T3 the theory of production and cost Flashcards
what do firms consider when deciding supply?
> maximising profits (profit = Revenue (R) - cost (C))
economic theory argues that firms are rational producers- convert inputs (L,L,K) into output (goods&services) in efficient manner
The Micro Economic System: the production process which generates cost
> land
labour ——-> Goods and services
capital
entrepreneurship
technical efficiency definition
when a ‘given’ level of output is
done using the minimum amount of inputs (avoiding waste)
optimal level of production
depends upon cost & demand conditions (this is the profit maximising point)
the production function equation= assuming that firms only need two inputs: Capital and Labour
Y= f(L,K)
> time frames: long term/short term
> Y= output
L= labour- variable factors of production: An input that can be altered within a given time period
K= Capital- Fixed Factor of production: An input that cannot be altered in quantity within a given time period
The short run is a time frame in which the quantity of at least one factor of production is fixed. In the short run capital is fixed. Thus, labour is our variable factor. So, to increase output in the short run, a firm must increase the quantity of labour employed. In the long run a firm can alter its level of labour and capital in order to alter its level of production.
THE SHORT RUN:
> production changes due to using the fixed factor more or less intensively
it is when at least one factor is fixed (e.g. capacity of restaurant)
in the short run, the firm makes (optimal decisions subject to the constraint that it cant vary the fixed factor
THE LONG RUN:
> production changes by varying all factors in the optimal (least cost) way
when all factors are variable- the firm’s output decisions is no longer constrained by a fixed factor
these periods are not strictly defined in chronological terms and will vary across firms and industries
Production in the short-run- total product definition:
the total amount produced
Production in the short-run- marginal product definition:
is the change in total product resulting from one unit-increase in a variable factor (in this case labour)
Production in the short-run- average product definition:
of an input is total product divided by the quantity of the input used
production process in the short run example question:
Q: what are the factors of production
Capital (K): the bar, beer pumps, glasses
Labour (L): the staff
> focus on the relationship between output of the bar (how many pints of beer are sold) (K), and the no. of bar staff employed (L)
A production schedule: sales of beer for a particular evening
____ L__total prod__marginal prod__average prod
A 0 0 ——-
B 1 40 40 40.00
C 2 100 60 50.00
D 3 130 30 43.3
E 4 150 20 37.5
F 5 160 10 32.0
> in the short run a firm has to increase its level of labour to increase output.
here capital is a fixed factor of production, whilst the amount of labour is the variable factor, so the above is correct only for one specific amount of capital.
FIRST COLUMN: we incrementally increase labour SECOND COLUMN: we summarise the firm’s level of output for each level of labour.
total product increases but at a diminishing rate.
MARGINAL PRODUCT: Marginal product is the extra output from hiring that additional worker.
40-0=40
100-40=60
130-100=30
150-130=20
160-150=10
AVERAGE PRODUCT: calculated by taking the total product and dividing by the number of units of labour.
Q: why does Total Product rise at a diminishing rate, why does marginal product start to rise and then gradually fall?
A: The answer to this lies in the economics concept of diminishing marginal returns.
> Production in the short run is subject to diminishing marginal returns. e.g. The case of the bar —> The fixed factor= capital & variable factor= labour. Since the size of the bar, the number of beer pumps and number of glasses is FIXED. OUTPUT INC WITH INC OF LABOUR. But as more workers get added to a fixed amount of capital, each worker has less and less capital to be productive with, so after a point the addition to output from each worker will begin to diminish. Hence total product increases at a decreasing rate and marginal product starts to fall.
Plotting graph of the total product, marginal product and average product data from the bar.
total product (pints sold)
I
150
I
I
100
I
I
50
I
I____________________________________
labour (bar staff employed)
> as labour rises, productivity rises–> slope getting steeper but near the end total production begins to level out (starts to grow at a diminishing rate) (look on moodle)
marginal product curve
> Marginal product is the extra output from hiring that additional worker. Its shows exactly the same core points as our total product curve -
> Marginal product increases :come from increased specialization and division of labour in the production process.
> Diminishing marginal returns: arises because more and more workers are using the same amount of capital, and therefore have less capital to be productive with.
so…..
the addition of successive workers generates progressively smaller increments of output. Marginal product starts to fall.
law of diminishing returns
When increasing amounts of a variable factor are used with a given amount of a fixed factor, there will come a point when each additional unit of the variable factor will produce less extra output than the previous unit.
