ECONOMICS CLASS
PRODUCTION FUNCTION
THE PRODUCTION DECISIONS OF A FIRM
• 1. Production Technology: We need a practical way of describing how inputs (such as labor, capital, and raw
materials) can be transformed into outputs (such as cars and televisions). Just as a consumer can reach a level of
satisfaction from buying different combinations of goods, the firm can produce a particular level of output by
using different combinations of inputs. For example, an electronics firm might produce 10,000 televisions per
month by using a substantial amount of labor (e.g., workers assembling the televisions by hand) and very little
capital, or by building a highly automated capital-intensive factory and using very little labor.
• 2. Cost Constraints: Firms must take into account the prices of labor, capital, and other inputs. Just as a consumer
is constrained by a limited budget, the firm will be concerned about its cost of production. For example, the firm
that produces 10,000 televisions per month will want to do so in a way that minimizes its total production cost,
which is determined in part by the prices of the inputs it uses.
• 3. Input Choices: Given its production technology and the prices of labor, capital, and other inputs, the firm must
choose how much of each input to use in producing its output. Just as a consumer takes account of the prices of
different goods when deciding how much of each good to buy, the firm must take into account the prices of
different inputs when deciding how much of each input to use. If our electronics firm operates in a country with
low wage rates, it may decide to produce televisions by using a large amount of labor, thereby using very little
capital.
FACTORS OF PRODUCTION
• Inputs into the production process (e.g., labor, capital, and materials).
• Production function
• Function showing the highest output that a firm can produce for every specified combination
of inputs.
q = F(K, L)
• Short run: Period of time in which quantities of one or more production factors cannot be
changed.
• Fixed input: Production factor that cannot be varied
• Long run: Amount of time needed to make all production inputs variable.
DIFFERENT
PRODUCT
•Average product: Output per unit of a particular input.
•Marginal product: Additional output produced as an input is
increased by one unit.
PRODUCTION WITH ONE INPUT VARIABLE
RELATION BETWEEN AVERAGE PRODUCT AND MARGINAL PRODUCT
• THE RELATIONSHIP BETWEEN THE AVERAGE AND MARGINAL
PRODUCTS Note the graphical relationship between average and
marginal products in Figure. At B, the marginal product of labor (the
slope of the tangent to the total product curve at B—not shown
explicitly) is greater than the average product (dashed line 0B). As a
result, the average product of labor increases as we move from B to
C. At C, the average and marginal products of labor are equal: While
the average product is the slope of the line from the origin, 0C, the
marginal product is the tangent to the total product curve at C (note
the equality of the average and marginal products at point E in
Figure 6.1 (b)). Finally, as we move beyond C toward D, the marginal
product falls below the average product; you can check that the
slope of the tangent to the total product curve at any point between
C and D is lower than the slope of the line from the origin
PRODUCTION WITH TWO VARIABLE INPUTS
isoquant Curve showing all possible combinations of inputs that yield the
same output
RETURNS TO SCALE
• returns to scale Rate at which output increases as inputs are increased proportionately
• increasing returns to scale Situation in which output more than doubles when all inputs are
doubled.
constant returns to scale
• decreasing returns to scale
Situation in which output doubles when all inputs are doubled
ISOCOST LINE AND INPUT CHOICE
isocost line Graph showing all possible combinations of labor and capital that can be
purchased for a given total cost
