Microeconomics

Sultan Qaboos University

Lecture 9

The Costs of Production

Before anyone can consume to satisfy

wants and needs, goods and services
must be produced.

Producers are profit-seeking, so they aim

to produce a salable product at the
lowest cost of resources used.

The Costs of Production

However, costs are not the only

consideration. Productivity is also important.
Paying

$10 an hour to typist A who types 90

words a minute is a lot cheaper than paying $2
an hour to typist B who types 10 words a minute.

Exercise: Compare the cost of words per hour

in the example above.
A:

5,400 words/$10 = 540 words/$1

B: 600 words/$2 = 300 words/$1

Learning Objectives

Know the relationship between output

and inputs.

Know what the production function

represents.

Know how the law of diminishing

returns applies to the production
process.

The Relationship Between Output and

Inputs

Production

Any activity that results in the conversion

of resources into products that can be used
in consumption.

Production Function

The production function is a technological

relationship between inputs and output.

The Production Function

Production function: a technological relation-ship

expressing the maximum quantity of a good
attainable from different combinations of factor
inputs. It represents maximum total efficiency.

In other words, how much can we produce with

the land, labor, and capital available?
We will consider the land to be a fixed amount.
So we can vary only the labor and the capital.

The Production Function

In order for labor to produce, it needs land

and capital. With neither, production is zero.
With fixed land and capital, adding more
labor will increase production.
First, at a rapid rate as the added workers put
the capital to full use.
Later, more workers will not add as much new
production as workers overwhelm the available
capital.

Short Run versus Long Run

Short Run

A time period when at least one input, such

as plant size (land), cannot be changed

Plant Size
The

physical size of the factories that a firm

owns and operates to produce its output

The Production Function

The
productivity of
any factor of
production
(e.g., labor)
depends on the
amount of
other resources
(e.g., capital)
available to it.

The Production Function

Note that when capital is fixed, as labor increases,

output increases but ultimately at a slower rate.
Ultimately output maxes out and begins to decline.

The measure of this added output as labor increases is

marginal physical product (MPP).

The change in total product occurring when a variable

input is increased and all other inputs are held constant

Also called marginal product

Marginal physical product

(MPP)

The additional output that results from

the use of an additional unit of a variable
input, holding other inputs constant
Measured as the ratio of the change in
output (TPP) to the change in the
quantity of labor (or other input) used
Marginal physical product (MPP)
total output

change in
change in

input quantity

Marginal Physical Product

(MPP)

Diminishing Marginal
Returns

Law of diminishing returns: the marginal physical

product of a variable input declines as more of it is
employed with a given quantity of other (fixed)
inputs, so output ultimately increases by
progressively smaller increments.

Added output begins to decrease and ultimately goes

negative as more and more workers are added with no
increase in capital.

The relative scarcity of other inputs (capital and land)

constrains the third workers marginal physical product

Diminishing Marginal
Product

The marginal product of labor may

increase very rapidly at the beginning

Beyond some point, marginal product

must begin to diminish as more workers
are hired

This is not because additional workers

are less qualified, but rather because
each worker has, on average, fewer
machines to work with

Diminishing Marginal Product (contd)

Production of computer servers as an

example of the law of diminishing
marginal profit:

We have a fixed amount of factory

space, assembly equipment, and quality
control diagnostic software

So the addition of more workers eventually

yields successively smaller increases in
output

The Production Function

and Marginal Product:

Summary Discussion

Know what the production function

represents.

A production function indicates the

maximum amount of output that can be
produced with different combinations of
inputs.
As the variable input is increased, more
output is produced. This is measured by
marginal physical product (MPP).

Summary Discussion (cont'd)

Know how the law of diminishing returns

applies to the production process.

Given a fixed input (usually capital), adding

a variable input (usually labor) will increase
total product but at a diminishing rate.
The

MPP of the variable input tends to decline

as more of it is used in a given production
facility.