Chapter 5

Production Functions
Production function: Mathematical relationship between the input(s) that a firm is using
and the corresponding output
Q=f (K , L)
● Q= total product (TP)
● K = capital
● L = labor
Marginal product (MP): represents the change in total product as the use of one input is
changed incrementally.

Labor usage— adding an additional worker or additional hour of labor time

Δ TP
● MPL=
ΔL
, change in total product divided by the change in total labor
Capital usage— if the variable that is going to be changing incrementally is capital, then
correspondingly you have a marginal product of capital
ΔTP
● MPK= , change in total product divided by the change in total capital
ΔK
Labor Capital

MPL MPK

Table formula: Table formula:

Δ TP ΔQ ΔTP ΔQ
●
ΔL
→ ΔL
●
ΔK
→
ΔK

Function formula (derivatives): Function formula (derivatives):

dQ dQ
dL dK

Partial derivative (meaning only labor is Partial derivative (only capital is

changing): changing):
ɗQ ɗQ
ɗL ɗK

One one variable input

Increasing Marginal Returns: a firm incrementally increases its use of one input and the
addition to output increases.
Diminishing Marginal Returns: a firm incrementally increases its use of one input and
the addition to output decreases. Total product increases but it is the addition to the output
that is getting smaller.

Negative Marginal Returns: a firm incrementally increases its use of one input and the
addition to output is negative. Total product decreases.

Q
Average product of Labor: APL=
L
Q
Average product of Capital: APK =
K

Law of Diminishing Marginal Returns: as a firm incrementally increases its use of one
input (for example labor) eventually the addition to output diminishes.

Optimal Output Rule: you should keep using additional units of an output as long as the
added benefit is at least as large as the added cost.

The added benefit at least as large The added cost

Value marginal product ≥ The cost of the

VMPL or VMPK labor or capital

VMPL= MPL × Price of the output How much is it

VMPK= MPK × Price of the output costing us to hire
one more worker
or to use one
more machine
(or machine time)

Number of Q (TP) ΔQ VMPL=MPL × P Wage

workers MP =
ΔL
L

0 0

1 10 10 $100 $50

2 30 20 $200 $50

3 60 30 $300 $50

4 80 20 $200 $50
 5 90 10 $100 $50

6 95 5 $50 $50

7 80 -15 -$150 $50

Increasing marginal returns
Decreasing marginal returns
Negative marginal returns
Q→ How many workers should be hired? You can hire up to 6 workers, to capture every possible
gain, after 6 there is no gain. Caution: recognize that the first line is a zero line.

Multiple Variable Inputs

L & K can be varied
W→ wage rate cost of labor
R→ cost of additional capital

MPL MPL
● IF >
W R use more L
MPL MPL
● IF <
W R use more K
MPL MPL
● IF =
W R use either

Example: MPL =100 MPK=200, which of the two should we employ more of?
● W = $20, R=$50
MPL 100 MPL 200
○ = > <
W 20 R 50
■ Use more labor
3 types of Production Functions
● Linear
○ K and L can be substituted for each other at a constant rate
○ Think of a production line
■ A machine can do the work of 5 workers.
○ Slope is constant
○ Isoquant— shows the combinations of K and L that can be used to produce the
same quantity of output.
■ Example Q= 4K + 3L
■ IF K= 2, L=3, what is Q?
● Q= 4(2) + (3)
● Q=17
dQ
○ MPL= =3
dL
dQ
○ MPK= =4
dK
 ● Leontieff
○ K and L CANNOT be substituted for each other
○ K and L are used in fixed proportions
■ Example: if you buy a new computer and do not hire another
person/operator, that computer will just sit there, and vice versa.
■ Example: Q= MIN{ 4K, 3L}
● If L=10, K=10
● Q= MIN{ 4(10), 3(10)}
● Q= MIN{ 40, 30}
○ 30 is the min
● Q=30
○ MPL= 0, MPK=0
■ We can answer this questions without calculus
■ K and L cannot be substituted→ no impact whatsoever when adding one more
worker without adding the other
● COBB-DOUGLAS
○ K and L can be substituted for each other, but not at a constant rate
○ NO straight slope isoquant
○ WE WILL SEE A DOWNWARD SLOPE ISOQUANT
■ Example: Q=10 K 0.5 L0.5
● IF K=9, L =16 Q=?
● Q=10 ¿
● Q=10 (3)(4)
●
Q=120
○ MPL= ?, MPK=?
■ Take a partial derivative
dQ
■ MPL= =0.5(10) K 0.5 L0.5−1
dL
dQ
● =5 K 0.5 L−0.5
dL
dQ
■ MPK= =0.5(10) K 0.5−1 L0.5
dK
dQ
● =5 K−0.5 L0.5
dK
1 1
Example: Q=30 L 3 K 2
1. What kind of production is this?
○ Cobb-Douglas
2. Can L and K be substituted for each other?
○ Yes, but not at a constant rate
3. Find MPL function
 dQ
○ MPL= =1/ 3(30)L1 /3−1 K 1/ 2
dL
■ 10 L −2 /3
K 1/ 2
4. Find MPK function
dQ
○ MPK= =1/2(30)L1 /3 K 1/ 2−1
dK
■ 15 L 1/ 3
K −1/2
5. Find MPL if L=8
○ If L=8
○ MPL= 10(8) L−2 /3 K 1/ 2
10 K 1/2
■ 82 /3
10 K 1/2
■ 4
5 K 1/2
■ 2
6. Find APL function
Q 30 L1/ 3 K 1/2
○ APL= =
L L
■ 30 L −2 /3
K 1/ 2
7. Find APK function
Q 30 L1 /3 K 1/ 2
○ APK= =
K K
■ 30 L 1/ 3
K −1/ 2
EXAMPLE:
Q=20 L0.5 K 0.3
K=1, W=20, P=10
● How much L should be used to maximize π?
● What is the output that will maximize π?
● What is the TR?

Set VMPL= WAGE

● MPL x Price of Output
dQ
○
dL
● If K=1, Q=20 L0.5 ¿
○ Q=20 L0.5
 dQ
○ MPL= =10 L−0.5
dL
VMPL = MPL x P
−0.5
=10 L (10)
=10 0 L ← MPL function
−0.5

Set VMPL=Wage
● 100 L−0.5=20
○ Rewrite it
100
● =20
L1/ 2
● L1/ 2=5
○ Raise both sides to that power
● L=25
0.5 0.3
Q=20 L K
● If l =25 an K=1
● Q=20(25)0.5 ¿
● Q=100