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Chapter 5

The document discusses production analysis and cost analysis in economics. It covers topics like production functions, total product, marginal product, isoquants, isocosts, cost minimization, and how firms determine optimal input levels. It provides examples of different production function forms like Cobb-Douglas and discusses the relationship between marginal product and input costs.

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13 views

Chapter 5

The document discusses production analysis and cost analysis in economics. It covers topics like production functions, total product, marginal product, isoquants, isocosts, cost minimization, and how firms determine optimal input levels. It provides examples of different production function forms like Cobb-Douglas and discusses the relationship between marginal product and input costs.

Uploaded by

Ss Ar
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Download as PPTX, PDF, TXT or read online on Scribd
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Chapter 5

The Production Process and Costs


5-2

Overview
I. Production Analysis
• Total Product, Marginal Product, Average Product
• Isoquants
• Isocosts
• Cost Minimization
II. Cost Analysis
• Total Cost, Variable Cost, Fixed Costs
• Cubic Cost Function
• Cost Relations
5-3

Production Analysis
• Production Function
• Q = F(K,L)
• Q is quantity of output produced.
• K is capital input.
• L is labor input.
• F is a functional form relating the inputs to output.
• The maximum amount of output that can be produced with K units of capital
and L units of labor.
Short-Run vs. Long-Run Decisions
• The short run is defined as the time frame in which there are fixed
factors of production.
• Fixed factors are the inputs the manager cannot adjust in the short
run.
• Variable factors are the inputs a manager can adjust to alter
production.
• The long run is defined as the horizon over which the manager can
adjust all factors of production
• Total product (TP): is simply the maximum level of output that can be
produced with a given amount of inputs.
• Average product: A measure of the output produced per unit of input.
• APL = Q/ L
• Marginal product: The change in total output attributable to the last
unit of an input.
• MPK = ∆Q /∆K
Increasing, Decreasing, and Negative
Marginal Returns
Increasing, Decreasing, and Negative
Marginal Returns
• increasing marginal returns :Range of input usage over which
marginal product increases.
• (diminishing) marginal returns: Range of input usage over which
marginal product declines.
• negative marginal returns: Range of input usage over which marginal
product is negative.
The Role of the Manager in the Production
Process
• Produce on the Production Function: To ensure that workers are in
fact working at full potential, the manager must institute an incentive
structure that induces them to put forth the desired level of effort.
• Use the Right Level of Inputs: by using the value marginal product
which is the value of the output produced by the last unit of an input.
• VMPL = P * MPL
A principle
• Profit-Maximizing Input Usage To maximize profits: a manager should
use inputs at levels at which the marginal benefit equals the marginal
cost. More specifically, when the cost of each additional unit of labor
is w, the manager should continue to employ labor up to the point
where VMPL = w in the range of diminishing marginal product. (the
graph is deleted)
The Value Marginal Product of Labor table
l p MPl VMP=P*MPL W228
0 3 - - 400
1 3 76 228 400
2 3 172 516 400
3 3 244 732 400
4 3 292 876 400
5 3 316 948 400
6 3 316 948 400
7 3 292 876 400
8 3 244 732 400
9 3 172 516 400
10 3 76 228 400
11 3 -44 -132 400
5-11

Production Function Algebraic Forms


• Linear production function: inputs are perfect
substitutes.
Q  F  K , L   aK  bL
• Leontief production function: inputs are used in
fixed proportions.

• Cobb-Douglas  F  K , L   min
Q production  bK , cL inputs have a
function:
degree of substitutability.

Q  F  K , L  K La b
Exercise
• What production function models each of the following technologies?
• One computer can be made from two 32 megabyte memory chips or
a single 64 megabyte chip.
• Every course that is taught requires 1 instructor, 2 teaching assistants,
and 1 lecture room.
solution
• F (z1, z2) = z1/2 + z2 where input 1 is 32-megabyte chips and input 2 is
64-megabyte chips.
• F (z1, z2) = min{z1, z2/2, z3} where input 1 is instructors, input 2 is TAs,
and input 3 is lecture rooms.
•  A firm's production function is given by
• F (z1, z2) = z2.
How much output can it produce if it has 16 units of input 1 and 2 units
of input 2?
• The output it can produce is F (16,2) = 2(16)1/4(2) = 2(2)(2) = 8.
Example of Cobb-Douglas function
• One example of Cobb-Douglas function is Q=K0.5L0.5. This describes a firm
that requires the least total number of inputs when the combination of
inputs is relatively equal. For example, the firm could produce 25 units of
output by using 25 units of capital and 25 of labor, or it could produce the
same 25 units of output with 125 units of labor and only one unit of capital.
• A Cobb-Douglas Function takes the form of Q=KαLβ where Q=output,
K=capital, L=labour, and alpha and beta are used to represent input shares
of capital and labour respectively. In this form we have used CD as a
production function. If we are given values for K,α,L,β (our independent
variables) then we can calculate a value for output, our dependent variable.
5-17

Isoquant
• Illustrates the long-run 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.
Family of isoquant
Isocosts
• A line that represents the combinations of inputs that will cost the
producer the same amount of money.
• wL + rK = C
• where w is the wage rate (the price of labor) and r is the rental rate
(the price of capital). This equation represents the formula for an
isocost line.
Isocost line
Changes in Isocost Line
Cost Minimization :When wages increases
Principle
• Optimal Input Substitution : To minimize the cost of producing a given
level of output, the firm should use less of an input and more of other
inputs when that input’s price rises.

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