PRODUCTION AND COSTS: THE SHORT RUN

Production
• An entrepreneur must put together resources -- land, labour, capital -- and produce a product people will be willing and able to purchase

PRODUCTION FUNCTION
• THE RELATIONSHIP BETWEEN THE AMOUNT OF INPUT REQUIRED AND THE AMOUNT OF OUTPUT THAT CAN BE OBTAINED IS CALLED THE PRODUCTION FUNCTION

What can you say about Marginal Product ?
• As the quantity of a variable input (labour, in the example) increases while all other inputs are fixed, output rises. Initially, output will rise more and more rapidly, but eventually it will slow down and perhaps even decline. • This is called the LAW OF DIMINISHING MARGINAL RETURNS

LAW OF DIMINISHING RETURNS IT HOLDS THAT WE WILL GET LESS & LESS EXTRA OUTPUT WHEN WE ADD ADDITIONAL DOSES OF AN INPUT WHILE HOLDING OTHER INPUTS FIXED. . IT IS ALSO KNOWN AS LAW OF VARIABLE PROPORTIONS.

INDIA INC..COMBINING RESOURCES • THERE ARE MANY COMBINATIONS OF RESOURCES THAT COULD BE USED • CONSIDER THE FOLLOWING TABLE SHOWING DIFFERENT NUMBER OF MECHANICS AND AMOUNT OF CAPITAL THAT THE HYPOTHETICAL FIRM. MIGHT USE .

ALTERNATIVE QUANTITIES OF OUTPUT THAT CAN BE PRODUCED BY DIFFERENT COMBINATIONS OF RESOURCES Number of Mechanics 0 1 2 3 4 5 6 7 CAPITAL 5 0 10 0 15 0 20 0 25 0 30 0 35 0 40 0 30 60 100 130 130 110 100 100 250 360 440 500 540 550 250 360 480 580 650 700 720 340 450 570 640 710 760 790 410 520 610 690 760 800 820 400 530 620 700 770 820 850 400 520 620 700 780 830 870 390 500 610 690 770 840 890 .

. THUS IN THE SHORT RUN PROUDCTION OF A COMMODITY CAN BE INCREASED BY INCREASING THE USE OF ONLY VARIABLE INPUTS LIKE LABOUR AND RAW MATERIALS.MACHINES) CANNOT BE CHANGED -.PRODUCTION IN THE SHORT RUN • THE SHORT RUN IS A PERIOD JUST SHORT ENOUGH THAT AT LEAST ONE RESOURCE (INPUT-INDUSTRIAL PLANT.IS FIXED OR INELASTIC.

Quantities of Output that Can Be Produced When One Resource is Fixed Number of Mechanics 0 1 2 3 4 5 6 7 CAPITAL 5 0 10 0 15 0 20 0 25 0 30 0 35 0 40 0 30 60 100 130 130 110 100 100 250 360 440 500 540 550 250 360 480 580 650 700 720 340 450 570 640 710 760 790 410 520 610 690 760 800 820 400 530 620 700 770 820 850 400 520 620 700 780 830 870 390 500 610 690 770 840 890 .

• THIS MEANS THAT THE FIRM CAN CHOOSE ANY COMBINATION ON THE MANUFACTURING TABLE -.LONG RUN • THE LONG RUN IS A PERIOD SUFFIECIENTLY LONG THAT ALL FACTORS INCLUDING CAPITAL CAN BE ADJUSTED OR ARE VARIABLE.NOT JUST THOSE ALONG COLUMN LABELLED “10” .

what happens to output? Number of Mechanics 0 1 2 3 4 5 6 7 CAPITAL 5 0 30 60 100 130 130 110 100 10 0 100 250 360 440 500 540 550 15 0 250 360 480 580 650 700 720 .The Long Run or Planning Period: As we double both resources.

of workers (N) (1) 1 2 3 4 5 6 7 8 9 10 11 12 Total product – TPL (tonnes) (2) 24 72 138 216 300 384 462 528 576 600 594 552 Marginal Product (MPL) (3) 24 48 66 78 84 84 78 66 48 24 -6 -42 Average Product (APL) (4) 24 36 46 54 60 64 66 66 64 60 54 46 II DIMINISHING RETURNS I INCREASING AND CONSTANT RETURNS Stage of production (5) III -VE RETURNS .THREE STAGES OF PRODUCTION No.

BEHAVIOUR OF TPP.MPP AND APP DURING THE THREE STAGES OF PRODUCTION TOTAL PHYSICAL PRODUCT STAGE I INCREASES AT AN INCREASING RATE STAGE II INCREASES AT A DIMINISHING RATE TILL IT REACHES MAXIMUM STAGE III STARTS DECLINING MARGINAL PHYSICAL PRODUCT AVERAGE PHYSICAL PRODUCT INCREASES & REACHES ITS MAXIMUM STARTS DIMINISHING INCREASES. REACHES ITS MAXIMUM & THEN DECLINES TILL MR = AP IS DIMINISHING AND BECOMES EQUAL TO ZERO BECOMES NEGATIVE CONTINUES TO DECLINE .

e ONLY STAGE I AND III ARE IRRATIONAL . MP IS NEGATIVE AND HENCE IT IS INADVISABLE TO USE ADDITIONAL LABOUR. IN STAGE III.FROM THE ABOVE TABLE ONLY STAGE II IS RATIONAL WHICH MEANS RELEVANT RANGE FOR A RATIONAL FIRM TO OPERATE. IN STAGE I IT IS PROFITABLE FOR THE FIRM TO KEEP ON INCREASING THE USE OF LABOUR. i.

. IT IS DEFINED AS A CURVE PASSING THROUGH THE PLOTTED POINTS REPRESENTING ALL THE COMBINATIONS OF THE TWO FACTORS OF PRODUCTION WHICH WILL PRODUCE A GIVEN OUTPUT.ISOQUANT AN ISOQUANT OR ISO PRODUCT CURVE OR EQUAL PRODUCT CURVE OR A PRODUCTION INDIFFERENCE CURVE SHOW THE VARIOUS COMBINATIONS OF TWO VARIABLE INPUTS RESULTING IN THE SAME LEVEL OF OUTPUT.

Labour (Units) 1 2 3 4 5 Capital (Units) 5 3 2 1 0 Output (Units) 10 10 10 10 10 .• For example from the following table we can see that different pairs of labour and capital result in the same output.

IT IS CALLED AN ISOQUANT MAP. FOR EXAMPLE IF LABOUR IS REDUCED IN A COMPANY IT WOULD HAVE TO BE COMPENSATED BY ADDITIONAL MACHINERY TO GET THE SAME OUTPUT. WHEN THE WHOLE ARRAY OF ISOQUANTS ARE REPRESENTED ON A GRAPH. . IMPORTANT ASSUMPTIONS THE TWO INPUTS CAN BE SUBSTITUTED FOR EACH OTHER.FOR EACH LEVEL OF OUTPUT THERE WILL BE A DIFFERENT ISOQUANT.

SLOPE OF ISOQUANT THE SLOPE OF AN ISOQUANT HAS A TECHNICAL NAME CALLED THE MARGINAL RATE OF TECHNICAL SUBSTITUTION (MRTS) OR THE MARGINAL RATE OF SUBSTITUTION IN PRODUCTION. THUS IN TERMS OF CAPITAL SERVICES K AND LABOUR L MRTS = Dk/DL .

CONVEX ISOQUANT .TYPES OF ISOQUANTS 1. LINEAR ISOQUANT 2. RIGHT-ANGLE ISOQUANT 3.

OIL OR A COMBINATION. i. . VARIOUS AMOUNTS OF ELECTRICITY COULD BE PRODUCED BY BURNING GAS.LINEAR ISOQUANT IN LINEAR ISOQUANTS THERE IS PERFECT SUBSTIUTABILTY OF INPUTS. HENCE THE ISOQUANT WOULD BE A STRAIGHT LINE. FOR EXAMPLE IN A POWER PLANT EQUIPED TO BURN OIL OR GAS.e OIL AND GAS ARE PERFECT SUBSITUTES.

RIGHT-ANGLE ISOQUANT IN RIGHT-ANGLE ISOQUANTS THERE IS COMPLETE NON-SUBSTIUTABILTY BETWEEN INPUTS. THIS IS ALSO KNOWN AS LEONTIEF ISOQUANT OR INPUT-OUTPUT ISOQUANT. . FOR EXAMPLE TWO WHEELS AND A FRAME ARE REQUIRED TO PRODUCE A BYCYCLE THESE CANNOT BE INTERCHANGED.

CONVEX ISOQUANT IN CONVEX ISOQUANTS THERE IS SUBSTIUTABILTY BETWEEN INPUTS BUT IT IS NOT PERFECT. BUT WITH A LARGER INCREASE IN . FOR EXAMPLE (1) A SHIRT CAN BE MADE WITH LARGE AMOUNT OF LABOUR AND A SMALL AMOUNT MACHINERY. BY INCREASING MACHINERY. (3) THE SAME SHIRT CAN BE MADE WITH STILL LESS LABOURERS MACHINERY. (2) THE SAME SHIRT CAN BE WITH LESS LABOURERS.

. THUS SUBSTIUTABILITY OF LABOURERS FOR MACHINERY DIMINISHES FROM M1 TO M2 TO M3. A VERY LARGE INCREASE IN MACHINERY TO M3 (COMPUTERISED EMBROIDERY) IS REQUIRED TO FURTHER DECREASE LABOUR FROM L2 TO L3.WHILE A RELATIVELY SMALL ADDITION OF MACHINERY FROM M1(MANUAL EMBROIDERY) TO M2(TAILORING MACHINE EMBROIDERY) ALLOWS THE INPUT OF LABOURERS TO BE REDUCED FROM L1 TO L2.

THE QUANTITY OF ONE VARIABLE WILL HAVE TO BE REDUCED IN ORDER TO INCREASE THE QUANTITY OF OTHER VARIABLE. THIS IMPLIES THAT FOR THE SAME LEVEL OF OUTPUT. i.e NEGATIVELY INCLINED. .PROPERTIES OF ISOQUANTS 1. AN ISOQUANT IS DOWNWARD SLOPING TO THE RIGHT.

A HIGHER ISOQUANT REPRESENTS LARGER OUTPUT. . THAT IS WITH THE SAME QUANTITY OF 0NE INPUT AND LARGER QUANTITY OF THE OTHER INPUT. LARGER OUTPUT WILL BE PRODUCED.PROPERTIES OF ISOQUANTS 2.

. IF THE TWO ISOQUANTS DO TOUCH OR INTERSECT THAT MEANS THAT A SAME AMOUNT OF TWO INPUTS CAN PRODUCE TWO DIFFERENT LEVELS OF OUTPUT WHICH IS ABSURD.PROPERTIES OF ISOQUANTS 3. NO TWO ISOQUANTS INTERSECT OR TOUCH EACH OTHER.

ISOQUANT IS CONVEX TO THE ORIGIN.PROPERTIES OF ISOQUANTS 4. THAT IS WHEN WE GO ON INCREASING THE QUANTITY OF ONE INPUT SAY LABOUR BY REDUCING THE QUANTITY OF OTHER INPUT SAY CAPITAL. THIS MEANS THAT THE SLOPE DECLINES FROM LEFT TO RIGHT ALONG THE CURVE. . WE SEE LESS UNITS OF CAPITAL ARE SACRIFICED FOR THE ADDITIONAL UNITS OF LABOUR.

let’s just consider the column under “10 capital” Number Total Mechanics Output 0 0 1 100 2 250 3 360 4 440 5 500 6 540 7 550 8 540 .Now.

TPP 500 400 300 TPP 200 100 0 1 2 3 4 5 6 7 8 Number of Mechanics .The Total Product Curve 600 Total Output.

Average Product = Total Output # of mechanics 0 1 2 3 4 5 6 7 8 0 100 250 360 440 500 540 550 540 0 100 125 120 110 100 90 78.5 .6 67.

Average Product. APP 150 Number Total Mechanics Output Average Product 125 100 75 50 25 0 1 2 3 4 5 6 7 Number of Mechanics 8 APP 0 1 2 3 4 5 6 7 8 0 0 100 100 250 125 360 120 440 110 500 100 540 90 550 78.6 540 67.5 .

5 -10 .Marginal Product = Change in Total Output Change in Number of Mechanics MechanicsOutput Product Product 0 0 0 0 1 100 100 100 2 250 125 150 3 360 120 110 4 440 110 80 5 500 100 60 6 540 90 40 7 550 78.6 10 8 540 67.

Let’s Plot the MPP Schedule We’ll place it on top of the APP schedule so we can compare the two .

Average and Marginal Marginal Product MPP>APP 150 |----------| and Average 125 100 75 50 25 |-----------------------------| MPP<APP APP MPP=APP 0 1 2 3 4 5 6 7 8 Number of Mechanics MPP .

THIS REFERS TO THE RETURNS TO SCALE OR EFFECT OF SCALE INCREASES OF INPURTS ON THE QUANTITY PRODUCED..RETURNS TO SCALE • DIMINISHING RETURNS REFER TO RESPONSE OF OUTPUT TO AN INCREASE OF A SINGLE INPUT WHILE OTHER INPUTS ARE HELD CONSTANT. FERTILISERS. • WHAT WOULD HAPPEN IF THE PRODUCTION OF WHEAT IF LAND. • WE HAVE TO SEE THE EFFECT BY INCREASING ALL INPUTS. ARE ALL DOUBLED. WATER ETC. . LABOUR.

CONSTANT RETURNS TO SCALE • THIS DENOTES A CASE WHERE A CHANGE IN ALL INPUTS LEADS TO A PROPORTIONAL CHANGE IN OUTPUT. . • FOR EXAMPLE IF LABOUR. LAND CAPITAL AND OTHER INPUTS DOUBLED. THEN UNDER CONSTANT RETURNS TO SCALE OUTPUT WOULD ALSO DOUBLE.

THIS ARISES WHEN AN INCREASE IN ALL INPUTS LEADS TO A MORE-THAN-PROPORTIONAL INCREASE IN THE LEVEL OF OUTPUT. CAPITAL AND MATERIALS BY 10% WILL INCREASE THE TOTAL OUTPUT BY MORE THAN 10%.INCREASING RETURNS TO SCALE • THIS IS ALSO CALLED ECONOMIES OF SCALE. . • FOR EXAMPLE AN ENGINEER PLANNING A SMALL SCALE CHEMICAL PLANT WILL GENERALLY FIND THAT BY INCREASING INPUTS OF LABOUR.

RISK OF PLANT FAILURE INCREASED. • IN MANY PROCESS.DECREASING RETURNS TO SCALE • THIS OCCURS WHEN A BALANCED INCREASE OF ALL INPUTS LEADS TO A LESS THAN PORPORTIONAL INCREASE IN TOTAL OUTPUT. . SCALING UP MAY EVENTUALLY REACH A POINT BEYOND WHIH INEFFICIENCIES SET IN. • THIS WAS VERY EVIDENT IN ELECTRICITY GENERATION WHEN PLANTS GREW TOO LARGE. THESE MIGHT ARISE BECAUSE THE COSTS OF MANAGEMENT OR CONTROL BECOME LARGE.

FIRMS OF ALL SIZES WOULD SURVIVE EQUALLY WELL. IN CASE OF INDUSTRIES WITH CONSTANT RETURNS TO SCALE. THE OPPOSITE WILL BE TRUE IN INDUSTRIES WHERE DECREASING RETURNS TO SCALE PREVAIL. THERE WILL BE A TENDENCY FOR EXPANDING THE SIZE OF THE FIRM AND THUS THE INDUSTRY WILL BE DOMINATED BY LARGE FIRMS.IMPORTANCE OF RETURNS TO SCALE CONCEPT IF AN INDUSTRY IS CHARACTERIZED BY INCREASING RETURNS TO SCALE. .

. • ASSUME THIS IS THE ONLY COST.FROM PRODUCTION TO COST • TO GET TO WHERE WE REALLY WANT TO BE. • LET’S ASSUME THE COST PER VARIABLE RESOURCE -. WE MUST TRANSLATE THE PRODUCT SCHEDULES AND CURVES TO COSTS.PER WORK -IS $1000 PER WEEK.

P ro d u ct io n a n d C os ts T o ta l # o f m e c h a n ic s 0 1 2 3 4 5 6 7 O u tp u t 0 T o ta l Cost 100 250 360 440 500 540 550 0 1000 2000 3000 4000 5000 6000 7000 .

Total Costs (thousands) 6 5 4 3 Total Costs 2 1 0 100 2 00 300 400 500 600 Total Output .

Average and Marginal • Economists find it useful to talk about three dimensions of something: • Total • Average = per unit • Marginal = incremental .

P ro d u ctio n a n d C o sts Total # of mechanics Output 0 1 2 3 4 5 6 7 0 100 250 360 440 500 540 550 Total Cost 0 1000 2000 3000 4000 5000 6000 7000 .

7 9.000 Average Cost 10 8 8.1 12.7 25 100 2.000 .1 12.33 9 10 11.5 16.000 4.7 Marginal Cost 10 6.000 5.000 6.Quantity of Output 100 250 360 440 500 540 550 Total Cost 1.000 3.000 7.

Plot the Average Cost and the Marginal Cost Schedules • Average Cost is the per unit cost: total cost divided by quantity of output • Marginal Cost is the change in total cost divided by the change in total output. .

Sign up to vote on this title
UsefulNot useful