# PRODUCTION ANALYSIS

Production

States the relationship between inputs and outputs Inputs – the factors of production classified as: Land – all natural resources of the earth –Price paid to acquire land = Rent Labour – all physical and mental human effort involved in production Price paid to labour = Wages Capital – buildings, machinery and equipment not used for its own sake but for the contribution it makes to production Price paid for capital = Interest

**Production Decisions of a Firm
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1.

Production Technology Describe how inputs can be transformed into outputs Inputs: land, labor, capital & raw materials Outputs: cars, desks, books, etc. Firms can produce different amounts of outputs using different combinations of inputs

2. capital and other inputs Firms want to minimize total production costs partly determined by input prices As consumers must consider budget constraints.
Cost Constraints Firms must consider prices of labor. firms must be concerned about costs of production
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may choose to produce with more labor and less capital
. the firm may choose different combinations of inputs to minimize costs If labor is cheap.
Input Choices Given input prices and production technology. the firm must choose how much of each input to use in producing output Given prices of different inputs.3.

L) Output (q) is a function of capital (K) and Labor (L) The production function is true for a given technology If technology increases.PRODUCTION FUNCTION
The production function for two inputs: q = F(K. more output can be produced for a given level of inputs
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Production Function
INPUT PROCESS OUTPUT
LAND LABOR CAPITAL
Product or service generated – value added
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Production function with constant K
output
Q=F(L.K0)
LABOUR
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each worker can produce
AP = Output q = Labor Input L
Marginal Product of Labor – additional output produced when labor increases by one unit Change in output divided by the change in labor
MP L = ∆Output ∆q = ∆Labor Input ∆L
.AVERAGE AND MARGINAL PRODUCTIVITY
Average product of Labor .Output per unit of a particular product Measures the productivity of a firm’s labor in terms of how much. on average.

2. output (q) increases up to 8 units of labor.
When labor is zero.TOTAL PRODUCTIVITY
1. Beyond this point.
3. output declines
Increasing labor can make better use of existing capital initially After a point. more labor is not useful and can be counterproductive
. output is zero as well With additional workers.

Analysis of Production Function: Short Run
In the short run at least one factor fixed in supply but all other factors capable of being changed Can increase or decrease output using more or less of some factors but some likely to be easier to change than others Increase in total capacity only possible in the long run
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SHORT RUN ANALYSIS
We will begin looking at the short run when only one input can be varied We assume capital is fixed and labor is variable Output can only be increased by increasing labor Must know how output changes as the amount of labor is changed
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The Law of Variable Proportion
The law of variable proportion states that as we go on employing more of one factor of production other factor constant. its marginal productivity will diminishes after some point
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Thirdly the law is not applicable when the two inputs are used in fixed proportion. Secondly.Assumptions
Firstly . it is assumed that one factor of s must always be kept constant.
.state of technology is assumed to be constant.

LAW OF VARIABLE PROPORTION
As the use of an input increases with other inputs fixed.
. the resulting additions to output will eventually decrease.

MP is slope of line tangent to corresponding point on TP curve 112 C 60 30
B
20
10
0 1 2 3 4 5 6 7 8 9 10
Labor
0 1 2 3 4 5 6 7 8 9 10
Labor
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the firm is able to increase its total capacity – not just short term capacity The period of time varies according to the firm and the industry In electricity supply. the ‘long run’ could be as little as a few weeks or months!
. for a market stall holder.Analysing the Production Function: Long Run
The long run is defined as the period of time taken to vary all factors of production By doing this. the time taken to build new capacity could be many years.

Returns to Scale
Rate at which output increases as inputs are increased proportionately Increasing returns to scale Constant returns to scale Decreasing returns to scale
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The law of returns to scale refer to the long run analysis of production The law of returns to scale refer to the effects of scale relationships which implies that in the long run output can be increased by changing all factors by the same proportion
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RETURNS TO SCALE
Increasing return
Total product Q
Constant returns (
Decreasing returns
Units of Input
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Technological change
Technical changes involve involve new products Improvements or cost reductions for existing products Better ways of managing the operations of a business
.

K)
Q = f(L.Shift in the production function caused by technological progress
Q = f(L.K)
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Isoquant
An isoquant shows the various combination of commodities that can be produced with the help of the K given level of two inputs
Q0 = f(L.K)
An isoquant slopes downward The slope of the isoquant is give by MRTS Isoquant are convex to the origin
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Isoquant
Input Y 10 9 8 7 6 5 4 3 2 1 0
Marginal rate of technical substitution – the slope of an isoquant at a particular point
1 2 3 4 5 6 7 8 9 10 Input X
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Equal Cost Lines
The locus of all combinations of labor and capital which satisfy the cost function is called the equal cost curve or isocost line
A C1/W
Slope = w/r
O
C0/W
B
L
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Changes in input prices change the slope of the isocost line.
K C1/r C0/r
New Isocost Line associated with higher costs (C0 < C1).Isocost
The combinations of inputs that produce a given level of output at the same cost: For given input prices. isocosts farther from the origin are associated with higher costs.
C0 C0/w K C/r
C1 C1/w
L
New Isocost Line for a decrease in the wage (price of labor: w0 > w1).
C/w0
C/w1
L
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K
Point of Cost Minimization
Slope of Isocost = Slope of Isoquant
Q
L
.Output maximisation subject to a given cost.

Cost minimization subject to a given level of output
K
Point of Cost Minimization
Slope of Isocost = Slope of Isoquant
Q
L
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EXPANSION PATH
Units of Y B3
PX MPX = P MP Y Y
B2 B 1 Expansion path A B C Q 1 Q3 Q2
Y3 Y2 Y1
X1 X2 X3
Units of X
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