Microeconomics

SEM II

Anuradha Saikia
Production Function
 Transforming resources—such as labor, power, raw materials, and the services
provided by facilities and machines—into finished products.

Q = f (K,L)

Minimise Costs

Objectives of any producer

Maximize output

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 Short Run VS Long Run

CASE I. COMPANY X manufactures smartphones.

The physical manufacturing facilities are production lines, and specialized machinery..
The number and capacity of R&D centers contribute to the development of new
features, designs, and technologies in smartphones.
They have a new product launch in a month and they need to expediate the process.
Is this a short run or long run ?
What are the fixed and variable inputs ?

CASE II. COMPANY X manufactures smartphones.

They have planned the new product launch in a year. They have decided on using the
same technology of their previous model .
The physical manufacturing facilities are production lines, and specialized machinery..
The number and capacity of R&D centers contribute to the development of new
features, designs, and technologies in smartphones.
They have a new product launch in a month and they need to expediate the process.
Is this a short run or long run ?
What are the fixed and variable inputs ?

Anuradha Saikia
Production Function With Single Input

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 TP : total output produced with the available input(s).
 AP: average amount of output per unit of labor.(also called average physical
product of labour).

 MP: the rate at which total output changes as the firm changes its quantity of
labor.

MPL =

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 Stage 1: When TP is increasing
RELATONSHIP between MP and AP?

 AP increases
 MP is greater than AP (MP>AP)

Stage 2: When TP is increasing at a

diminishing rate
 AP decreases
 MP is less than AP (MP < AP)
 MP is min and TP is the highest

Stage 3: When TP decreases

 MP is negative
 AP is falling

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Standard of living in the United States,
Europe, and Japan
 The level of output per employed person
in the United States in 2009 was higher
than in other industrial countries.

 Productivity growth during 1974–2009 was

much lower in all developed countries
than it had been in the past.

 Differences in rates of investment and

growth in the stock of capital in each
country.

 Sluggish growth in more recent years

suggests that ICT’s contribution may
have already peaked.

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Production with two variable Inputs
(K,L)
 ISOQUANT : Curve showing
all possible combinations of
inputs that yield the same
output

Why are isoquants important?

 flexibility that firms have when

making production decisions.

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Marginal rate of technical substitution
(MRTS)
 MRTS: Amount by which the quantity of one input
can be reduced when one extra unit of another
input is used, so that output remains constant.

 The marginal rate of technical substitution of labor

for capital is the amount by which the input of
capital can be reduced when one extra unit of labor
is used, so that output remains constant

Diminishing MRTS : As more labour is added , its

productivity reduces. Similarly, when more capital is
added in place of labor, the productivity of capital
falls.
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MRTS and Marginal Productivity
 = MPL ( Adding some labor and reducing the amount of capital
sufficient to keep output constant. )
 ∆Q = MPL (∆L)

 Similarly, the decrease in output resulting from the reduction in capital is the
loss of output per unit reduction in capital.
∆Q = MPK (∆K)

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  What is the MRTS of capital
for labour at point B?

 Is the substitution of capital

for labour technically
efficient ?

Isoquant showing production of wheat

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 Let’s Think !
 Consider the production function whose equation is given by the formula
Q=
What is the equation of the isoquant corresponding to Q = 20?

 A firm’s production function requires that it use at least 1 unit of labor and 1 unit of capital,
i.e., L ≥ 1 and K ≥ 1. Initially, the production function is
Q= , with MPK = ) and MPL =0.5( ). Over time, the
production function changes to Q= , with MPK = ) and MPL =

 Does this change represent technological progress? How?

 Show whether this change is labor-saving, capital saving, or neutral.

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 Consider the production function whose equation is given by the formula
Q=
What is the equation of the isoquant corresponding to Q = 20?

 A firm’s production function requires that it use at least 1 unit of labor and 1 unit of
capital, i.e., L ≥ 1 and K ≥ 1. Initially, the production function is
Q= , with MPK = ) and MPL =0.5( ). Over time, the
production function changes to Q= , with MPK = ) and MPL =

 Does this change represent technological progress? How?

 Show whether this change is labor-saving, capital saving,or neutral.

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 Can an isoquant be upward sloping ?

 What is the slope of an isoquant ?

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Q1. CALCULATE TP,AP and MP

AP = Q/L

MP =
change in Q/Change in
L

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Labour TP APL MPL
0 0 0 - For 3rd labour units
1 19 19 19
MPL = TP(4th labour units)-TP (at 3rd
2 72 36 53 labour units/(4-3)
3 153 51 81 103 = 256 – x
x =153
4 256 64 103
TP = 153
5 375 75 119 AP = 153/3 = 51
6 504 84 129 MP = 153-72/1 = 81
7 637 91 133
8 768 96 129
9 891 99 133
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10 1000 100 131
11 1089 99 89
12 1152 96 63
13 1147 88.2 -5
14 1140 81.4 -7
15 1125 75 -15
 Suppose the production function is given by the
following equation (where a and b are positive
constants):
Q = aL + bK.
What is the marginal rate of technical substitution
of labor for capital (MRTSL,K) at any point along an
isoquant?

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How Isoquant Properties Aid in Decision-
Making for Managers
 Optimising Resource Use: If there is a shortage of labour supply, businesses
can increase their capital to maintain the production level or vice-versa.

 Minimising Costs: By studying the Isoquant Curve, managers can determine

which input (labour or capital) can be substituted without altering the
output. This guides managers in the strategic allocation of resources to
minimise total cost while keeping production levels intact.

 Production Planning: Managers can choose the most practical and cost-
effective combination of inputs for each output level.

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Properties of Isoquant

 Negatively Sloping: An Isoquant is negatively sloped, signifying that as

you increase one input, you need to decrease the other to ensure that the
production output remains constant.

 Convex shape: Increase in the other input, the additional output obtained
from the extra unit of the increased input gradually decreases.

 Non-intersecting: Isoquants do not intersect each other. The intersection

of Isoquants would imply a contradiction, meaning the same level of
output could be obtained from two different combinations of
inputs/consumption baskets.
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Q: For the production function Q = 6L2 − L3,
fill in the following table and state how much
the firm should produce so that:

a) average product is maximized

b) marginal product is maximized
c) total product is maximized

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L Q (TP) AP MP
0 0 0 -
1 5 5 5
2 16 8 11
3 27 9 11
4 32 8 5
5 25 5 -7
6 0 0 -

 AP is maximum when firm produces 27 units of output

 MP is maximum when firm produces 27 and 16 units of output
 TP is maximum when firm is producing 32 units of output

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 Suppose the production function for automobiles is Q = LK, where Q is the
quantity of automobiles produced per year, L is the quantity of labor
(man-hours), and K is the quantity of capital (machine-hours).

a) Sketch the isoquant corresponding to a quantity of Q = 100.

b) What is the general equation for the isoquant corresponding to any
level of output Q?
c) Does the isoquant exhibit diminishing marginal rate of technical
substitution?

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 TYPES OF PRODUCTION FUNCTION
 LINEAR : The MRTS of one input for another may
be constant. For example, a manufacturing
process may require energy in the form of
natural gas or fuel oil, and a given amount of
natural gas can always be substituted for each
liter of fuel oil.(PERFECT SUBSTITUTES).

Q = aL + Bk (constant slope)
Elasticity of substitution : infinity

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 LEONTIFF : Inputs must be
combined in fixed proportions
is called a fixed-proportions
production function, and the
inputs in a fixed-proportions
production function are called
perfect complements.

Q = min(2H,O)

Elasticity of substitution : 0

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COBB DOUGLAS : Intermediate
between a linear production
function and a fixed-proportions
production function.
With the Cobb–Douglas
production function, capital and
labor can be substituted for
each other. Unlike a fixed-
proportions production
function, capital and labor can
be used in variable proportions.
Unlike a linear production
function, though, the rate at
which labor can be substituted
for capital is not constant as
you move along an isoquant.

Q= ALαKβ
U.S. and European companies to exploit information
technology (IT) to raise productivity. Specifically, they
estimated production functions of the general form:

Q = A Lά Kβ ITγ

 ELASTICITY OF SUBSTITUTION : 0 to infinity

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RETURNS TO SCALE
 Percentage increase in output when a firm increases all of
its input quantities by a given percentage amount:

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 Increasing returns to scale : a proportionate increase in all input quantities
results in a greater than proportionate increase in output.

 Constant returns : proportionate increase in all input quantities results in the

same proportionate increase in output.

 Decreasing returns to scale: proportionate increase in all input quantities

results in a less than proportionate increase in output.

Anuradha Saikia