Theory of production

Numericals
Fill in the gaps in the table below
Quantity of Total Output Marginal Average Product
Variable Input Product

0 0
1 225
2 300
3 300
4 1140
5 225
6 225
Fill in the gaps in the table below
Quantity of Total Output Marginal Average
Variable Input /Total Product Product( Product(AP) List of formula:
(TP) MP)
TP=APL*L
APL=TP/L
MP=TP2 –TP1

0 0
1 225 225 225
2 300*2=600 375 300
3 600+300= 900 300 900/3=300
4 1140 240 1140/4=285
5 1140+225=1365 225 1365/5=273
6 225*6=1350 -15 225
Strictly for lecture purpose at NMIMS SOC
• The number of repairs produced by a No. of No. of Repairs
computer repair shop depends on the workers per
number of workers as follows. week
• Assume that all inputs (office space,
telephone, utilities) other than labour
0 0
are fixed in the short run.
• Add two additional columns to the table 1 8
and enter MP and AP for each no. of 2 20
workers. What are the stages of the
production function you can identify.
3 35
• Why MP is rising initially? What happens
to TP, MP and AP in the IInd Stage and 4 45
why? Will MP eventually become
negative? Give your reasons. 5 52
6 57
7 60
• The number of repairs produced by a computer
repair shop depends on the number of workers as
follows. No. of workers No. of MPL APL
per week Repairs
• Assume that all inputs (office space, telephone,
utilities) other than labour are fixed in the short run. 0 0 -----
• Add two additional columns to the table and enter 1 8 8 8
MP and AP for each no. of workers. What are the
stages of the production function you can identify. 2 20 12 10
• Why is MP rising initially? (Law of variable
proportion: given a fixed amount of capital, 3 35 15 11.6
initially, output increases at an increasing rate)
What happens to TP, MP and AP in the IInd Stage
4 45 10 11.2
and why. (TP increases but a decreasing rate here 5 52 7 10.4
because MP is decreasing. Law of variable
proportion: given a fixed amount of capital, as 6 57 5 9.5
labor increases, after a certain point MP starts
falling. AP falls when MP is below AP. 7 60 3 8.6
• Will MP eventually become negative? Give your
reasons.
• Yes. It will. With more number of labourer hired,
output will fall , since capital is fixed. (negative
returns-stage III. Due to too much of labourer Diminishing returns to variable factor
(overcrowding) since capital is fixed

Increasing returns to variable factor

Assume that MPL = 5, and MPK = 10 and that price of a unit of labour
and a unit of capital are Rs. 20 and Rs. 50 respectively, is the producer
operating at the least cost combination of factors. Should the firm
increase labour and reduce capital? Give reasons for your answer.

Strictly for lecture purpose at NMIMS SOC

Assume that MPL = 5, and MPK = 10 and that price of a unit of labour and
a unit of capital are Rs. 20 and Rs. 50 respectively, is the producer
operating at the least cost combination of factors. Should the firm
increase labour and reduce capital? Give reasons for your answer.

Slope of the isoquant

ΔK/ΔL (MRTS)=-MPL/MPK=-(5/10)=-0.5
Slope of the isocost
ΔK/ΔL=-(PL/PK)=-(20/50)=-0.4
MPL/MPK>PL/PK. The firm is not operating at the least cost combination
of factors
MPL/PL>MPK/PK. Marginal productivity per dollar from labour is more
than marginal productivity per dollar from capital. This implies the firm
should increase labour andStrictly
decrease capital.
for lecture purpose at NMIMS SOC
Suppose that a firm’s production function is Q=10L1/2K1/2. The cost of a unit of labor is Rs.20 and the
cost of capital is Rs.80. The firm is currently producing 100 units of output and has determined that
the cost-minimizing quantities of labor and capital are 20 and 5 respectively.
Do you think that the above input combination is cost-minimizing? Illustrate graphically.

Strictly for lecture purpose at NMIMS SOC

Suppose that a firm’s production function is Q=10L1/2K1/2. The cost of a unit of labor is Rs.20 and the cost of
capital is Rs.80. The firm is currently producing 100 units of output and has determined that the cost-
minimizing quantities of labor and capital are 20 and 5 respectively.
Do you think that the above input combination is cost-minimizing? Illustrate graphically.
Optimality condition is that MPL/MPK (slope of isoquant)=PL/PK (slope of isocost)

Q=10L1/2K1/2
Marginal productivities of labor and capital is obtained by differentiating the production function with
respect to that input
Definition of marginal productivity of labor: MPL=dQ/dL=10(1/2)L1/2-1K1/2 (keep K constant)
MPL=10(1/2)L-1/2K1/2
Definition of marginal productivity of capital: MPK=dQ/dK=10(1/2)L1/2K1/2-1 (keep L constant)
MPK=10(1/2)L1/2K-1/2
Slope of isoquant (MRTS)=MPL/MPK=[10(1/2)L-1/2K1/2]/[10(1/2)L1/2K-1/2]=K/L
L=20 and K=5. Therefore, MPL/MPK=K/L=5/20=0.25
PL=20, PK=80. Slope of isocost=PL/PK=20/80=0.25
Yes the above input combination is cost-minimizing. Optimal input combination.
Strictly for lecture purpose at NMIMS SOC
The following table gives the various combinations of labour and capital that can be
used to produce 300 units of output.
Combination Units of Units of
labour capital
A 1 30
B 2 25
C 3 21
D 4 18
E 5 16
F 6 15

Given that the price of a unit of labour and capital is Rs.15 and Rs.5 respectively,
where would the producer be at equilibrium.
The following table gives the various combinations of labour and capital that can be
used to produce 300 units of output.
Combination Units of Units of ΔK/ΔL (MRTS):
labour capital slope of isoquant
A 1 30 -----
B 2 25 (25-30)/(2-1)=-5
C 3 21 (21-25)/(3-2)=-4
D 4 18 (18-21)/(4-3)=-3
E 5 16 (16-18)/(5-4)=-2
F 6 15 (15-16)/(6-5)=-1

Given that the price of a unit of labour and capital is Rs.15 and Rs.5 respectively,
where would the producer be at equilibrium.

ΔK/ΔL (slope of isocost)=PL/PK=-15/5=-3

The equilibrium/optimal combination is (4,18)
Optimal combination: cost minimizing combination
The output levels and the quantity of inputs employed by Ice Cream Express is given below
Output Capital Labour Output Capital Labour
(litres) (Units) (Units) (litres) (Units) (Units)

800 26 45 820 25 46

850 26 46 850 26 46

If the price of a unit of labour is Rs 25, and the price of a unit of capital is Rs. 15, is
the firm producing at the least cost combination of factors. Explain.
The output levels and the quantity of inputs employed by Ice Cream Express is given below

Output Capital Labour Output Capital Labour

(litres) (Units) (Units) (litres) (Units) (Units)

800 26 45 820 25 46

850 26 46 850 26 46

If the price of a unit of labour is Rs 25, and the price of a unit of capital is Rs. 15, is the firm
producing at the least cost combination of factors. Explain.
MPL=(850-800)/(46-45)=50
MPK=(850-820)/(26-25)=30
MPL/MPK=50/30=1.66
PL/PK=25/10=1.66
MPL/MPK=PL/PK
Therefore the firm is producing at the least cost combination of factors.
Of the following production functions, which exhibit increasing,
constant or decreasing returns to scale. Explain.
a) Q = AL0.6K0.2
b) Q = ALK
c) Q = A L0.4K0.6
Of the following Cobb-Douglas production functions, which exhibit
increasing, constant or decreasing returns to scale. Explain.
a) Q = AL0.6K0.2 (Decreasing returns to scale. 0.6+0.2=0.8<1)
b) Q = ALK (Increasing returns to scale. 1+1=2>1)
c) Q = A L0.4K0.6 (Constant returns to scale. 0.4+0.6=1)