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EC 260 > Lesson 1.3 - Production Theory (Chp 5) > Flashcards

Lesson 1.3 - Production Theory (Chp 5) Flashcards

1
Q

what’s the terms managers use to find the optimal way to produce?

A

production process

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2
Q

what does the production process explain

A

how scarce resources (inputs) are used to produce a good or service (output); shows max product output achieved from any specific set of inputs; shows tech available and constraints faced by managers

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3
Q

how does efficiently using inputs affect a firm?

A

minimizes costs and leads to maximizing profits

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4
Q

simplest case of the production process

A

one input is fixed, the other is variable

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5
Q

production function formula

A

Q = f(X1, X2)

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6
Q

what do we assume in the long run for the production function

A

all inputs are variable

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7
Q

what does Average product tell us?

A

output per worker; how many units of output on average each worker is responsible for making

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8
Q

formula for AP

A

AP = Q / X1 holding X2 constant

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9
Q

what does marginal product tell us

A

good measure of the efficiency of each worker; the incremental change in output created by a small change in use of the input; increase in output resulting from the last worker hired

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10
Q

formula for MP

A

MP = dQ/dX1 holding X2 constant if labour can be varied continuously or change in Q / change in L if labour is discrete; OR Q(L) - Q(L-1) for year 2 where L is year 2 and L-1 is year 1

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11
Q

explain MP and AP curves

A

eventually both reach a maximum and decrease as more labour is employed

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12
Q

what are the common units in the production function

A

labour is variable and X1 and capital is fixed and is X2

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13
Q

where does MP = AP

A

where AP is maximized, where slope of AP = 0

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14
Q

where is MP maximized with respect to AP

A

MP is maximized before AP

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15
Q

explain law of diminishing returns

A

if we keep adding increments of labour, eventually the incremental gains (i.e., the change in output for the change in labour used or the MP) get smaller, and eventually the extra labour is counterproductive

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16
Q

What happens to production function and the variables in the long run

A

both labour and capital are variable, for both variables we can find MP and AP

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17
Q

how do we graph the production function where 2 variables are variable?

A

quantity of variable x1 used on one axis and quantity of variable x2 used on the second axis. isoquants are drawn on the graph

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18
Q

explain an isoquant

A

a curve that shows all of the possible (efficient) input bundles capable of producing a given level of output

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19
Q

what does it mean when an isoquant is farther from the origin?

A

higher level of output it represents

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20
Q

what does each isoquant represent?

A

an infinite number of possible input combinations, given a continuous production function

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21
Q

shape of isoquants

A

downward and increasing slope

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22
Q

when are isoquants right angles

A

when production process uses inputs in fixed proportions, then no substitution is possible, perfect complements

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23
Q

when are isoquants straight lines drawn from one axis to the other?

A

if inputs are perfectly substitutable

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24
Q

what must managers operate within with isoquants?

A

since isoquants could bend back on themselves, managers must operate on the segments for which each input has a positive MP

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25
Q

what does a positive slope for an isoquant mean?

A

increases in both capital and labour are required to maintain a specific output rate

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26
Q

explain ridge lines

A

the lines that profit-maximizing firms operate within, because outside them, MPs of inputs are negative and isoquant slope is positive

27
Q

shape of ridge lines

A

2 lines curving outwards towards each other from the origin with labour and capital as the axis

28
Q

what is MRTS and definition

A

marginal rate of technical substitution (MRTS) shows the rate at which a firm can substitute one input for another while holding output constant

29
Q

MRTS formula

A

-dX2 / dX1 with Q held constant = -MP1 / MP2 = -1*slope of isoquant

30
Q

what does an MRTS of 0.58 mean when MRTS = -dX2/dX1 = -MP1 / MP2

A

could subsitute 0.58 pounds of x2 for one pound of x1 and get the same output

31
Q

total outlay M formula

A

M = Price of L * L + price of K * K

32
Q

what does the isocost curve show?

A

It shows all of the possible bundles of K and L that can be purchased for a total outlay of M, given PK and PL

33
Q

what is the isocost curve formula?

A

total outlay M formula solved for K

34
Q

what is the slope of the isocost curve?

A

-Price of L / Price of K

35
Q

how to maximize output with isocost curve and isoquants?

A

maximize output at a given cost by selecting combination of inputs that is determine by the point where the isocost curve is tangent to the highest valued isoquant possible

36
Q

formula for maximum output

A

MP L / PL = MP K / P KOR marginal product per dollar spent should be the same for all inputs

37
Q

explain corner solution for isoquant/isocurve

A

optimal input bundle with just one input deployed; if no tangency was possible between isocost curve and isoquants, they just touch

38
Q

explain increasing returns to scale

A

doubling both inputs more than double the output

39
Q

explain decreasing returns to scale

A

doubling both inputs leads to less than a doubling of output

40
Q

explain constant returns to scale

A

doubling both inputs leads to double the output

41
Q

explain output elasticity

A

the percentage change in output resulting from a one percent increase in all inputs or resulting from a 1% increase in a single input (in cobb-douglas function) OR % change in output divided by an equal percentage change in all inputs = change in Q/Q /change in input/input

42
Q

what can we use the output elasticity to determine

A

if there is increasing/decreasing/constant returns to scale

43
Q

what is a Cobb Douglas Production function

A

Q = aL^bK^c

44
Q

how to find partial output elasticity with respect to labour

A

dQ/dL * (L/Q) = b

45
Q

how to find partial output elasticity with respect to capital

A

dQ/dK * (K/Q) = c

46
Q

increasing/decreasing/constant returns to scale with output elasticity

A

if b + c > 1, increasing returns to scale;
if b + c = 1, constant;
if b + c < 1, decreasing

47
Q

formula for estimating production function

A

log Q = log a + b log L + c log K

48
Q

what happens if MRTS is large?

A

isoquant is steep, it takes a lot of X2 to substitute one unit of x1

49
Q

what happens if MRTS is small

A

isoquant is flat, it takes little of X2 to substitute for 1 unit of x1

50
Q

what happens if MRTS is constant

A

isoquant is straight and X1 and X2 are perfect substitutes

51
Q

what happens if MRTS is undefined

A

isoquant is right angle and X1 and X2 are perfect complements and no substitution possible

52
Q

4 sources of increasing returns to scale

A

1) Indivisibilities: some tech can only be implemented at a large scale of production
2) Subdivision of task: larger scale allows increased division of tasks and increased specialization
3) Probabilistic efficiencies: law of large numbers may reduce risk as scale increases
4) Geometric relationships: doubling size of box multiplies surface area by 4 times but increases volume by 8 times (storage, transport devices)

53
Q

2 sources of decreasing returns to scale

A

1) Coordination inefficiencies: larger organizations are more difficult to manage
2) Incentive problems: designing efficient compensation systems in large organizations is difficult

54
Q

formula relating price of output to price of input **

A

MP U * P of output = MP U

55
Q

formula for MRTS of hay for grain

A

MRTS = change in grain / change in hay

56
Q

what does the production process include and 4 examples

A

all activities associated with providing goods and services like employment practices, acquisition of capital resources, production distribution, managing intellectual resources

57
Q

what does a production function show?

A

shows the maximum amount that can be produced per time period with the best available technology from any given combination of inputs.

58
Q

how can a production function be represented?

A

table, graph, equation

59
Q

what happens to AP if MP > AP

A

AP must be increasing

60
Q

what happens to AP if MP < AP

A

AP must be decreasing

61
Q

where is the economic region of production located?

A

inside ridge lines

62
Q

graph of isocost curve?

A

downward straight line, y axis is K (M/Pk), x axis is L (M/PL)

63
Q

how is AP of labour geometrically represented?

A

slope of total product curve with respect to labour

64
Q

Hedge Fun is a landscaping firm that specializes in topiary. Last year, the firm had 30 employees and served 120 customers. This year, it had 35 employees and served 135 customers. The average product of labor is at a maximum when the number of customers

A

less than 120; AP maximized when MP = AP

EC 260 (11 decks)

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