Chapter 7

PRODUCTION FUNCTIONS

Copyright ©2005 by South-Western, a division of Thomson Learning. All rights reserved. 1

 Production with
One Variable Input (Labor)

• Observations:

With additional workers, output (Q)

increases, reaches a maximum, and
then decreases.
 Production with
One Variable Input (Labor)

• Observations:

2) The average product of labor (AP),

or output per worker, increases and
then decreases.

Output Q
AP  
Labor Input L
 Production with
One Variable Input (Labor)

• Observations:

3) The marginal product of labor (MP),

or output of the additional worker,
increases rapidly initially and then
decreases and becomes negative..

Output Q
MPL  
Labor Input L
 Production with
One Variable Input (Labor)
Output
per
Month D
112

C Total Product

60 A: slope of tangent = MP (20)

B
B: slope of OB = AP (20)
C: slope of OC= MP & AP
A

0 1 2 3 4 5 6 7 8 9 10 Labor per Month

 Production with
One Variable Input (Labor)
Outpu
t Observations:
per Left of E: MP > AP & AP is increasing
Month Right of E: MP < AP & AP is decreasing
E: MP = AP & AP is at its maximum
30
Marginal Product

E Average Product
20

10

0 1 2 3 4 5 6 7 8 9 10 Labor per Month

 Production with
One Variable Input (Labor)

• Observations:
– When MP = 0, TP is at its maximum
– When MP > AP, AP is increasing
– When MP < AP, AP is decreasing
– When MP = AP, AP is at its maximum

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 Production with
One Variable Input (Labor)
AP = slope of line from origin to a point on TP, lines b, & c.
MP = slope of a tangent to any point on the TP line, lines a & c.
Output Output
per per
Month D Month
112

C 30
E
60 20
B

A 10
Labor Labor
0 1 2 3 4 5 6 7 8 9 10 0 1 2 3 4 5 6 7 8 9 10 per Month
per Month
 Production with
One Variable Input (Labor)

The Law of Diminishing Marginal Returns

• As the use of an input increases in

equal increments, a point will be
reached at which the resulting additions
to output decreases (i.e. MP declines).
 Production with
One Variable Input (Labor)

The Law of Diminishing Marginal Returns

• When the labor input is small, MP

increases due to specialization.

• When the labor input is large, MP

decreases due to inefficiencies.
 Production with
One Variable Input (Labor)

The Law of Diminishing Marginal Returns

• Can be used for long-run decisions to

evaluate the trade-offs of different plant
configurations
• Assumes the quality of the variable
input is constant
 Production with
One Variable Input (Labor)

The Law of Diminishing Marginal Returns

• Explains a declining MP, not necessarily

a negative one
• Assumes a constant technology

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 The Effect of
Technological Improvement
Output
per Labor productivity
time C can increase if there
period are improvements in
technology, even though
100 any given production
B O3 process exhibits
diminishing returns to
labor.

A
50 O2

O1

Labor per
time period
0 1 2 3 4 5 6 7 8 9 10
 Production Function with 2 input
• The firm’s production function for a
particular good (q) shows the maximum
amount of the good that can be produced
using alternative combinations of capital
(k) and labor (l)

q = f(k,l)

14
 Marginal Physical Product
• To study variation in a single input, we
define marginal physical product as the
additional output that can be produced by
employing one more unit of that input
while holding other inputs constant
q
marginal physical product of capital  MPk   fk
k
q
marginal physical product of labor  MPl   fl
l 15
 Diminishing Marginal
Productivity
• The marginal physical product of an input
depends on how much of that input is
used
• In general, we assume diminishing
marginal productivity

MPk  2f MPl  2f
 2  fkk  f11  0  2  fll  f22  0
k k l l
16
 Diminishing Marginal
Productivity
• Because of diminishing marginal
productivity, 19th century economist
Thomas Malthus worried about the effect
of population growth on labor productivity
• But changes in the marginal productivity of
labor over time also depend on changes in
other inputs such as capital
– we need to consider flk which is often > 0
17
 Average Physical Product
• Labor productivity is often measured by
average productivity
output q f (k, l )
APl   
labor input l l

• Note that APl also depends on the

amount of capital employed

18
 A Two-Input Production
Function
• Suppose the production function for
flyswatters can be represented by
q = f(k,l) = 600k 2l2 - k 3l3
• To construct MPl and APl, we must
assume a value for k
– let k = 10
• The production function becomes
q = 60,000l2 - 1000l3 19
A Two-Input Production Function
• The marginal productivity function is
MPl = q/l = 120,000l - 3000l2
which diminishes as l increases
• This implies that q has a maximum value:
120,000l - 3000l2 = 0
40l = l2
l = 40
• Labor input beyond l = 40 reduces output
20
 A Two-Input Production
Function
• To find average productivity, we hold
k=10 and solve
APl = q/l = 60,000l - 1000l2
• APl reaches its maximum where
APl/l = 60,000 - 2000l = 0
l = 30

21
 A Two-Input Production
Function
• In fact, when l = 30, both APl and MPl are
equal to 900,000

• Thus, when APl is at its maximum, APl

and MPl are equal

22
 Isoquant Maps
• To illustrate the possible substitution of
one input for another, we use an
isoquant map
• An isoquant shows those combinations
of k and l that can produce a given level
of output (q0)

f(k,l) = q0
23
 Isoquant Map
• Each isoquant represents a different level
of output
– output rises as we move northeast
k per period

q = 30
q = 20

l per period
24
 Marginal Rate of Technical
Substitution (RTS)
• The slope of an isoquant shows the rate
at which l can be substituted for k
k per period
- slope = marginal rate of technical
substitution (RTS)
RTS > 0 and is diminishing for
kA
A increasing inputs of labor
B
kB
q = 20

l per period
lA lB 25
 Marginal Rate of Technical
Substitution (RTS)
• The marginal rate of technical
substitution (RTS) shows the rate at
which labor can be substituted for
capital while holding output constant
along an isoquant
 dk
RTS (l for k ) 
dl q  q0

26
RTS and Marginal Productivities
• Take the total differential of the production
function:
f f
dq   dl   dk  MPl  dl  MPk  dk
l k
• Along an isoquant dq = 0, so
MPl  dl  MPk  dk
 dk MPl
RTS (l for k )  
dl q q0 MPk
27
 Returns to Scale
• How does output respond to increases
in all inputs together?
– suppose that all inputs are doubled, would
output double?
• Returns to scale have been of interest
to economists since the days of Adam
Smith

28
 Returns to Scale
• It is possible for a production function to
exhibit constant returns to scale for some
levels of input usage and increasing or
decreasing returns for other levels
– economists refer to the degree of returns to
scale with the implicit notion that only a
fairly narrow range of variation in input
usage and the related level of output is
being considered
29
 Constant Returns to Scale
• Along a ray from the origin (constant k/l),
the RTS will be the same on all isoquants
k per period

The isoquants are equally

spaced as output expands

q=3

q=2
q=1

l per period
30
 DECREASING Returns to Scale
Capital
(machine
hours) A

Decreasing Returns:
Isoquants get further
4 apart

30
2
20
10

0 5 10
Labor (hours)
 INCREASING Returns to Scale
Capital
(machine
hours) A

Increasing Returns:
The isoquants move
closer together
4

30

2 20
10
Labor (hours)
0 5 10
 Returns to Scale
• Returns to scale can be generalized to a
production function with n inputs
q = f(x1,x2,…,xn)
• If all inputs are multiplied by a positive
constant t, we have
f(tx1,tx2,…,txn) = tkf(x1,x2,…,xn)=tkq
– If k = 1, we have constant returns to scale
– If k < 1, we have decreasing returns to scale
– If k > 1, we have increasing returns to scale
33
 Cobb-Douglas Production
Function
• Suppose that the production function is
q = f(k,l) = Akalb A,a,b > 0
• This production function can exhibit any
returns to scale
f(tk,tl) = A(tk)a(tl)b = Ata+b kalb = ta+bf(k,l)
– if a + b = 1  constant returns to scale
– if a + b > 1  increasing returns to scale
– if a + b < 1  decreasing returns to scale
34
 Cobb-Douglas Production
Function
• The Cobb-Douglas production function is
linear in logarithms
ln q = ln A + a ln k + b ln l
– a is the elasticity of output with respect to k
– b is the elasticity of output with respect to l

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TERIMAKASIH!

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