Firms and Production Flashcards
Production Functions, product of labour, short run and long run, isoquants
What is a firm and what are the different types?
A firm is an organisation that converts inputs (labour, materials and capital) into outputs
Firm Types:
- Private (for profit) firms: Owned by individuals or other non-government entities trying to earn a profit
- Not for profit
- Public (govt)
What is the equation for profit (basic)?
π=R-C
Profit= Revenue - Costs
What does it mean for a firm to “produce as efficiently as possible”?
Efficient Production means it cannot produce its current level of output with fewer inputs.
Efficient production is necessary but not sufficient for profit maximisation.
What is a Production Function?
A production function summarises how much output you can produce for every possible combination of your inputs.
This is similar to the utility function of a consumer, instead of the goods we have inputs.
What is the difference between the short and long run?
- In the short run a firm cannot vary all of it’s inputs, at least one cannot be varied, usually capital (K) (eg, new labourers but not new large machines)
- In the long run, all inputs can be varied.
State the general formula for the short run production function
Capital (K) is fixed in the short run, this is shown by the bar above it.
Labour is a variable in the short run.
Therefore the output in the short run only depends on how much labour is put in, hence why it is equal to f(L).
Define the marginal product of labour
Additional output produced by hiring one more worker, ceterus parabus.
It is the slope (differential) of the SR production function
Substitute a value of x in to find additional output produced by the last worker at that level of workers.
Define the average product of labour
Average product of labour = Output per worker
It can be used to give productivity of your business as a whole rather than just the extra worker.
What do the values of the slope of the production function mean?
The differential (slope/gradient) of the SR production function is the MPL (marginal product of labour).
When the slope is increasing each worker hired adds more output than the last
When the slope is decreasing (flattening) each worker is producing less than the last (diminishing MPL).
When the slope is negative, each worker hired actually reduces output.
At what point will the MPL intersect the APL on a short run production function with variable labour?
The MPL always intersects the APL at the APL’s maximum point.
So when the differential of the APL = 0 —> MPL=APL
If f’(APL) = 0 then MPL=APL
This is shown by B on the graph.
Past this point, hiring workers reduces APL (output per worker); C on the graph.
This is also the reason why the intersection is at the maximum, it would not be possible to hire workers producing negative output, but still increase output per worker (APL).
Where does MPL begin to decrease?
MPL starts to decrease at the second differential of the SR production function, this is the same as the differential of the MPL
This is shown by A on the graph
What factors of production vary in the long run?
Labour (L) and Capital (K)
Give a general formula for a long run production function
q = ALaKb
A, a and b are constants, therefore only labour and capital vary.
How do you do draw a long run (LR) production function?
q = ALaKb
Can’t be drawn in 2D space so we draw an isoquant curve.
Iso means the same/constant.
quant means quantity
Therefore an isoquant shows the same level of output all the way along it, with varying levels of labour and capital.
Explain the 4 properties of isoquants
- The farther an isoquant from the origin, the greater the level of output
- Isoquants do not cross
- Isoquants slope downwards
- This is because we assume capital and labour are substitutable.
- Isoquants cannot be thick as the more input we have, the more we produce.
- If they were thick it would suggest a slight increase in input does not produce more output; this is wrong and therefore they can’t be thick.
What do isoquants look like for perfect substitutes?
Give an example
Eg- A crisp maker looking at two types of potatoes as the inputs.
They don’t care which potato they use, they just want to make crisps.
There is no diminishing marginal productivity of the inputs here as a potato can’t give any more or less just because you have more of them.
Show/describe isoquants for perfect substitutes
What is the MRTS (Marginal Rate of Technical Substitution)?
The Marginal Rate of Technical Substitution (MRTS) is the slope of the isoquant at a single point.
It tells us how many units of K the firm can replace with 1 extra unit of L. (where q stays the same since it’s an isoquant).
- E.g Below, where the MRTS is -4, we can reduce capital by 4 and hire one more worker and still be on q=6.
- At Point (d), it is 1 for 1
- At point (e), to give up one unit of capital (K) we would need 4 units of labour to stay at q=6.
The MRTS also shows that the productivity of an input diminishes as you have more of it.
What is the equation for MRTS?
The MRTS is the total derivative of the LR production function as it is the slope at any one point.
