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    Production Analysis

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    gappu007
    This document provides an overview of production analysis and the production function. It discusses how firms combine inputs like labor, capital, and raw materials to produce outputs. The firm's objective is to maximize profit. The production function describes the technological relationship between inputs and maximum possible output. Common forms of production functions discussed include the Cobb-Douglas production function, which is frequently used in empirical analysis. The document also covers concepts like total product, marginal product, returns to scale, and isoquants.

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    Production Analysis

    Uploaded by

    gappu007
    59 views31 pages
    This document provides an overview of production analysis and the production function. It discusses how firms combine inputs like labor, capital, and raw materials to produce outputs. The firm's objective is to maximize profit. The production function describes the technological relationship between inputs and maximum possible output. Common forms of production functions discussed include the Cobb-Douglas production function, which is frequently used in empirical analysis. The document also covers concepts like total product, marginal product, returns to scale, and isoquants.

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    This document provides an overview of production analysis and the production function. It discusses how firms combine inputs like labor, capital, and raw materials to produce outputs. The firm's objective is to maximize profit. The production function describes the technological relationship between inputs and maximum possible output. Common forms of production functions discussed include the Cobb-Douglas production function, which is frequently used in empirical analysis. The document also covers concepts like total product, marginal product, returns to scale, and isoquants.

    Copyright:

    Attribution Non-Commercial (BY-NC)
    Download as PDF, TXT or read online from Scribd
    Download as pdf or txt
    59 views31 pages

    Production Analysis

    Uploaded by

    gappu007
    This document provides an overview of production analysis and the production function. It discusses how firms combine inputs like labor, capital, and raw materials to produce outputs. The firm's objective is to maximize profit. The production function describes the technological relationship between inputs and maximum possible output. Common forms of production functions discussed include the Cobb-Douglas production function, which is frequently used in empirical analysis. The document also covers concepts like total product, marginal product, returns to scale, and isoquants.

    Copyright:

    Attribution Non-Commercial (BY-NC)
    Download as PDF, TXT or read online from Scribd
    Download as pdf or txt
    of 31

    PRODUCTION ANALYSIS

    Dr. SK LAROIYA
    UNIVERSITY OF DELHI
    AND
    AMITY BUSINESS SCHOOL
    A FIRM IS AN ORGNISATION THAT COMBINES AND
    ORGANISES
    LABOR
    CAPITAL
    RAW MATERIAL OR ANY OTHER INPUT
    FOR THE PURPOSE OF PRODUCING GOODS AND
    SERVICES FOR SALE

    THE FIRMS OBJECTIVE IS TO MAXIMISE PROFIT AND
    OTHER RELATED AIMS SUCH AS MAXIMISING SALES OR
    GROWTH
    2 September 2012 2
    THE BASIC PRODUCTION DECISION FACING THE FIRM

    HOW MUCH OF GOODS OR SERVICES TO BE
    PRODUCED AND HOW MUCH OF INPUTS TO BE
    USED TO PRODUCE A GIVEN OUT OUTPUT MOST
    EFFICIENTLY

    FOR THIS A FIRM REQUIRES ENGINEERING OR
    TECHNOLOGICAL DATA ON PRODUCTION POSSIBILITIES
    AS WELL AS ECONOMIC DATA ON INPUT AND OUTPUT
    PRICES
    2 September 2012 3
    PRODUCTION FUNCTION

    Q= f( a,b,c,d,e) FOR GIVEN T ( TECHNOLOGY)

    IF T CHANGES, PRODUCTION FUNCTION ALSO
    CHANGES
    f
    1
    ,f
    2
    ,f
    3
    ,f
    4
    ,f
    5
    > 0

    2 September 2012 4

    CONCEPT OF INPUT COEFFICIENT



    FIXED AND VARIABLE INPUT COEFFICIENTS
    2 September 2012 5
    PRODUCTION FUNCTION WITH VARIABLE
    INPUT COEFFICIENTS
    NEO CLASSICAL PRODUCTION FUNCTION

    PRODUCTION FUNCTION WITH FIXED INPUT
    COEFFICIENTS
    LEONTIEF PRODUCTION FUNCTION
    2 September 2012 6
    PRODUCTION FUNCTION WITH ONE VARIABLE
    INPUT
    SHORT RUN PRODUCTION FUNCTION
    RETURNS TO A FACTOR

    PRODUCTION FUNCTION WITH MORE THAN ONE
    VARIABLE INPUTS-
    LONG RUN PRODUCTION FUNCTION
    RETURNS TO SCALE
    2 September 2012 7
    PRODUCTION FUCTION WITH ONE
    VARIABLE INPUT

    TOTAL PRODUCT TP = Q = f(L)
    MARGINAL PRODUCT MP = TP/ Q

    AVERAGE PRODUCT AP = TP/Q

    PRODUCTION OR
    OUTPUT ELASTICITY OF LABOR
    E
    L
    = Q/ L x L /Q
    2 September 2012 8
    TOTAL , MARGINAL AND AVERAGE PRODUCT OF LABOR (VARIABLE INPUT)
    AND OUTPUT ELASTICITY
    2 September 2012 9
    RELATIONSHIP BETWEEN TP, AP AND MP
    THE TOP PANEL SHOWS THE TOTAL PRODUCT OF LABOUR CURVE.TP IS THE HIGHEST BETWEEN 4L AND 5L.
    THE BOTTOM PANEL SHOWS THE MP AND AP LABOUR CURVES. THE MP OF LABOUR IS PLOTTED HALF WAY
    BETEEN SUCCESSIVE UNITS OF LABOUR USED. THE MP OF LABOUR CURVE RISES UPTO 1.5 L AND THEN
    DECLINES AND IT BECOMES NEGATIVE PAST 4.5 L. THE AP IS THE HIGHEST BETWEEN 2L AND 3L
    2 September 2012 10
    RETURNS TO A FACTOR-

    STAGE I
    - II
    -III
    2 September 2012 11
    TP , AP AND MP CURVES AND STAGES OF PRODUCTION
    2 September 2012 12
    PRODUCTION FUNCTION WITH TWO
    OR MORE VARIABLE INPUTS
    Q = (a,b,c,d,e)

    LONG RUN PRODUCTION FUNCTION


    THE CONCEPT OF ISOQUANT


    2 September 2012 13


    PRODUCTION FUNCTION WITH TWO VARIABLE INPUTS
    2 September 2012 14
    ECONOMIC REGION OF PRODUCTION AND
    RIDGE LINES-


    ECONOMIC REGION OF PRODUCTION IS GIVEN BY THE NEGATIVELY SLOPED SEGMENT OF
    THE ISOQUANTS BETWEEN RIDGE LINES OVI AND OZI. THE FIRM SHALL NOT PRODUCE IN
    THE POSITIVELY SLOPED PORTION OF THE ISOQUANTS BECAUSE IT COULD PRODUCE THE
    SAME LEVEL OF OUTPUT WITH LESS LABOUR AND LESS CAPITAL
    2 September 2012 15
    RIDGE LINES SEPARATE THE RELEVANT (NEGATIVELY SLOPED) FROM
    THE IRRELEVANT (OR POSITIVELY SLOPED) PORTION OF THE
    ISOQUANTS

    THE ISOQUANTS ARE NEGATIVELY SLOPED TO THE LEFT OF THIS RIDGE
    LINE AND POSITIVELY SLOPED TO THE RIGHT

    THE NEGATIVELY SLOPED PORTION OF THE ISOQUANTWITH IN THE
    RIDGE LINES REPRESENT THE RELEVANT REGION OF PRODUCTION

    THIS REFERS TO STAGE II OF PRODUCTION FOR LABOR AND CAPITAL
    WHERE MP
    K
    AND MP
    L
    ARE BOTH POSITIVE BUT DECLINING

    PRODUCERS WILL NEVER WANT TO OPERATE OUTSIDE THIS REGION
    2 September 2012 16

    OPTIMAL INPUT COMBINATION FOR
    MINIMIZING COST OR MAXIMIZING OUTOUT
    2 September 2012 17
    RETURNS TO SCLAE

    RETURNS TO SCALE USING ISOQUANTS

    EXPANSION PATH OF A FIRM
    2 September 2012 18
    EMPIRICAL PRODUCTION FUNCTIONS
    THE PRODUCTION FUNCTION MOST COMMONLY USED IN
    EMPIRICAL ESTIMATION IS THE POWER FUNCTION OF THE
    FORM:

    Q= A K
    a
    L
    b


    WHERE
    Q= OUTPUT
    K=CAPITAL
    L= LABOR

    AND A , a, and b ARE PARAMETERS TO BE
    ESTIMATED EMPIRICALLY


    2 September 2012 19

    THIS FORM OF PRODUCTION REFERRED TO
    AS

    COBB- DOUGLAS PRODUCTION FUNCTION IN
    HONOR OF MATHEMATICIANS, CHARLES W.
    COBB AND PAUL H. DOUGLAS (WHO
    INTRODUCED IT IN 1920s)
    2 September 2012 20
    THE EQUATION FOR THE MARGINAL PRODUCT OF CAPITAL IS

    MP
    K
    = Q/ K
    = a AK
    a-1
    L
    b


    THE EQUATION FOR THE MARGINAL PRODUCT OF LABOR IS

    MP
    L
    = Q/ L
    = b AK
    a
    L
    b-1


    2 September 2012 21
    PROPERTIES OF COBB- DOUGLAS
    PRODUCTION FUNCTION:

    - THE MP OF CAPITAL AND MP OF LABOR
    DEPEND BOTH ON THE QUANTITY OF CAPITAL
    AND QUANTITY OF LABOR USED IN THE
    PRODUCTION AS IS THE CASE IN THE REAL
    WORLD

    2 September 2012 22
    - THE EXPONENTS OF K AND L (i.e., a and b)
    REPRESENT RESPECTIVELY,
    THE OUTPUT ELASTICITY OF CAPITAL AND LABOR
    (E
    K
    AND E
    L
    ), AND THE SUM OF TWO EXPONENTS
    (a+b) MEASURES THE RETURNS TO SCALE

    IF a+b > 1 . INCREASING RETURNS TO SCALE
    IF a+b = 1 . CONSTANT RETURNS TO SCALE
    IF a+b < 1 . DECREASING RETURNS TO SCALE



    2 September 2012 23
    OUTPUT ELASTICITY OF CAPITAL IS

    E
    K
    = Q/ K x K/Q
    = a

    OUTPUT ELASTICITY OF LABOR IS

    E
    L
    = Q/ L x L/Q
    = b

    AND E
    K
    AND E
    L
    = a+b = RETURNS TO SCALE
    2 September 2012 24
    GIVEN THE COBB- DOUGLAS PRODUCTION FUNCTION

    Q = A K
    a
    L
    b

    IF a+b = 1

    IT IS CONSTANT RETURNS TO SCALE

    LET US SEE HOW DO WE GET IT

    WITH 2L UNITS LABOR AND 2K UNITS OF CAPITAL,
    THE OUTPUT IS
    F(2K,2L) = A(2K)
    a
    (2L)
    b
    = 2
    a+b
    (AK
    a
    L
    b
    )
    = 2
    a+b
    F(K, L)

    THUS OUTPUT EXACTLY DOUBLES IF a+b =1( SINCE THEN 2
    a+b
    =2)




    2 September 2012 25
    - COBB- DOUGLAS PRODUCTION FUNCTION
    CAN BE ESTIMATED BY REGRESSION
    ANALYSIS BY TRANSFORMING IT INTO

    In Q= ln A+ a ln K+ b ln L

    WHICH IS LINEAR IN THE LOGARITHMS


    2 September 2012 26


    - FINALLY COBB-DOUGLAS PRODUCTION
    FUNCTION CAN BE EXTENDED TO DEAL WITH
    MORE THAN TWO INPUTS
    2 September 2012 27
    COBB-DOUGLAS PRODUCTION FUNCTION CAN BE ESTIMATED

    FROM DATA

    1.
    FOR A SINGLE FIRM, INDUSTRY OR NATION OVER TIME( TIME
    SERIES ANALYSIS)

    2.
    OR FOR NUMBER OF FIRMS, INDUSTRIES OR NATIONS AT ONE
    POINT IN TIME (USING CROSS SECTIONAL DATA)

    2 September 2012 28
    IN EITHER CASE , THE RESEARCHERS FACE
    THREE POTENTIAL DIFFICULTIES:

    - IF A FIRM PRODUCES NUMBER OF DIFFERENT
    PRODUCTS, OUTPUT MAY HAVE TO BE MEASURED IN
    MONETARY RATHER THAN IN PHYSICAL UNITS, AND THIS
    WILL REQUIRE DEFLATING THE VALUE OF OUTPUT BY
    THE PRICE INDEX IN TIME-SERIES ANALYSIS
    OR
    ADJUSTING FOR THE PRICE DIFFERENCES FOR FIRMS
    AND INDUSTRIES LOCATED IN DIFFERENT REGIONS IN
    CROSS SECTIONAL ANALYSIS
    2 September 2012 29

    - ONLY THE CAPITAL CONSUMED IN THE
    PRODUCTION OF OUTPUT SHOULD BE COUNTED,
    IDEALLY

    SINCE MACHINERY AND EQUIPMENTS ARE OF
    DIFFERENT TYPES AND AGES (VINTAGES) AND
    PRODUCTIVITIES, HOWEVER, THE TOTAL STOCK
    OF CAPITAL IN EXISTENCE HAS TO BE USED
    INSTEAD
    2 September 2012 30
    - IN TIME-SERIES ANALYSIS A TIME TREND IS ALSO
    USUALLY INCLUDED TO TAKE INTO
    CONSIDERATION TECHNICAL CHANGES OVER
    TIME


    WHILE IN CROSS SECTIONAL DATA ANALYSIS, WE
    MUST ASCERTAIN THAT ALL FIRMS OF
    INDUSTRIES USE THE SAME TECHNOLOGY
    (THE BEST AVAILABLE)
    2 September 2012 31

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