Managerial Economics Final-1 Production2

Class Lecture
Managerial Economics (Econ-5302)

Course instructor: Basharat Hossain
Department of Business Administration (DBA),
International Islamic University Chittagong (IIUC)
Theory of Production
Production transforms inputs into outputs. For instance, producing automobiles requires a
variety of inputs (also called factors of production): raw materials (steel, plastic, rubber, and
so on), factories, machines, land, and many different categories of workers.
Production Function:
The firm’s production function indicates the maximum level of output the firm can produce
for any combination of inputs.
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.
The relationship between the amount of input required and the amount of output that
can be obtained is called the production function.
Production function: Q= f (L, Lb, K, O)

L, Lb, K, O= factors of production, or input.
Q=A - Cobb Douglas production function
A= Technology/scale of the production
=Marginal productivity of capital

=Marginal productivity of labor
+ = 1, constant Returns to scale.
+ > 1, Increasing Returns to scale.
+ < 1, Decreasing Returns to scale.
Prepared by - Basharat Hossain, Assistant Professor of Economics, Dept. of Business Administration,

International Islamic University Chittagong, Bangladesh
Page 1
Factors of Production-Four
1. Land—or, more generally, natural resources— represents the gift of nature to

our societies. It consists of the land used for farming or for under- pinning
houses, factories, and roads; the energy resources that fuel our cars and heat
our homes; and the nonenergy resources like copper and iron ore and sand.
In today’s congested world, we must broaden the scope of natural resources
to include our environmental resources, such as clean air and drinkable water.
2. Labor consists of the human time spent in production—working in
automobile factories, writing software, teaching school, or baking piz- zas.
Thousands of occupations and tasks, at all skill levels, are performed by labor.
It is at once the most familiar and the most crucial input for an advanced
industrial economy. Labor includes production workers, marketers, and managers.
3. Capital resources form the durable goods of an economy, produced in order to

produce yet other goods. Capital goods include machines, roads, com- puters,
s o f t w a r e , trucks, steel mills, automobiles, washing machines, and buildings.
As we will see later, the accumulation of specialized capital goods is essential to
the task of economic development.
4. Entrepreneurship/Organization: An entrepreneur is someone who organizes,
manages, and assumes the risks of a business or enterprise. An entrepreneur is an
agent of change. Entrepreneurship is the process of discovering new ways of
combining resources. When the market value generated by this new combination of
resources is greater than the market value these resources can generate elsewhere
individually or in some other combination, the entrepreneur makes a profit
Factors Definition Price
Labor Human time spent for production in exchange of Wage /salary

money. Physical : day labor, construction &
intellectual labor: students, teacher, doctor,
engineer
Land All kinds of natural resources & Gift of Allah. Rent
Ex. Ocean, physical means of production, space,
river, mountain, forest
Capital Material used for further production & it has Profit/Interest

depreciation. Ex. Mobile hand set, laptop ,
machinery, building, chair, table,
Human capital-Knowledge, education, health
organization Legal entity for production profit

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Pricing of Factors:
Factors of Production Prices of Factors

Land Rent
Labor (L) Wage (W)
Capital (K) Interest (r)
Entrepreneurship/Organization Profit
…………………………………………………………………………………………………
Short run : financial transaction: less than 1 year
Long run: more than 1 year
Short Run Production function : Short run is a period in which firms c an adjust
production by changing variable factors such as materials and labor but cannot
change fixed factors such as capital. The short run is the period of time in which only
some inputs, the variable inputs, can be adjusted. In the short run, fixed factors,
Production function: Q=f (L, Lb, K, O)-short run
At least one factor is fixed-short run PF. K is fixed. How much time? For 5
years, short run: 5 years , fixed for a single day: short run : 1 day
Short Run Production function: Q=f (L, K) where L is variable and K is fixed.
Long Run Production function: The long run is the period in which all factors
employed by the firm, including capital, can be changed. The long run is a period
sufficiently long that all factors including capital can be adjusted.
Production function: Q=f (L, Lb, K, O)- long run. All factors are variable.
Automobile/car factory:
Long Run Production function: Q=f (L, K) where both L and K is variable

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Eample:
Restaurant Business: Production function: Q=f (L, Lb, K, O)
Lb, = Manager &staff
L, = space/building, room.
K, = furniture, chair, table, fan, AC, Cooking mateials,
O = restaurant /owner.
Consider an example, you usually serves the lunch for 500 customers. You are said to serve
lunch for 1000 customers at a time.
Land –fixed./ difficult.
Labor-variable, easily changeable.
Capital: variable, easily changeable.
Organization: efficient
Cannot manage or change the land. So it is short run production. How much time it is in the
short run:1 month, 1 year, 5 years
If managed, then it is long run production function.
………………………………………………………………………………………………….
There is no universal rule for distinguishing between the short and long run; rather, the
dividing line must be drawn on a case-by-case basis. For a petrochemical refinery, the short
run might be any period less than five years since it takes roughly this long to build a new
refinery. For a fast-food chain, six months (the time it takes to obtain zoning approvals and
construct new restaurants) may be the dividing line between the short and long run.
Inputs that cannot be changed in the short run are called fixed inputs. A firm’s production
facility is a typical example. In the long run, the firm could vary the size and scale of its
plant, whereas in the short run the size of this plant would be fixed at its existing capacity. If
a firm operates under restrictive, long term labor contracts, its ability to vary its labor force
may be limited over the contract duration, perhaps up to three years. In this case, labor could
be a fixed input in the short run.
The total product (TP) is the amount of total production. Total product is simply the total
output that is generated from the factors of production employed by a business. In most
manufacturing industries such as motor vehicles, freezers and DVD players, it is
straightforward to measure the volume of production from labour and capital inputs that are
used. But in many service or knowledge-based industries, where much of the output is
―intangible‖ or perhaps weightless we find it harder to measure productivity.

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TP=Q
The average product (AP), which equals total output divided by total units of input.
Average product is the total output divided by the number of units of the variable factor of
production employed (e.g. output per worker employed or output per unit of capital
employed)
TP=TOTAL PRODUCT=Q=500
= =10
The Marginal product (MP) of an input is the extra output produced by 1 additional
unit of that input while other inputs are held constant. Marginal product is the change in
total product when an additional unit of the variable factor of production is employed. For
example marginal product would measure the change in output that comes from increasing
the employment of labour by one person, or by adding one more machine to the production
process in the short run.
Factors /labor Q MP AP
50 500 - 10
51 512 12 10.039
Q=A
Q=100
MPL= = = 0.5*100 =

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MPK= = = 0.5*100 =
Q=100
MPL=
MPK=
Law of diminishing returns / LAW of diminishing marginal product / Law of variable

proportion: applicable for short run:
Under the law of diminishing returns, a firm will get less and less extra output when it
adds additional units of an input while holding other inputs fixed. In other words,
the marginal product of each unit of input will decline as the amount of that
input increases, holding all other inputs constant.
In the short run, the law of diminishing returns states that as we add more units of a variable
input (i.e. labour or raw materials) to fixed amounts of land and capital, the change in total
output will at first rise and then fall. Diminishing returns to labour occurs when marginal
product of labour starts to fall. This means that total output will still be rising – but increasing
at a decreasing rate as more workers are employed. As we shall see in the following
numerical example, eventually a decline in marginal product leads to a fall in average
product.
What happens to marginal product is linked directly to the productivity of each extra worker
employed. At low levels of labour input, the fixed factors of production - land and capital,
tend to be under-utilized which means that each additional worker will have plenty of capital
to use and, as a result, marginal product may rise. Beyond a certain point however, the fixed
factors of production become scarcer and new workers will not have as much capital to work
with so that the capital input becomes diluted among a larger workforce.
As a result, the marginal productivity of each worker tends to fall – this is known as the
principle of diminishing returns.
An example of the concept of diminishing returns is shown below. We assume that there is a
fixed supply of capital (e.g. 20 units) available in the production process to which extra units
of labour are added from one person through to eleven.
 Initially the marginal product of labour is rising.

 It peaks when the sixth worked is employed when the marginal product is 29.
 Marginal product then starts to fall. Total output is still increasing as we add more
labour, but at a slower rate. At this point the short run production demonstrates
diminishing returns.

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The Law of Diminishing Returns
Capital Input Labour Input Total Output Marginal Product Average Product of Labour
20 1 5 - 5
20 2 16 11 8
20 3 30 14 10
20 4 56 26 14
20 5 85 28 17
20 6 114 29 19
20 7 140 26 20
20 8 160 20 20
20 9 171 11 19
20 10 180 9 18
20 11 187 7 17
20 12 187 0 17
20 13 185 -2
Stage-1: MP is maximum, when TP is increasing at increasing rate.
Stage-2: MP is declining, when TP is increasing at decreasing rate.

MP is zero, when TP is Maximum.
Stage-3: MP is negative, when TP is falling.

Average product will continue to rise as long as the marginal product is greater than the
average – for example when the seventh worker is added the marginal gain in output is 26
and this drags the average up from 19 to 20 units. Once marginal product is below the
average as it is with the ninth worker employed (where marginal product is only 11) then the
average will decline.

Page 7
Long Run
The Law of Diminishing Returns in Graph

TP max:
187
Stage-1
Stage-2:
Rational
Stage-3
stage
114
MP
max:29
29
AP=MP=
20=20
MP
ZERO

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………………………………………………………………
Short run
Example: an office of particular company has room=4, 4 seats
in each room.
R-1 R-3
Employee 4: production 100 Recruit more 4 Employees,
8+4=12: production 300.
R-2 R-4
Employee 4+4=8: production Again Recruit more 4
200 Employees, 12+4=16:
production 400
Since output rises with the proportional change with

employee, Again we Recruit more 4 Employees, 16+4=20:
production ???? rise/fall/fixed at 400?
Long Run:
New room allocation: 4 employees.
…………………………………………………………………………………………
The shapes of the APL and MPL curves are determined by the shape of the corresponding TP
curve. The APL at any point on the TPL curve is given by the slope of the straight line from
the origin to that point on the TP curve. The APL curve usually rises at first, reaches a
maximum, and then falls, but it remains positive as long as the TP is positive.
The MPL between two points on the TP curve is equal to the slope of the TP curve between
the two points. The MPL curve also rises at first, reaches a maximum (before the APL
reaches its maximum), and then declines.
The MPL becomes zero when the TP is maximum and negative when the TP begins to
decline. The falling portion of the MPL curve illustrates the law of diminishing returns.

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Long run production - Returns to scale:
In the long run, all factors of production are variable. How the output of a business responds
to a change in factor inputs is called returns to scale. Returns to scale is the effect of
increasing all inputs on output.
1. Increasing returns to scale occur when the % change in output >

% change in inputs
2. Decreasing returns to scale occur when the % change in output
< % change in inputs
3. Constant returns to scale occur when the %
change in output = % change in inputs
Q=A - Cobb Douglas production function
A= Technology/scale of the production
=Marginal productivity of capital

=Marginal productivity of labor
+ = 1, constant Returns to scale.
+ > 1, Increasing Returns to scale.
+ < 1, Decreasing Returns to scale.
0.5+0.5=1
0.3+0.7=1
0.4+0.7=1.1
0.4+0.3=0.7

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Constant returns to scale denote a case where a change in all inputs leads to a
proportional change in output. For example, if labor, land, capital, and other
inputs are doubled, then under constant returns to scale output would also double.
Many handicraft industries (such as hair- cutting in America or handloom operation
in a developing country) show constant returns.
Increasing returns to scale (also called economies of scale) arise when an increase in all
inputs leads to a more-than-proportional increase in the level of output.
Decreasing returns to scale occur when a balanced increase of all inputs leads to a
less-than- proportional increase in total output.
Production shows increasing, decreasing, or constant returns to scale when a
balanced increase in all inputs leads to a more-than-proportional, less- than-
proportional, or just-proportional increase in output.
A numerical example of long run returns to scale
Units of Units of Total % Change in % Change in Returns to Scale

Capital Labour Output Inputs Output
20 150 3000
40 300 7500 100 150 Increasing
60 450 12000 50 60 Increasing
80 600 16000 33. 33. Constant
33 33
100 750 18000 25 12. Decreasing
5
In the example above, we increase the inputs of capital and labour by the same proportion
each time. We then compare the % change in output that comes from a given % change in
inputs.
 In our example when we double the factor inputs from (150L + 20K) to (300L + 40K)
then the percentage change in output is 150% - there are increasing returns to scale.
 In contrast, when the scale of production is changed from (600L + 80K0 to (750L +
100K) then the percentage change in output (13%) is less than the change in inputs
(25%) implying a situation of decreasing returns to scale.
Returns to scale in Graphs:

Page 11
5 10
18
10
7
14
10 10 10
Panel: A: IRTS: Economies of scale

OM>MN>NR=10>7>5=100=100=100
Panel: B: CRTS:
OG=GH=HJ=10=10=10=100=100=100
Panel: C:DRTS : Diseconomies of scale:
OS<ST<TZ=10<14<18=100=100=100
 Panel B shows constant returns to scale. It shows that when we double both inputs, we
double output; if we triple all inputs, we triple the level of output. Thus, OG = GH =
HJ (and similarly for any other ray from the origin). Note that output expands along
ray OE (and the K/L ratio remains unchanged), as long as relative factor prices remain
unchanged. (Compare panel B with panel A of Fig. 6-23, where the K/L ratio was
technologically fixed.)
 The case of increasing returns to scale is shown in panel A, where an increase in both
inputs in a given proportion causes a more than proportionate increase in output.
Thus, OM > MN > NR. Once again, if relative factor prices remain unchanged, output
expands along ray OD.
 Panel C shows decreasing returns to scale. Here, to double output per unit of time, the
firm must more than double the quantity of both inputs used per unit of time. Thus,
OS < ST < TZ.

Page 12
Economies of scale is also known as Increasing returns to scale. Information
technologies often display strong economies of scale. A good example is Microsoft’s
Windows Vista operating system. Developing this program reportedly required $10 billion
in research, development, beta-testing, and promotion. Yet the cost of adding Windows
Vista to a new computer is very close to zero because doing so simply requires a few
seconds of computer time. We will see that strong economies of scale often lead to firms
with significant market power and sometimes pose major problems of public policy.
Economies of scale, or decreasing average costs, are the major source of imperfect
competition. When firms can lower costs by expanding their output, perfect competition is
destroyed because a few companies can produce the industry’s output most efficiently. When
the minimum efficient size of plants is large relative to the national or regional market, cost
conditions produce imperfect competition.
Increasing returns to scale/ economies of scale:
1. Highly efficient: Average cost declines as production increases.

2. Efficient management, Management size is optimal to the size of
company
3. Workforce are efficient and highly qualified
4. Workers are highly satisfied
5. Facilities for worker are amazing
6. Wage = efficiency wage > market wage
7. Fired if shirking
8. Modern technology
Diseconomies of scale: Economic theory predicts that a firm may become less efficient if it
becomes too large. The additional costs of becoming too large are called diseconomies of
scale. Diseconomies of scale result in rising long run average costs which are experienced
when a firm expands beyond its optimum scale, at Q.

Page 13
C*
Q1 Q3 Q4 Q5 Q6
Q2
Examples of diseconomies of Scale include:

1. inefficient: Average cost rises as production increases.
2. inefficient management, Management size is not optimal to the size of company
3. poor communication,
4. Co-ordination problems,
5. X’ inefficiency: u r qualified but not eager to extract ur efforts, u are not satisfied.
6. Low motivation of workers in large firms,
7. the principal-agent problem
8. Wage= market wage
9. Continue job through shirking
10. Over employment/disguised unemployment.
11. Nepotism/localism
12. Branch expansion: nill/ extremely slow
Economies of scope: A different kind of efficiency arises when there are

economies of scope, which occur when a number of different products can be
produced more efficiently together than apart.
A prominent example is seen for computer software. Software programs often

incorporate additional features as they evolve. For example, when consumers buy
software to prepare their federal income taxes, the CD-ROM usually contains several
other modules, including a link to a Web page, government documents, and a tax
preparation manual. This shows economies of scope because the different modules
can be more inexpensively produced, packaged, and used together than separately.
Page 14
Economies of scope are like the specialization and division of labor that increase
productivity as economies become larger and more diversified.
Productivity grows because of technological advances such as the process and product
innovations described above. Additionally, productivity grows because of economies of scale
and scope.
X-inefficiency: Production function shows the technological relationship that shows the
maximum quantity of a commodity that can be produced per unit of time for each input
combination. However, in many real-world situations, neither labor nor management work as
hard or as efficiently as they could, so that output is not maximum. This was called X-
inefficiency by Leibenstein, who first introduced the concept.
X-inefficiency often occurs because of lack of motivation due to the absence of incentives or
competitive pressures. For example, labor contracts often do not specify a job completely,
leaving the amount and quality of effort required open to interpretation. In such cases, labor
and management often choose not to exert themselves as much as they could, leading to X-
inefficiency.
An isoquant shows the different combinations of labor (L)

and capital (K) with which a firm can produce a specific
quantity of output. A higher isoquant refers to a greater
quantity of output and a lower one, to a smaller quantity of
output.
lABOR
X
IQ3
A
L1
B
IQ2
Y
L2
IQ1
K1 K2 CAPITAL
A, B , X, Y: efficient, output is maximized.

Page 15
Isoquants have the same characteristics as indifference curves: (1) in the relevant range
isoquants are negatively sloped, (2) isoquants are convex to the origin and (3) isoquants never
cross.
Isoquants have the same characteristics as indifference curves: (1) in the relevant range
isoquants are negatively sloped, (2) isoquants are convex to the origin and (3) isoquants never
cross.
An isocost shows all the different combinations of labor and capital

that a firm can purchase, given the total outlay (TO) of the firm and
factor prices. The slope of an isocost is given by 2PL/PK, where PL
refers to the price of labor and PK to the price of capital.
p
COST
/BUDGET
=100
The marginal rate of technical substitution of L for K (MRTSLK)

refers to the amount of K that a firm can give up by increasing the
amount of L used by one unit and still remain on the same isoquant.
The MRTSLK is also equal to MPL/MPK. As the firm moves down a
isoquant, the MRTSLK diminishes.
A producer is in equilibrium when he or she maximizes

output for the given total outlay. Another-way of saying this is
that a producer is in equilibrium when the highest isoquant is
reached, given the particular isocost. This occurs where an
isoquant is tangent to the isocost. At the point of tangency, the

Page 16
absolute slope of the isoquant is equal to the absolute slope of
the isocost.
BUDGET IS
REMAINING
, NOT MEET
THE
RPODUCTIO
N TARGET
N
COST
/BUDGET
E
K1
IQ2
IQ1
IQ3
L1 M L
LABOR: 5*20=100
Capital: 5*20=100
Isocost= 100+100=200
Production target: Potato Chips =100000 pac
II= producer equilibrium, IQii touches the isocost line
N point: IQ1=cut the isocost line.

COST=100,
Potato Chips =50000 pac ? efficient? NOT EFFICIENT.
Least-cost rule: To produce a given level of output at least cost, a firm
should buy inputs until it has equalized the marginal product per
dollar spent on each input. This implies that

Page 17
10=10
If the marginal products per $1 of inputs were not equal, you could reduce the low-MP-
per-dollar input and increase the high-MP-per-dollar input and produce the same
output at lower cost.
Substitution rule: If the price of one factor falls while all other factor prices remain the
same, firms will profit by substituting the now-cheaper factor for the other factors until
the marginal products per dollar are equal for all inputs.
Optimality / Efficiency conditions:
Slope of Isoquant=Slope of Isocost
Expansion Path: is the locus of least cost equilibrium

points generated through expansion in output. Each
point of Expansion Path is characterised by the
Optimality conditions:

Page 18
Expansion path
Isocost1=6-…………….6. eqm: D,isocost=100

Isocost2=10-……………..10, eqm: M, isocost=200
Isocost3=14-……………14, eqm: P, , isocost=300
NOW WE adding D, M,P, we get another curve / line=S, that is expansion path.
K=2L
K=0.5L
……………………………………………………

Page 19
,
Expansion
I3 path
E3
I2
E2
K3
I1
K2
K1
E1
0
Labor
L3
L1 L2
Cobb-Douglas Production function:
Q=A
Q=200
=1, CRTS =0.5+0.5=1

>1, IRTS = 0.7+0.4=1.1
<1, DRTS =0.4+0.4=0.8

Page 20
Q= output
A= technology
a=marginal productivity of capital
= marginal productivity of labor
Q=A
MPL=
= 0.5 A
=0.5A
=0.5*200
=100
Q=A
MPK=
=0.5*A
=0.5A
=0.5*200
=100
…………………………………………………………………………………………………
Example:
Q=A , Q=200 ,
Page 21
A=200, W = 4, r = 2
Find out :
1. Expansion path :

Page 22
2K=4L
K*=2L…………Expansion path
………………………………………………………………………………………………
Requirement-2:
Currently, this firm produces 1000 unit of

output (Q), By using 20 Units of Labor and 30
Units of capital respectively. Is it efficient input
combination for producing 1000 unit of output?
Ans:
Q=A
Q=200
Q=200
1000=4,898.97
1000<4,898.97
No , it is not efficient input combination. Because, This firm

should produce 4,898.97 units of output by using 20 Units of
Labor and 30 Units of capital respectively. Instead it only
produces 1000 units of output.
…………………………………………………………………………………………………
Requirement-3:

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If not efficient, then find out the efficient combination of
Labor and capital to produce 1000 units of output.
Ans:
Q=A
Q=200
1000=200 ……(since K=2L in expansion path)
1000=200
1000=200
1000=200
1000=282.84
282.84 =1000
=3.53
K=2L=2*3.53=7.06
To produce 1000 units of output, the efficient combination
of Labor and capital are: =3.53, K=7.06
…………………………………………………………………………………………………

Page 24
Q=A
Q= OUTPUT
A= Scale of production/ technology=200
Q=A = Cobb-Douglas production function.
a= marginal productivity of capital

β= marginal productivity of labor
a+ β=1= CRTS=0.5+0.5=1
a+ β>1= IRTS = 0.8+0.6=1.4>1
a+ β<1= DRTS = 0.5+0.3 = 0.8<1
Q=A
0.5+0.5=1=CRTS
0.3+0.7=1
0.4+0.6=1
0.6+0.4=1
HANDICRAFT: O.1+0.9=1

Page 25
…………………………………………………….
Home work:
Q=A , W=4, r=2, A=200

Q=A
……………………………………………………………………………………………
Home work: Q=A
=2.08
=2.08
= 1.946
……………………………………………………………
Factor price determination
Factors of Production Prices of Factors

Land Rent
Labor (L) Wage (W)
Capital (K) Interest (r)
Entrepreneurship/Organization Profit
Factor price determination

 Demand Supply
Page 26
Ls
W*eff=50
Ls1
W*=40
W*=30 Ld
QL
L* L1
 Production process-Islamic economics

 Ex: educational cost of a Business graduate
 CS-PS: consumer’s surplus, producer’s surplus-

Islamic economics
Ls
W*=40
PS=10
W*=30
LS=05 Ld
C=25
QL
L*
PRODUCT
S

Page 27
P=40
CS=10
P*=30
PS=15 d
C=15
Q
Q*
 Marginal Productivity
 Scarcity: price is extremely higher: price
according to the buying cost
 Justice/insaaf-Islamic economics
 Humanity/EHSAAN-Islamic economics
 Characteristics of land, capital (speculation,
forgery)
 Labor qualifications: Norway, Finland, Sweden
Optimal employment/use of a factor/input: A firm should buy/hire a factor until it

equalizes the Marginal Revenue Product to its prices. To maximize profits, firms should add
inputs up to the point where the marginal revenue product of the input equals the marginal
cost or price of the input.
MRPL = W
Marginal Revenue product of Labor = Wage
MPL*P = W
Marginal Product of Labor*Price of the Product = wage
1000*100 =100000
MRPK = r
MPK*P = r
1000*100 = 100000
………………………………………………………………………………………………

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Example:
Price of the product: 50

K=30
W=6
r=3
Find out the optimal amount/employment of labor.
Ans:
Optimal labor:
MRPL=W
MPL*P=W …..(P=price of the product)
MPL*P=W
= *P = 6
100 *P=6
*P=6
*P=6
*50=6

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=6
=6
= (0.5= 5/10)
=20831191.37
OPTIMAL AMOUNT OF LABOR IS 20831191.37
……………………………………………………………………………………………
Home work
Price of the product: 80

L=50
r=30
Find out the optimal amount of Capital.
Page 30
………………………………………………………….
MRPL=W
Marginal revenue product of labor=wage
MPL*P=W
Marginal product of labor*price of product=w
100*100=10000
+other qualifications/characteristics
+efficiency
Marginal revenue product is the formal name for the marginal revenue associated with
increased use of an input. An input’s marginal revenue product is the extra revenue that
results from a unit increase in the input.
More generally, labor’s marginal revenue product can be expressed as MRPL =(MR)(MPL),
where MR denotes marginal revenue per unit of output And Capital’s marginal revenue
product can be expressed as MRPk =(MR)(MPk),
Business firms are specialized organizations devoted to managing the process of

production. Pro- duction is organized in firms because efficiency generally requires
large-scale production, the raising of significant financial resources, and careful
management and coordination of ongoing activities.
The individual p r o prietorships, the classic small businesses
Any two or more people can get together and form a partnership.
A corporation is a form of business organization chartered in one of the 50 states

or abroad and owned by a number of individual stockholders. The corporation has a
separate legal identity, and indeed is a legal ―person‖ that may on its own behalf buy,
sell, borrow money, produce goods and services, and enter into contracts. In
addition, the corporation enjoys the right of limited liability, whereby each owner’s
investment and financial exposure in the corporation is strictly limited to a specified
amount.
Efficiency: Efficiency denotes the most effective use of a society’s resources in satisfying
people’s wants and needs. An economy is producing efficiently when it cannot make anyone
economically better off without making someone else worse off.
Productive Efficiency: it occurs when an economy cannot produce more of one good
without producing less of another good; this implies that the economy is on its PPF.
Opportunity cost: Whatever must be given up to obtain some item. The opportunity cost of
a decision is the value of the good or service forgone.
Page 31
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Managerial Economics Final-1 Production2

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Managerial Economics Final-1 Production2

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Class Lecture

Managerial Economics (Econ-5302)

Production function: Q= f (L, Lb, K, O)

Q=A - Cobb Douglas production function

A= Technology/scale of the production

=Marginal productivity of capital

Prepared by - Basharat Hossain, Assistant Professor of Economics, Dept. of Business Administration,

1. Land—or, more generally, natural resources— represents the gift of nature to

3. Capital resources form the durable goods of an economy, produced in order to

Factors Definition Price

Labor Human time spent for production in exchange of Wage /salary

Capital Material used for further production & it has Profit/Interest

Prepared by - Basharat Hossain, Assistant Professor of Economics, Dept. of Business Administration,

Factors of Production Prices of Factors

Long run: more than 1 year

Production function: Q=f (L, Lb, K, O)-short run

Prepared by - Basharat Hossain, Assistant Professor of Economics, Dept. of Business Administration,

Restaurant Business: Production function: Q=f (L, Lb, K, O)

Lb, = Manager &staff

K, = furniture, chair, table, fan, AC, Cooking mateials,

Land –fixed./ difficult.

Labor-variable, easily changeable.

Capital: variable, easily changeable.

If managed, then it is long run production function.

Prepared by - Basharat Hossain, Assistant Professor of Economics, Dept. of Business Administration,

Prepared by - Basharat Hossain, Assistant Professor of Economics, Dept. of Business Administration,

Law of diminishing returns / LAW of diminishing marginal product / Law of variable

 Initially the marginal product of labour is rising.

Prepared by - Basharat Hossain, Assistant Professor of Economics, Dept. of Business Administration,

Stage-1: MP is maximum, when TP is increasing at increasing rate.

Stage-2: MP is declining, when TP is increasing at decreasing rate.

Stage-3: MP is negative, when TP is falling.

Prepared by - Basharat Hossain, Assistant Professor of Economics, Dept. of Business Administration,

The Law of Diminishing Returns in Graph

Prepared by - Basharat Hossain, Assistant Professor of Economics, Dept. of Business Administration,

Since output rises with the proportional change with

New room allocation: 4 employees.

Prepared by - Basharat Hossain, Assistant Professor of Economics, Dept. of Business Administration,

1. Increasing returns to scale occur when the % change in output >

Q=A - Cobb Douglas production function

A= Technology/scale of the production

=Marginal productivity of capital

Prepared by - Basharat Hossain, Assistant Professor of Economics, Dept. of Business Administration,

A numerical example of long run returns to scale

Units of Units of Total % Change in % Change in Returns to Scale

Returns to scale in Graphs:

Prepared by - Basharat Hossain, Assistant Professor of Economics, Dept. of Business Administration,

Panel: A: IRTS: Economies of scale

Prepared by - Basharat Hossain, Assistant Professor of Economics, Dept. of Business Administration,

Increasing returns to scale/ economies of scale:

1. Highly efficient: Average cost declines as production increases.

Prepared by - Basharat Hossain, Assistant Professor of Economics, Dept. of Business Administration,

Examples of diseconomies of Scale include:

Economies of scope: A different kind of efficiency arises when there are

A prominent example is seen for computer software. Software programs often

An isoquant shows the different combinations of labor (L)

A, B , X, Y: efficient, output is maximized.

An isocost shows all the different combinations of labor and capital

The marginal rate of technical substitution of L for K (MRTSLK)

A producer is in equilibrium when he or she maximizes

Prepared by - Basharat Hossain, Assistant Professor of Economics, Dept. of Business Administration,

N point: IQ1=cut the isocost line.

Prepared by - Basharat Hossain, Assistant Professor of Economics, Dept. of Business Administration,

Optimality / Efficiency conditions: