3a. Firms and Production Flashcards
What does this equation tell us?
A firm’s profit (π), is the difference between its revenue, R, which is what it earns from selling a good, and its cost, C, which is what it pays for labor, materials, and other inputs
What are the 3 inputs of a production function?
- Capital (K) - long-lived inputs. land, buildings (factories, stores), and equipment (machines, trucks).
- Labor (L) - human services. managers, skilled workers (architects, economists, engineers, plumbers), and less-skilled workers (custodians, construction laborers, assembly-line workers).
- Materials (M) - raw goods (oil, water, wheat) and processed products (aluminum, plastic, paper, steel)
Which two inputs do we usually use in the production function?
K and L,
M is rarely ever used
What is the definition of “production function”?
“the relationship between the quantities of inputs used and the maximum quantity of output that can be produced, given current knowledge about technology and organization.”
What does “efficient production” really mean?
Efficient production (achieves technological efficiency) if firm cannot produce its current level of output with fewer inputs, given existing knowledge about technology and the organization of production.
How is the production function expressed?
q = f(L, K)
so, output is a function of labor and capital
How is the production function in the short-run expressed?
K has a bar as it is FIXED in the short run
What is specific about short-run production?
Short run - a period of time so brief that at least one factor of production (capital) cannot be varied practically.
whereas quantity of labor (L) can be changed, the line above the K shows that capital is capped and cannot be varied (in the SR)
Is there anything specific about long-run production?
No. There are no fixed inputs.
Long run - a lengthy enough period of time that all inputs can be varied. No fixed inputs
What is the definition of “total product of labor”?
Total product of labor - the amount of output (or total product) that can be produced by a given amount of labor.
What is the definition of “marginal product of labor”?
Marginal product of labor (MPL) - the change in total output, Dq, resulting from using an extra unit of labor, DL, holding other factors (capital) constant:
What is the definition of “average product of labor”?
Average product of labor (APL) - the ratio of output, q, to the number of workers, L, used to produce that output
What does point “A” on this curve mean?
diminishing marginal returns sets in - as at this point there is a peak in MPL
Meaning, every additional worker will add less of a marginal product, but MPL > 0, so the total output keeps increasing
What does point “C” on this curve mean?
where MPL is 0, at this point each additional worker will start decreasing the total output
What is the “law of diminishing marginal return”?
The law of diminishing marginal returns (or diminishing marginal product) holds that if a firm keeps increasing an input, holding all other inputs and technology constant, the corresponding increases in output will become smaller eventually. That is, if only one input is increased, the marginal product of that input will diminish eventually.
What is the definition of an “isoquant”?
a curve that shows the efficient combinations of labor and capital that can produce a single (iso) level of output (quantity)
What does an isoquant for perfect substitutes look like?
What does an isoquant for perfect complements look like?
example:
production of boxes of cereal
So, you need cereal and a box. If you have 100 boxes, and 50 cereal = you can only make 50 cereal boxes.
-> hence the production output is equal to the SMALLEST value of the two
What is the equation for MRTS (slope of an isoquant)?
How else can the MRTS equation be expressed?
What are “constant returns to scale”?
If, when all inputs are increased by a certain percentage, output rises by that same percentage, the production function is said to exhibit constant returns to scale.
What are “increasing returns to scale”?
If output rises more than in proportion to an equal percentage increase in all inputs, the production function is said to exhibit increasing returns to scale.
What are “decreasing returns to scale”?
If output rises less than in proportion to an equal percentage increase in all inputs, the production function exhibits decreasing returns to scale.
What does it mean to exhibit “varying returns to scale”?
This production function exhibits varying returns to scale. Initially, the firm uses one worker and one unit of capital, point a. It repeatedly doubles these inputs to points b, c, and d, which lie along the dashed line. The first time the inputs are doubled, from a to b, output more than doubles from q = 1 to q = 3, so the production function has increasing returns to scale. The next doubling, from b to c, causes a proportionate increase in output, constant returns to scale. At the last doubling, from c to d, the production function exhibits decreasing returns to scale.
