Professional Documents
Culture Documents
Production Theory
Lecture Plan
Objectives
Production
Types of inputs
Factors of production
Production function
Production function with one variable input
Production function with two variable inputs
Isoquants
Producer’s equilibrium
Returns to scale
Cobb Douglas and CES production functions
Technical progress
Chapter Objectives
Output
4 120 30 30 Diminishing Product
50
5 140 20 28 returns Average
Product
0
6 150 10 25
1 2 3 4 5 6 7 8 9
7 150 0 21.5 -50
Total
C
First stage
Output Increasing Returns to
B TPL the Variable Factor
MP>0 and MP>AP
A Second stage
Diminishing Returns to
a Variable Factor
O MP>0 and MP<AP
Labour
Total Third Stage
Output Negative Returns
Stage I Stage II Stage III
MP<0 while AP is falling
A*
B but positive
* Technically inefficient
stage of production
APL A rational firm will never
C
O operate in this stage
*L
MP Labour
Production Function with Two Variable Inputs
output 0
6 7 8 9 10
Downward sloping
Convex to the origin
A higher isoquant represents a higher output
Two isoquants do not intersect
Capital Capital
C A
B A Q1
B C
Q2
Q1
Q0 Q2
O
O Labour Labour
Marginal Rate of Technical Substitution
Q3
Q2
Q1
Q1 Q2 Q3
O O
Labour Labour
Total Cost is sum of Labour cost (wL) and Capital cost (rK) where
wage (w) and interest (r)
C wL rK
Capital •The isocost line represents
A2 the locus of points of all the
different combinations of two
A
inputs that a firm can procure,
A1
given the total cost and
prices of the inputs.
O B1 B B2 Labour
C
K w
The (absolute) slope of this line is Slope r
equal to the ratio of the input prices. L C r
w
Producer’s Equilibrium
Capital AB is the isocost line
Any point below AB is feasible but not
A desirable
C E is the point of tangency of Q2 with
E isocost line AB
K*
Corresponds to the highest level of
Q output with given cost function.
Q2 3
D Q1
Q0 Firm would employ L* and K* units of
O labour and capital
L B Labour
* Q3 is beyond reach of the firm
E2
E1
O
Labour