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CHAPTER 8 PRODUCTION ANALYSIS 2 nd Semester, S.Y 2013 – 2014

CHAPTER 8 PRODUCTION ANALYSIS 2 nd Semester, S.Y 2013 – 2014. The Role of the Firm. A firm is an economic institution that transforms factors of production into goods and services. Firms: Buy and o rganize factors of production Produce goods and services and/or

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CHAPTER 8 PRODUCTION ANALYSIS 2 nd Semester, S.Y 2013 – 2014

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  1. CHAPTER 8 PRODUCTION ANALYSIS 2nd Semester, S.Y 2013 – 2014

  2. The Role of the Firm Afirmis an economic institution that transforms factors of production into goods and services. Firms: Buy and organize factors of production Produce goods and services and/or Sell produced goods and services 12-2

  3. Firm’s Objectives Minimize Cost 2. Maximize Profit 12-3

  4. Production • Production is the transformation of inputs (factors of production) to produce outputs (final goods and services). • Economic Resources: • Land • Labor • Capital • Entrepreneurship

  5. Fixed and Variable Input Fixed inputs are inputs whose quantity is fixed for a period of time and cannot be varied. The quantity remains constant, regardless of how much output is produced. Variable inputs are inputs whose quantity the firm can vary at any time. The quantity changes as the level of output changes.

  6. Let’s Check Your Understanding! • Identify the following as either fixed input or variable input. • 10-hectare farm • Fuel • Machineries • Fertilizer • Salaries of Workers • Raw materials • Manufacturing plant

  7. Short run is defined as the period of production in which in which quantities of one or more production inputs are fixed or cannot be changed. Plant size (capital) is fixed, labor is variable. Long run is defined as the period required for all inputs to be variable Both plant size (capital) and labor are variable. Short Run vs. Long Run

  8. Production function The relationship between the quantity of inputs a firm uses and the quantity of output it produces. A mathematical representation that shows the maximum quantity of output a firm can produce given the quantities of inputs that it might employ. Q f(L, K ) where Q is the quantity of output, L is the quantity of labor used, and K is the quantity of capital employed. Production Function

  9. Production Function

  10. Production with One Variable Input • An analysis on production which shows how the quantity of output depends on the quantity of the variable input, for a given quantity of the fixed input. • This examines three important concepts in production process: Total product (TP), Average product (AP) and Marginal product (MP).

  11. Production Schedule A production schedule is a table showing the output resulting from various combinations of factors of production or inputs. This analysis will concentrate on short run production in which one of the factors is fixed

  12. A Production Table Average product is the output per worker Marginal product is the additional output that will be forthcoming from an additional worker, other inputs constant

  13. Represents the relationship between the number of workers (L) or and the total number of units of output produced (Q) holding all other factors of production (the plant size) constant. It is the total product produced by each combination of labor and the fixed amount of capital. For a coffee shop, output would be measured in “number of coffee cups a day” For a steel mill, output would be measured in “tons of steel produced a day” Total Product (TP)

  14. The amount of output produced per unit of input used at a certain level of production. The total product divided by the number of units of input. It is expressed by the formula. Average Product

  15. It is the extra output that can be produced by using one more unit of the input. For instance, the difference in output when a firm's labor usage is increased from six to seven units, assuming that the quantities of other inputs are constant. The marginal product of a given input can be expressed as: MP is the mathematical derivative of the production function with respect to that input. Marginal Product

  16. Graphing a Production Function TP 32 26 20 14 8 2 TP A total product curve showing the relationship between inputs and the outputs Number of workers 1 2 3 4 5 6 7 8 9 10 Increasing marginal productivity Diminishing marginal productivity Diminishing Absolute productivity

  17. Graphing Marginal and Average Product AP, MP 8 6 4 2 0 -2 -4 -6 AP Number of workers 1 2 3 4 5 6 7 8 9 10 Marginal productivity first increases Then marginal productivity declines Eventually marginal productivity is negative Observations: MP = 0, TP is at its maximum MP > AP & AP is increasing MP < AP & AP is decreasing MP = AP is at its maximum MP Diminishing marginal productivity Diminishing Absolute productivity Increasing marginal productivity

  18. Stages of Production Total Product Stage 1: characterized by increasing productivity of any input used resulting in increasing level of output. TP Stage I Stage II Stage III Quantity of Input Marginal, Average Product AP Stage 2: characterized by decreasing productivity of input resulting in output still increasing but at a slower rate . Stage 3: characterized by further decreasing productivity of input finally resulting in a decline in total production. MP Quantity of Input

  19. Law of Diminishing Marginal Productivity Law of diminishing marginal productivity states as more of a variable input is added to an existing fixed input, after some point the additional output from the additional input will fall.

  20. Let’s Check Your Understanding! Derive the values of marginal product and total product. Units of Variable Resource TotalProduct(Output) MarginalProduct AverageProduct 0 ----- ----- 0 8 8 8 1 20 12 10 2 34 14 11.3 3 46 12 11.5 4 56 10 11.2 5 64 8 10.7 6 70 6 10 7 74 8 4 9.3 75 1 8.3 9 10 73 - 2 7.3

  21. A curve showing all possible combinations of inputs that yield the same output. The isoquant emphasizes how different input combinations can be used to produce the same output. This information allows the producer to respond efficiently to changes in the markets for inputs. Isoquant

  22. Observations: 1) For any level of K, output increases with more L. 2) For any level of L, output increases with more K. 3) Various combinations of inputs produce the same output. Isoquants

  23. Production with Two Variable Inputs LABOR INPUT Capital Isoquant Curve Labor Isoquantcurve showing all possible combinations of inputs that yield the same output.

  24. An isoquant is downward sloping to the right. i.e negatively inclined. This implies that for the same level of output, the quantity of one variable will have to be reduced in order to increase the quantity of other variable. Higher isoquant represents larger output. that is with the same quantity of one input and larger quantity of the other input, larger output will be produced. Properties of Isoquant Curves

  25. Properties of Isoquant Curves • No two isoquants intersect or touch each other. If the two isoquants do touch or intersect that means that a same amount of two inputs can produce two different levels of output which is absurd. • Isoquant is convex to the origin. This means that the slope declines from left to right along the curve. that is when we go on increasing the quantity of one input say labour by reducing the quantity of other input say capital, we see less units of capital are sacrificed for the additional units of labour.

  26. Marginal Rate of Technical Substitution Marginal Rate of Technical Substitution (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.

  27. Marginal Rate of Technical Substitution MRTS = − Change in capital input/change in labor input = − ΔK/ΔL (for a fixed level of q) Like indifference curves, isoquants are downward sloping and convex. The slope of the isoquant at any point measures the marginal rate of technical substitution—the ability of the firm to replace capital with labor while maintaining the same level of output. On isoquant q2, the MRTS falls from 2 to 1 to 2/3 to 1/3.

  28. Isoquant Map Isoquant map is a graph combining a number of isoquants, used to describe a production function. The isoquants are derived from the productionfunction for output of of55, 75, and 90. A set of isoquants, or isoquant map, describes the firm’s production function. Output increases as we move from isoquant q1 (at which 55 units per year are produced at points such as A and D), to isoquant q2 (75 units per year at points such as B) and to isoquant q3 (90 units per year at points such as C and E).

  29. Isoquant Map

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