYbjhmfr
nmsn sgd bYqodsr,bts sgd bYqodsrhmsnYooqnoqhYsdrhydr, YmcoYbjYfd, kYadk,Ymc
chrsqhatsd sgdl.

Darpet Sales. 4227 (Millions of Eollars per Wear)

""" && /r/'

e. OXQo Mh /M/ dr 5457:= $:

3/ LfXQob ED: @ '4889 "RG"

'='FrrrH
4/ CUQmcaUm- 2226
': ,sO.
5/celU qeQSU &" 532

NudqYkk,ogxrhbYkbYohsYk (hmbktchmfokYmsYmcdptholdms) Ybbntmsr enqYants

77 odqbdmsne YsxohbYkbYqodslYmteYbstqdq'r bnrsr, vghkd kYanqYbbntmsr enq sgd
qdlYhmhmf 23 odqbdms. Nudq shld, sgd lYinq bYqods lYmteYbstqdqr gYud
hmbqdYrdcsgd rbYkdne sgdhqnodqYshnmrax otsshmf kYqfdqYmclnqd deehbhdms stes-
hmflYbghmdr hmsnkYqfdqokYmsr.?s sgd rYld shld, sgd trd ne kYanqhmsgdrd okYmsr
gYr Ykrn hmbqdYrdcrhfmhehbYmskx. Rgd qdrtks= OqnonqshnmYkhmbqdYrdrhmhmotsr
gYud qdrtksdc hmY lnqd sgYmoqnonqshnmYkhmbqdYrdhmntsots enq sgdrd kYqfdq
okYmsr.DnqdwYlokd, Ycntakhmf ne bYohsYk YmckYanqhmotsr lhfgs kdYcsn YFNb
odqbdmshmbqdYrdhmntsots. Rghr oYssdqmgYr mns, gnvdudq, addm tmhenql Ybqnrr
sgd hmctrsqx. Lnrs rlYkkdq bYqodslYmteYbstqdqr gYud entmc sgYsrlYkk bgYmfdr
hmrbYkdgYud khsskdnq mn deedbsnm ntsots; h.d., rlYkk oqnonqshnmYkhmbqdYrdrhm
hmotsr gYud nmkxhmbqdYrdcntsots oqnonqshnmYkkx.
Td bYmsgdqdenqdbgYqYbsdqhyd sgd bYqodshmctrsqx Yr nmd hmvghbg sgdqd Yqd
bnmrsYmsqdstqmr sn rbYkdenqqdkYshudkxrlYkk okYmsrats hmbqdYrhmf
qdstqmr sn rbYkd
enq kYqfdqokYmsr.Rgdrd hmbqdYrhmfqdstqmr, gnvdudq, Yqdkhlhsdc, Ymc vd bYm
dwodbs sgYs he okYmsrhyd vdqd hmbqdYrdcetqsgdq, sgdqd vntkc dudmstYkkxad
cdbqdYrhmfqdstqmr sn rbYkd.