Theory of Production

Question 1

What is the Theory of Production?

Answer 1

• Firms convert inputs into outputs

Question 2

What is the short-run production function?

Answer 2

• no specific time period
• at least one fixed factor of production

– total physical product (TPPL)
– average physical product (APPL)
– marginal physical product of labour (MPPL)

Differentiate TPPL- you get MPPL

Question 3

What is the total physical product?

Answer 3

TPPL

total output from the firm

Question 4

What is the average physical product?

Answer 4

APPL
§ Output by e.g. each worker
APP = TPP/L

(L- labour)

Question 5

what is the marginal physical product of labour

Answer 5

MPPL
How a small change affects production
MPP = ∆TPP/∆L 
(= dTPP/dL) 
i.e. Differentiate TPPL

Question 6

Define short-run

Answer 6

one fixed factor or production

Question 7

define long-run

Answer 7

all factors of production are variable

Question 8

define Marginal Product of labour

Answer 8

If I get x number or workers, how many more products will they produce
-is constant- why line is linear

MPL= Q/L = g

Question 9

what will happen to the marginal labour product, as the marginal requirement for labour increases?

Answer 9

assume marginal physical product of labour remains constant- each worker produces the same amount

Question 10

what is the law of diminishing returns production?

Answer 10

• as labour increases, total output increases, but gets smaller

○ As I take on more workers, each new worker become more unproductive
○ Marginal productivity i.e. efficiency, goes down
○ Marginal product requirement increases

Question 11

What is constant returns to labour?

Answer 11

CRL

• Average product of labour in constant at all levels of outputs to labour
• marginal product of labour in constant at all levels of output
• MRL- e.g. half and extra worker required

Question 12

What is diminishing returns to labour?

Answer 12

DRL

APL is decreasing

MPL is decreasing

As output goes up, marginal labour requirement (MRL) also goes up

Question 13

What is increasing returns to labour?

Answer 13

APL is increasing
MPL is increasing
MRL is decreasing

Question 14

Define the law of diminishing returns?

Answer 14

• When increasing amounts of a variable factor with a given amount of a fixed factor, there will come a point when each extra unit of the variable factor will produce less extra output than the previous unit.
• Short-run concept as there is a fixed factor of production

Question 15

What types of return will Labour affect?

Answer 15

• A firm’s decision-making process
○ E.g. how many workers to employ; how much to increase output, when to invest/ expand

• Its opportunity cost
○ Combination of input the firm uses e.g. capital vs. labour intensive

• Its costs
- therefore their profit

Question 16

Define the production possibility frontier

Answer 16

• The maximum combination of two goods that can be produced with given resources and technology
• With a given stock of inputs of labour and physical capital, firms have to decide on a product mix which uses the inputs most effectively

Question 17

define allocative efficient

Answer 17

are they producing the right combination of goods

Question 18

define opportunity cost

Answer 18

(using e.g.)
o to increase production of X, cut no. of workers who produce Y

E.g. With constant returns to labour, increasing the output of 1 good does not lead to falling or increasing efficiency in the production of that good

Question 19

Define linear

Answer 19

constant opportunity cost, ever worker is productive

Question 20

Variable costs

Answer 20

from variable inputs

Question 21

Fixed costs

Answer 21

from fixed or quasi-fixed inputs

Question 22

What does quasi-fixed result from?

Answer 22

○ a) institutional constraints on layoffs,
e.g. labour laws, trade unions

○ b) skills and knowledge of the labour force in which firms have invested and which they want to amortise . Replacement is also costly

Question 23

define quasi-fixed

Answer 23

some characteristics of being fixed, and some of being variable

Question 24

Total cost formula

Answer 24

Total cost = fixed cost + variable cost

independent of Q) + (dependent on Q

Question 25

Average cost formula

Answer 25

AC = TC / Q

Question 26

Define marginal

Answer 26

increase in total cost if you produce one extra uni

Question 27

Marginal cost formula

Answer 27

MC = change in TC/ change in Q
or
MC = derivative TC/ derivative Q

Question 28

What happens to the average total, average fixed and average variable costs as Q increases for constant returns?

Answer 28

ATC - decreases: as output produced increases,
(As AFC (b/Q) is decreasing)
AFC- decreases

Question 29

What is the marginal cost for constant returns?

Answer 29

MC = differentiate change in TC/ change in Q = w

will be the same and constant and output changes

Question 30

What are the diminishing returns production costs

Answer 30

○ TC = b + wQ + wQ2 
	§ TFC = b
	§ TVC = wQ + wQ2
	§ AFC = b/Q
	§ AVC =  wQ+wQ2/Q = w+ wQ
	§ ATC = b/Q + w + wQ
MC = w + 2wQ

Question 31

What are the constant returns production costs?

Answer 31

constant returns function:
TC = b + wQ

□ TFC = b- fixed cost (doesn’t depend on output)
□ TVC = wQ (depends on output)
□ ATC= (b+ wQ)/ Q = b/Q + w
□ AFC= b/Q
□ AVC= wQ/Q = w
□ MC = differentiate change in TC/ change in Q = w

n.b. last two: same and constant as output changes

Question 32

What will the average total cost curve look like (diminishing)

Answer 32

As Q increases,

1) b/Q- will decrease i.e. ATC decreases
2) W- doesn’t change

3) +wQ- increases i.e. ATC increases
Therefore ATC will increase

Question 33

What are the increasing returns production costs?

Answer 33

○ TC = b + wQ - wQ2 
	§ TFC = b
	§ TVC = wQ - wQ2
	§ AFC = b/Q
	§ AVC =  wQ + wQ2/Q = w - wQ
	§ ATC = b/Q + w - wQ
MC = w - 2wQ

Question 34

What will the average total cost curve look like (increasing)

Answer 34

○ As Q increases,

1. b/Q- will decrease i.e. ATC decreases
2. W- doesn’t change
3. -wQ- decreases i.e. ATC decreases

Therefore ATC will decrease

Question 35

What is the Mixed Case

Answer 35

• Increasing returns dominate at low levels of output
– This leads to falling marginal costs

• Decreasing returns then dominate at high levels of output
– This then leads to rising marginal costs

Question 36

Economies of scale: what are the benefits of falling average costs as output expands?

Answer 36

–specialisation & division of labour 
– indivisibilities 
– container principle 
– greater efficiency of large machines 
– by-products 
– multi-stage production 
– organisational & administrative economies 
– financial economies 
– Economies of scope

Question 37

What is diseconomies of scale?

Answer 37

• Costs begin to rise when output expands beyond the minimum efficient scale (MES)
○ Managerial complexity
○ Alienation
○ Industrial relations problems
○ Disruption if part of complex production chains fail

Question 38

What causes profit to fall?

Answer 38

a) SRATC increases, Profit decreases

b) Q decreases, profit decreases

Question 39

Which ways can firms be vulnerable?

Answer 39

i) a steep SRATC curve -( big cost penalty)
(ii) rises in external bought in costs - susceptible to profit changing significantly

effect is volatile profit

Question 40

the problem of an economic downturn

Answer 40

Q↓ so SRATC ↑

The cost penalty depends on the shape of SRATC

Question 41

What makes the SRATC curve steep?

Answer 41

High fixed costs of physical capital and ‘quasi-fixed’ personnel costs

Low variable costs when Q < Q* so fixed/variable ratio is raised

Learning which causes input productivity to rise as output increases and to fall if output falls

Question 42

external costs- problem of an economic boom

Answer 42

Oil, energy and raw material prices rise

This pushes up the SRATC curve and raises the cost of producing Q* to C3

Question 43

What makes a firm vulnerable to rising external costs?

Answer 43

high input cost intensity, e.g. executive salaries for banks, energy and iron ore for steel manufacturers and universities anxious about their RAE scores!

Question 44

How can the vulnerability of a firm be reduced?

Answer 44

Type 1 vulnerability (a steep SRATC curve)
- reduce fixed costs and convert them to variable costs (‘variabilisation’) e.g. outsourcing
- will flatten the SRATC curve
- may increase Type 2
vulnerability

Type 2 vulnerability (to external costs)

• reducing dependence on the input
• negotiate a long term contract with suppliers at an agreed price
• vertical integration ( buy out main suppliers)