Production

Chapter 9

Production

Defined as any activity that creates present or future utility

The chapter describes the production possibilities available to us with a given state of technology and resources

The Input-Output Relationship

Production function

The Production Function

A means of describing the technically efficient quantities of outputs corresponding to all possible combinations of inputs

Technical Efficiency & Economic Efficiency Technical Efficiency is the attainment of

the maximum possible output from a given combination of inputs

Economic efficiency occurs when we produce the given level of output at the minimum cost

Intermediate Products

Products that are transformed by a production process into products of greater value (value added)

For simplification, ignore intermediate goods in this chapter

Fixed & Variable Inputs

Long Run: the shortest period of time required to alter the amounts of all inputs used in production

Short Run: the longest period of time during which at least one of the inputs used in a production process cannot be varied

Short Run Production

Capital levels are fixed

Law of Diminishing Returns

If other inputs are fixed, the increase in output resultant from an increase in the variable input must eventually decline

Total, Marginal & Average Products

The total product curve shows the amount of output as a function of the amount of variable input

Total, Marginal & Average Products

Marginal product is a change in total product due to a one-unit change in the variable input

The average product is the total output divided by the quantity of the variable input

The Relationships Between Curves

When the marginal product curve lies above the average product curve, the average product curve must be rising

When the marginal product curve lies below the average product curve, the average product curve must be falling

The two curves intersect at the maximum value of the average product curve

Rules for resource allocation

Rule for non-perfectly divisible inputs

Where marginal product of an input is higher in one activity, allocate each unit of the input to the activity with the highest marginal product.

Rule for perfectly divisible inputs

Where marginal product of an input is not always higher in one activity, allocate each unit of the input so that marginal product is the same in every activity.

Production in the Long Run

All factors are variable

Isoquants are the set of all technically efficient input combinations that yield a given level of output

The Marginal Rate of Technical Substitution (MRTS)

The rate at which one input can be exchanged for another without altering the total level of output

Returns to Scale

Tells us what happens to output when all inputs are increased by exactly the same proportion

The concept of returns to scale is a long-run concept

Returns to Scale: Increasing

Increasing returns to scale occur when a proportional increase in every input yields a more than proportional increase in output

Returns to Scale

Constant returns to scale occur when a proportional increase in every input yields an equal proportion increase in output

Decreasing returns to scale occur when a proportional increase in every input yields a less than proportional increase in output

Returns to Scale: The Distinction

Decreasing returns to scale have nothing to do with the law of diminishing returns

Decreasing returns to scale mean all inputs are varied