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IMPORTANT Concepts

Production
Production function
Inputs
Classification of inputs
Short run :The time period during which
at least one input is fixed.
Long run:The time period during which
all inputs are variable.

PRODUCTION Function
Production functions demonstrate
the relationship between the
amounts of inputs and the quantities
of output that a firm produces.
Q=f(a,b,c.)

Long Run vs. Short Run


In the long run, the quantities of all

inputs may be changed. All inputs are


variable! The long run is sometimes
referred to as the planning horizon.
In the short run, at least one input is
fixed. Capital is usually assumed to be
fixed in the short run. Production takes
place in the short run.

Product SHORT RUN) - Total,


Marginal, and Average
oTotal product refers to the total output
produced.
oWhen labor is combined with a fixed
amount of capital, the additional output
gained from additional units of labor is termed
the marginal product of labor.
oAverage product is the quantity of output
per worker.

Product- Total, Marginal, and


Average
Marginal
Marginal Product
Product == output/
output/
labor
labor
Average
Average Product
Product == Total
Total Product/Total
Product/Total Labor
Labor

Total Product, Average Product


and Marginal Product
No. of Labors
Employed (L)

Total Product
(TPL)

Average
Product (APL)

Marginal
Product (MPL)

0
1
2
3
4
5
6
7
8
9

0
20
50
90
120
140
150
155
155
150

20
25
30
30
28
25
22
19.375
17

20
30
40
30
20
10
5
0
-2
6

Product- Total, Marginal, and


Average
o Average product will
o Increase when marginal product is
greater than the initial average product.
o Decrease when marginal product is less
than average product.
o Remain constant when marginal product
is equal to average product.

Law of Diminishing Returns or


Law of Variable Proportions
Marginal product is subject to the law of
diminishing returns which states that, when
additional units of labor or any other
variable input are added to a fixed input,
the marginal product of the variable
input must eventually decrease.

Assumptions to Law of
Diminishing Returns
(a) State of technology should remain
constant
(b) Only one factor should be variable
(c) Inputs should not be used in a fixed
proportion

Total Product

TPL

A
L1

L3

Average
Product and marginal
product

No. of labor employed


Increasing
marginal
returns

Negative
marginal
returns

Diminishing
marginal
returns
A

L1

APL
L2

L3

MPL

No. of labor employed

10

Law of Diminishing Returns


Quantity of
output

Increasing Decreasing
marginal marginal
product
product

Negative
marginal
product

Labor

Points to Remember

When MP = AP, AP will be maximum


When MP = 0, TP will be maximum

Stages of Marginal Returns:


Increasing marginal returns: From the starting
point of MP until MP reaches its maximum point.
Diminishing marginal returns: From the
maximum point of MP until MP = 0.
Negative marginal returns: From the point
where MP = 0
12

TPL

product

Total Product, Average


Product and marginal

Prof. Cassels Three Stages of


Production

II

III

APL
MPL

13

Three Stages of Production


Ist Stage:There is increasing
average returns to the factor of
production.The APL is increasing
but MPL is first increasing and
then decreasing but MP is more
than AP.

II

ND

Stage of Production

The APL as well as


MPL is decreasing but
marginal product is
positive.

III Stage of production

Total product is
decreasing and
marginal product is
negative.Entrepreneur
will operate in the
second stage only.

MRP AND MRC


(1)
Units of
Labor

(2)
(3)
(4)=(2) (3) (5)
Marginal Marginal MRP
MRC=w
Product revenue
=P

10

40

20

10

30

20

10

20

20

10

10

20

10

20

Optimal use of Variable input


MRP= MRC
MRP= Marginal Revenue product
MRC= Marginal Resource Cost

LONG RUN : RETURNS TO


SCALE

The word scale refers to


the long run situation
where all inputs are
changed in the same
proportion.

Law of Returns to Scale


Constant returns to scale (CRS)
Decreasing returns to scale (DRS)
Increasing returns to scale (IRS)

20

Types of Returns to Scale


Types of Returns to Scale

Description

Constant Returns to scale (CRS)

% Q = %I

Increasing Returns to Scale (IRS)

% Q > %I

Decreasing Returns to Scale (DRS)

% Q < %I

21

Types of Returns to Scale


Q

IRS
CRS

DRS

FACTORS OF PRODUCTION
22

A:Fill in the missing numbers


B:Comment on the relation between Apland
Capital(K)

Labour(L)

Total Product

APL

MPL

12

14

2.5

15

2.5

14

1 1/3

-2

LONG RUN : RETURNS TO


SCALE

The word scale refers to


the long run situation
where all inputs are
changed in the same
proportion.

Types of returns to scale

Constant returns to scale


Increasing returns to scale
Decreasing returns to scale

Terms Along the Way Continued


production
production function
function
long-run
long-run
short
short run
run
total
total product
product
marginal
marginal product
product
average
average product
product

Test Yourself
6.
a.
b.
c.
d.

In the long run,


all inputs are fixed.
all inputs are variable.
at least one input is fixed.
one input is variable, while others are
fixed.

Test Yourself
5.
5.
a.
a.
b.
b.
c.
c.
d.
d.

The
The short
short run
run is
is the
the
time
time period
period in
in which
which all
all inputs
inputs are
are
variable.
variable.
time
time period
period in
in which
which all
all inputs
inputs are
are
fixed.
fixed.
time
time period
period in
in which
which at
at least
least one,
one, but
but
not
not all,
all, inputs
inputs are
are fixed.
fixed.
planning
planning horizon.
horizon.

The following table gives the quantities of output that can


be produced with different amounts of capital and labor
used by a firm

Units of K
6
5
4

Units of Output
122

174

213

244

3
2
1

112
100
87
71
50

158
142
122
100
71

194
173
150
122
87

224
200
173
142
100

250
224
194
158
112

274
244
213
174
122

2
Units of L

274

300