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The economic theory of production consists of conceptual frameworks for managers to efficiently combine inputs to produce outputs. Production analysis involves assigning costs to output levels and communicating operations plans. Key concepts include: - Production functions relate inputs like labor, capital, and materials to maximum feasible output. The Cobb-Douglas production function is a common mathematical model. - In the short-run, one or more inputs is fixed. Inputs are classified as fixed or variable. Marginal product is the change in output from an extra unit of a variable input. Average product is output per unit of input. - Diminishing marginal returns states that adding more of a variable input while holding others fixed initially increases then decreases marginal product as

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11 views

Latest Production Function

The economic theory of production consists of conceptual frameworks for managers to efficiently combine inputs to produce outputs. Production analysis involves assigning costs to output levels and communicating operations plans. Key concepts include: - Production functions relate inputs like labor, capital, and materials to maximum feasible output. The Cobb-Douglas production function is a common mathematical model. - In the short-run, one or more inputs is fixed. Inputs are classified as fixed or variable. Marginal product is the change in output from an extra unit of a variable input. Average product is output per unit of input. - Diminishing marginal returns states that adding more of a variable input while holding others fixed initially increases then decreases marginal product as

Uploaded by

Partha
Copyright
© © All Rights Reserved
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Download as PDF, TXT or read online on Scribd
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Production Analysis

The economic theory of production consists of a conceptual framework to assist managers in deciding how to
combine most efficiently the various inputs needed to produce the desired output (product or service),
given the existing technology. This technology consists of available production processes, equipment, labor
and management skills, as well as information-processing capabilities. Production analysis is often applied by
managers involved in assigning costs to the various feasible output levels and in communicating with plant
engineers the operations plans of the company.
Production function: A mathematical model, schedule (table), or graph that relates the maximum feasible
quantity of output that can be produced from given amounts of various inputs. A resource or factor of
production, such as a raw material, labor skill, or piece of equipment that is employed in a production process.
Q= f (L, L, K, O).
Cobb-Douglas production function:
A particular type of mathematical model, known as a multiplicative exponential function, used to represent the
relationship between the inputs and the output. Letting L and K represent the quantities of two inputs (labor L
and capital K) used in producing a quantity Q of output, a production function can be represented in the form of
a mathematical model, such as
Q = αLβ1Kβ2
where α, β1, and β2 are constants. This particular multiplicative exponential model is known as the Cobb-
Douglas production function.
Short run :The period of time in which one (or more) of the resources employed in a production process is
fixed or incapable of being varied.
Fixed and Variable Inputs
In deciding how to combine the various inputs (L and K) to produce the desired output, inputs are usually
classified as being either fixed or variable.
A fixed input is defined as one required in the production process but whose quantity employed in the process is
constant over a given period of time.
A variable input is defined as one whose quantity employed in the process changes, depending on the desired
quantity of output to be produced.
The short run corresponds to the period of time in which one (or more) of the inputs is fixed.
Marginal and Average Product Functions

The marginal product is defined as the incremental change in total output ΔQ that can be produced by the use of
one more unit of the variable input ΔL, while K remains fixed. The marginal product is defined as MPL =ΔQ /ΔL.
The average product is defined as the ratio of total output to the amount of the variable input used in producing
the output. The average product of labor is APL =Q/L.

The Law of Diminishing Marginal Returns


The tabular production function just discussed illustrates the production law of diminishing marginal returns.
Initially, the assignment of more workers to the crew operating the mining equipment allows greater labor
specialization in the use of the equipment. As a result, the marginal output of each worker added to the crew at
first increases, and total output increases at an increasing rate. Thus, as listed in Table 7.2 and graphed in Figure
7.2, the addition of a second worker to the crew results in 10 additional tons of output; the addition of a third
worker results in 13 additional tons of output; and the addition of a fourth worker yields 15 additional tons. A
point is eventually reached, however, where the marginal increase in output for each worker added to the crew
begins to decline. This decrease in output occurs because only a limited number of ways exist to achieve greater
labor specialization and because each additional worker introduces crowding effects. Thus, the addition of a fifth
worker to the crew yields a marginal increase in output of 11 additional tons, compared with the marginal
increase of 15 additional tons for the fourth worker. Similarly, the additions of the sixth and seventh workers to
the crew yield successively smaller increases of 5 and 2 tons, respectively. With enough additional workers, the
marginal product of labor may become zero or even negative. Some work is just more difficult to accomplish
when superfluous personnel are present.
The Relationship between Total, Marginal, and Average Product

Figure 7.4 illustrates a production function total value added or total product (TP) with a single variable input to
highlight the relationships among the TP, AP, and MP concepts.

In the first region labeled “Increasing returns,” the TP function is increasing at an increasing rate. Because the marginal
value added or marginal product (MP) curve measures the slope of the TP curve (MP = ∂Q/∂L), the MP curve is
increasing up to L1. In the region labeled “Decreasing returns,” the TP function is increasing at a decreasing
rate, and the MP curve is decreasing up to L3. In the region labeled “Negative returns,” the TP function is decreasing, and
the MP curve continues decreasing, becoming negative beyond L3. An inflection point occurs at L1. Next, if a line is
drawn from the origin 0 to any point on the TP curve, the slope of this line, Q/L, measures the average value added or
average product (AP). Hence, we see that the AP curve reaches a maximum at a point where the average and the marginal
products are equated.

Production Isoquants
A production function with two variable inputs can be represented graphically by a set of two-dimensional
production isoquants. A production isoquant is either a geometric curve or an algebraic function representing all
the various combinations of the two inputs that can be used in producing a given level of output.

Production Isoquant characteristics:


1. Convexity
2. Upper isoquant shows higher level of production
3. Isoquant curve never intersect to each another
4. More isoquant curve shows a isoquant map.

The Marginal Rate of Technical Substitution (MRTS)


In addition to indicating the quantity of output that can be produced with any of the various input combinations
that lie on the isoquant curve, the isoquant also indicates the rate at which one input may be substituted for
another input in producing the given quantity of output.
In the Deep Creek Mining Company example, ΔL = 3 − 4 = −1, ΔK = 750 − 500 = 250.
MRTS =−250/−1= 250.

Isocost Lines
The total cost of each possible input combination is a function of the market prices of these inputs. Assuming
that the inputs are supplied in perfectly elastic fashion in competitive markets, the per-unit price of each input
will be constant, regardless of the amount of the input that is purchased. Letting CL and CK be the per-unit
prices of inputs L and K, respectively, the total cost (C) of any given input combination is C = CL + CK .

Minimizing Cost Subject to an Output Constraint


The total cost of producing the required output is minimized by finding the input combinations within this
region that lie on the lowest cost isocost line. Combination D on the C(2) isocost line satisfies this condition.
Combinations E and F, which also lie on the Q(2) isoquant, yield higher total costs because they fall on the C(3)
isocost line. Thus, the use of L1 units of input L and K1 units of input K will yield a (constrained) minimum
cost solution of C(2) dollars. At the optimal input combination, the slope of the given isoquant must equal the
slope of the C(2) lowest isocost line. As in the previous section, the slope of an isoquant is equal to dK/dL and
MRTS =MPL/MPk.
Returns to scale:
Returns to scale the proportionate increase in output that results from a given proportionate increase in all the
inputs employed in the production process.
1. Increasing returns to scale: Output increases by more than λ; that is, Q(2) > λQ(1).
2. Decreasing returns to scale: Output increases by less than λ; that is, Q(2) < λQ(1).
3. Constant returns to scale: Output increases by exactly λ; that is, Q(2) = λQ(1)

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