Short-run production function

MAN ECON DEPTALS 3

- essentially only a function of labor since
The Production Process and Costs capital is fixed rather than variable
- If K* is the fixed level of capital, the short-
The Product Function
run production function may be written as
- Technology summarizes the feasible means
Q = f (L) = F(K*, L)
of converting raw inputs into an output
- Exploiting an existing technology to its Long Run
greatest potential
- defined as the horizon over which the
- Utilizes 2 inputs, Capital(K) and Labor(L)
manager can adjust all factors of production
- Q is the Level of Output produces in the
production process Measures of Productivity
- Capital – machines ; Labor – people
- these measures are useful for evaluating
Production Function the effectiveness of a production process
and for making input decisions that
- technology available for converting capital
maximize profits
and labor into output is summarized in the
production function. Total Product (TP)
- an engineering relation that defines the
maximum amount of output that can be - the maximum level of output that can be
produced with a given set of inputs. produced with a given amount of inputs.
- I think same lang sya with Q
Q = F(K,L)
Average Product
the maximum amount of output that can be
produced with K units of capital and L units of labor - A measure of the output produced per unit
of input
Short-Run vs. Long-Run Decisions
average product of labor (APL) is
- As a manager, your job is to use the
available production function efficiently; this 𝑄
𝐴𝑃𝐿 =
means that you must determine how much 𝐿
of each input to use to produce output. average product of capital (APK) is
Fixed Factors 𝑄
𝐴𝑃𝐾 =
- The inputs a manager cannot adjust in the 𝐾
short run Marginal Product (MP)
- limits your choices in making input decisions
- The change in total output attributable to the
Variable Factors last unit of an input.
- The inputs a manager can adjust to alter MP of Capital
production.
ΔQ
Short Run 𝑀𝑃𝐾 =
ΔK
- Time frame in which there are fixed factors MP of Labor
of production
ΔQ
- Usually capital is fixed and labor is 𝑀𝑃𝐿 =
adjustable ΔL
 • A negative marginal product means that the Produce on the Production Function
last unit of the input actually reduced the
- For the case of labor, this means that
total product
workers must be putting forth maximal
• If a manager continued to expand the
effort.
number of workers on an assembly line, he
- To ensure that workers are in fact working
or she would eventually reach a point where
at full potential, the manager must institute
workers were packed like sardines along
an incentive structure that induces them to
the line, getting in one another’s way and
put forth the desired level of effort.
resulting in less output than before
Use the Right Level of Inputs
Increasing marginal returns
- to ensure that the firm operates at the right
- Range of input usage over which marginal
point on the production function.
product increases.
Value marginal product
Decreasing (diminishing) marginal returns
- The value of the output produced by the last
- Range of input usage over which marginal
unit of an input.
product declines.
If each unit of output can be sold at a price of P, the
Negative marginal returns
value marginal product of labor is
- Range of input usage over which marginal
VMPL = P × MPL
product is negative.
and the value marginal product of capital is
VMPK = P × MPK
Profit-Maximizing Input Usage
- To maximize profits, a manager should use
inputs at levels at which the marginal benefit
equals the marginal cost. More specifically,
when the cost of each additional unit of
labor is w, the manager should continue to
employ labor up to the point where VMPL =
w in the range of diminishing marginal
product.
Law of diminishing marginal returns
Phases of Marginal Returns - States that the marginal product of an
additional unit of an input will at some point
- As the usage of an input increases,
be lower than the marginal product of the
marginal product initially increases
previous unit
(increasing marginal returns), then begins to
decline (decreasing marginal returns), and
eventually becomes negative (negative
marginal returns).
The Role of the Manager in the Production Process
- (1) to ensure that the firm operates on the
production function
- (2) to ensure that the firm uses the correct
level of inputs
Algebraic Forms of Production Functions Algebraic Measures of Productivity
Linear Production Function Formula: Marginal Product for a Linear
Production Function.
- A production function that assumes a
perfect linear relationship between all inputs If the production function is linear and given by
and total output.
Q = F(K, L) = aK + bL
- inputs are perfect substitutes
then
Q = F(K, L) = aK + bL
MPK = a and MPL =
where a and b are constants.
b
Leontief production function
Formula: Marginal Product for a Cobb-Douglas
- also called the fixed-proportions production Production Function.
function
If the production function is Cobb-Douglas and
- A production function that assumes that
inputs are used in fixed proportions. given by Q = F(K, L) = 𝐾 𝑎 𝐿𝑏

Q = F(K, L) = min {aK, bL} then

where a and b are constants MPL = 𝑏𝐾 𝑎 𝐿𝑏−1 and MPK =

a𝐾 𝑎−1 𝐿𝑏
DEMONSTRATION PROBLEM
The engineers at Morris Industries obtained the
following estimate of the firm’s production function:
Q = F(K, L) = min { 3K, 4L}
How much output is produced when 2 units of labor
and 5 units of capital are employed?
ANSWER:
We simply calculate F(5, 2). But F(5, 2) = min{3(5),
OR
4(2)} = min{15, 8}. Since the minimum of the
numbers “15” and “8” is 8, we know that 5 units of MPL = 0.5L^-1/2
capital and 2 units of labor produce 8 units of
output. VMPL = 10 x 0.5L^1/2 → = 5L^1/2

Cobb-Douglas production function VMPL = w → 5L^-1/2 = 2

- A production function that lies between the
extremes of the linear production function
and the Leontief production function
- A production function that assumes some
degree of substitutability among inputs.
- the relationship between output and inputs
is not linear.
Q = F(K, L) = 𝐾 𝑎 𝐿𝑏
where a and b are constants.
L = 6.25 (just solve it thru mathpapa xd)
Isoquants
- Defines the combinations of inputs that yield
the same level of output.
- The basic tool for understanding how
alternative inputs can be used to produce
output
 • Notice that the isoquants are convex. The
reason isoquants are typically drawn with a
convex shape is that inputs such as capital
Isocost – check book
and labor typically are not perfectly
substitutable. Isocost Line
Marginal Rate of Technical Substitution (MRTS) - A line that represents the combinations of
inputs that will cost the producer the same
- The rate at which a producer can substitute
amount of money.
between two inputs and maintain the same
level of output. Cost Minimization
𝑀𝑃𝐿 - Producing output at the lowest possible
𝑀𝑅𝑇𝑆𝐾𝐿 =
𝑀𝑃𝐾 cost.
- Different production functions will imply - Because of scarcity
different marginal rates of technical
substitution. For example, the linear
production function implies isoquants that
are linear, The Leontief production function,
on the other hand, implies isoquants that
are L shaped
- Pero walang MRTS sa Leontief kase
walang substitution Input Mix B Minimizes the Cost of Producing 100
Units of Output

• For most production relations, the isoquants

lie somewhere between the perfect
substitute and fixed-proportions cases. In Cost-minimizing Input Mix
these instances, the inputs are substitutable
for one another, but not perfectly, and the - the slope of the isoquant is equal to the
rate at which a manager can substitute slope of the isocost line.
among inputs will change along an isoquant MRTSKL = w /r
Law of diminishing marginal rate of technical
substitution
- A property of a production function stating
that as less of one input is used, increasing
amounts of another input must be employed
to produce the same level of output.
Cost-Minimizing Input Rule
- To minimize the cost of producing a given
level of output, the marginal product per
dollar spent should be equal for all inputs:
𝑀𝑃𝐿 𝑀𝑃𝐾
=
𝑤 𝑟
- Equivalently, to minimize the cost of
production, a firm should employ inputs
such that the marginal rate of technical
substitution is equal to the ratio of input
prices:
𝑀𝑃𝐿 𝑤
= producing isoquant Q in the cost-minimizing
𝑀𝑃𝐾 𝑟
Optimal Input Substitution
- A change in the price of an input will lead to
a change in the cost-minimizing input
bundle
- suppose that the wage rate increases so
that if the firm spent the same amount on
inputs, its isocost line would rotate
clockwise
- Due to the increase in the price of labor
relative to capital, the producer substitutes
away from labor and toward capital and
adopts a more capital-intensive mode of
production.
Optimal Input Substitution
- To minimize the cost of producing a given
level of output, the firm should use less of
an input and more of other inputs when that
input’s price rises.
The Cost Function
- Mathematical relationship that relates cost
to the cost-minimizing output associated
with an isoquant.
- Since the cost of production increases as
higher isoquants are reached, it is useful to
let C(Q) denote the cost to the firm of
fashion. The function C is called the cost
function.
- the cost function summarizes information
about the production process
- The cost function thus reduces the amount
of information the manager has to process
to make optimal output decisions.
Short-Run Costs
- the total cost of producing output in the
short run consists of (1) the cost of fixed
inputs and (2) the cost of variable inputs.
Total cost (TC)
- Sum of fixed and variable costs.
Fixed costs (FC)
- Costs that do not change with changes in
output; include the costs of fixed inputs
used in production.
Variable costs (VC)
- Costs that change with changes in output;
include the costs of inputs that vary with
output.
Short-run cost function - it decreases as marginal product increases
and increases when marginal product is
- A function that defines the minimum
decreasing
possible cost of producing each output level
when variable factors are employed in the
cost minimizing fashion.
Average and Marginal Costs
- One fundamental implication of scarcity is
that to produce more output, more must be
spent
Average fixed cost (AFC)
• ATC and AVC curves get closer together as
- Fixed costs divided by the number of units
output increases. This is because the only
of output. difference in ATC and AVC is AFC
- fixed costs do not vary with output, as more
• ATC = AFC + AVC
and more output is produced, the fixed
costs are allocated over a greater quantity Fixed and Sunk Costs
of output.
- average fixed costs decline continuously as Fixed Cost
output is expanded. - Cost that does not change when output
𝐹𝐶 changes
𝐴𝐹𝐶 =
𝑄 Sunk Cost
Average variable cost (AVC) - A cost that is forever lost after it has been
paid.
- Variable costs divided by the number of
units of output. Irrelevance of Sunk Costs
𝑉𝐶(𝑄) - A decision maker should ignore sunk costs
𝐴𝑉𝐶 =
𝑄 to maximize profits or minimize losses
Average total cost (ATC)
- Total cost divided by the number of units of
output.
𝐶(𝑄)
𝐴𝑉𝐶 =
𝑄
C = TC
Marginal (incremental) cost (MC)
- The change in total costs arising from a Algebraic Forms of Cost Functions
change in the managerial control variable Q.
- the cost of producing an additional unit of Cubic cost function
output, that is, the change in cost - Costs are a cubic function of output;
attributable to the last unit of output provides a reasonable approximation to
𝛥𝐶 virtually any cost function.
𝑀𝐶 =
𝛥𝑄 𝐶(𝑄) = 𝑓 + 𝑎𝑄 + 𝑏𝑄 2 + 𝑐𝑄 3
- Remember that marginal product increases where a, b, c, and f are constants. Note that f
initially, reaches a maximum, and then represents fixed costs
decreases
 Multiple-Output Cost Functions
- A function that defines the cost of producing
given levels of two or more types of outputs
assuming all inputs are used efficiently.
Economies of scope
- Exist when the total cost of producing two
products within the same firm is lower than
when the products are produced by
separate firms.
C(Q1,0)+C(0,Q2) > C(Q1,Q2)
Cost complementarities
- Exist when the marginal cost of producing
one output is reduced when the output of
Long-Run Costs another product is increased.
- all costs are variable because the manager
is free to adjust the levels of all inputs.
Long-run average cost curve
- A curve that defines the minimum average
cost of producing alternative levels of
output, allowing for optimal selection of both
fixed and variable factors of production.
Economies of scale
- Exist whenever long-run average costs To examine whether economies of scope exist for a
decline as output increases. quadratic multiproduct cost function, recall that
there are economies of scope if
Diseconomies of scale
- Exist whenever long-run average costs
increase as output increases.
Constant returns to scale
- Exist when long-run average costs remain
constant as output is increased.
Accounting costs
- are explicit costs (those stated costs that
occur in exchange for a defined good or
service).
Economic costs
- include accounting costs and opportunity
costs.
- Opportunity costs are the benefits you could
have received if you had chosen one course
of action, but that you didn't because you
went with another option.