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Chapter 6:

Chapter 6:. Production Processes and Behaviors of Firms. Key Topics. Production Definition Relationship to profit Short-run vs long-run Short-run production concepts Total product (or production function) Marginal product (& diminishing returns) Average product Stages of production.

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Chapter 6:

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  1. Chapter 6: Production Processes and Behaviors of Firms

  2. Key Topics • Production • Definition • Relationship to profit • Short-run vs long-run • Short-run production concepts • Total product (or production function) • Marginal product (& diminishing returns) • Average product • Stages of production

  3. Key Topics 3. Long-run production concepts • Isoquants • Labor vs. capital intensive • Marginal rate of technical substitution • Technological progress

  4. Common goal of business firms = profit = total revenue (TR) – total costs (TC)

  5. Questions • What business firm decisions affect profits of the firm? • How can a firm increase its profits?

  6. Firm decisions that impact TR • Products to produce • Product prices • Quantity of products • How to market/promote products

  7. Firm decisions that impact TC • Quantity of products produced • What inputs to use to produce products • What quantity and combinations of inputs to use • How to acquire inputs • How to make inputs more productive

  8. Production = the process by which inputs are combined and transformed into outputs

  9. Question • What’s the difference between short-run and long-run production to an economist?

  10. Types (or lengths) of production periods • Short run (SR)  period of time for which a firm is stuck with a fixed or given quantity of at least one input • Long run (LR)  period of time for which a firm can vary or alter the quantities of all inputs

  11. Production Function = a numerical, tabular, or graphical expression showing the maximum units (quantities) of a product that can be produced as a function of units (quantities) of inputs

  12. General equation of a typical SR production function

  13. SR Production Concepts • TP = total product = total physical units of output = total quantity of output = q = f 2. AP = average product = output per unit of input = output of ‘average’ input = slope of line from origin to TP curve = q/L

  14. SR Production Concepts 3. MP = marginal product = additional output per unit of additional input = slope of TP curve = output of last input unit = Δq/ΔL

  15. ‘Linear’ SR Production Function TP q=aL L AP, MP a MP=AP=a L

  16. Nonlinear SR production function • See Fig. 6.6 and Table 6.2.

  17. “Stages” of production StageCharacteristic I AP is ing II* AP is ing and MP > 0 III MP < 0 *Firms will be maximizing profits only if they are operating in Stage II.

  18. Questions • How does your cumulative GPA and your last-term GPA relate to production concepts? • What happens to your cumulative GPA if your last-term GPA is greater?

  19. AP and MP relationship • If MP > AP, AP is ing • If MP < AP, AP is ing • If MP = AP, AP is either at a max or is a constant

  20. The law of diminishing returns  As additional units of a variable input are combined with fixed inputs, there will come a point where the marginal product of the variable input will start to decline.

  21. General equation of a LR production function q = f (K,L) q = physical units of output k = physical units of capital that are variable L = physical units of labor that are variable

  22. Isoquant • A graph of the combinations of inputs (K, L) that yield the producer the same level of output. • The shape of an isoquant reflects the ease with which a producer can substitute among inputs while maintaining the same level of output. (See Figure 6A.1)

  23. Pt ‘a’ = ‘capital’ intensive production process Pt ‘b’ = ‘labor’ intensive production process K a Ka b Kb La Lb L

  24. SR Production in LR Diagram K q2 q1 L L1 L2

  25. - Slope of Isoquant From 1 pt on an isoquant to another Δq = MPK (ΔK) + MPL (ΔL) = 0 • MPK (ΔK) + MPL (-ΔL) = Rate K can be exchanged for 1 unit of L holding output constant (= marginal rate of technical substitution)

  26. SR Technological Progress q TP2 TP1 L

  27. LR Technological Progress K b a K1 c q1 (old) q1 (new) L1 L

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