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PPA 723: Managerial Economics

PPA 723: Managerial Economics. Lecture 10: Production. Managerial Economics, Lecture 10: Production. Outline Production Technology in the Short Run Production Technology in the Long Run. Managerial Economics, Lecture 10: Production. Production.

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PPA 723: Managerial Economics

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  1. PPA 723: Managerial Economics Lecture 10: Production

  2. Managerial Economics, Lecture 10: Production Outline • Production Technology in the Short Run • Production Technology in the Long Run

  3. Managerial Economics, Lecture 10: Production Production • A production process transform inputs or factors of production into outputs. • Common types of inputs: • capital (K): buildings and equipment • labor services (L) • materials (M): raw goods and processed products.

  4. Managerial Economics, Lecture 10: Production Production Functions • A production function specifies: • the relationship between quantities of inputs used and the maximum quantity of output that can be produced • given current knowledge about technology and organization. • For example, q = f(L, K)

  5. Managerial Economics, Lecture 10: Production Short Run versus Long Run • Short run: A period of time so brief that at least one factor of production is fixed. • Fixed input: A factor that cannot be varied practically in the short run (capital). • Variable input: a factor whose quantity can be changed readily during the relevant time period (labor). • Long run: A time period long enough so that all inputs can be varied.

  6. Managerial Economics, Lecture 10: Production Total, Average, and Marginal Product of Labor • Total product: q • Marginal product of labor: MPL = q/L • Average product of labor: APL = q/L • The graphs for these concepts appear smooth because a firm can hire a "fraction of a worker" (part time).

  7. (a) Output, q , ManagerialEconomicsLecture 10:Production Units per day C 110 APL = MPL at maximum APL APL = Slope of straight line to the origin 90 B 56 A MPL = Slope of total product curve Figure 6.1 Production Relationships with Variable Labor 0 4 6 11 , Workers per day (b) L AP , MP L L a 20 b 15 Average product, AP L Marginal product, MP L c 0 4 6 11 L , Workers per day

  8. Managerial Economics, Lecture 10: Production Effects of Added Labor • APL • Rises and then falls with labor. • Equals the slope of line from the origin to the point on the total product curve. • MPL • First rises and then falls. • Cuts the APL curve at its peak. • Is the slope of the total product curve.

  9. Managerial Economics, Lecture 10: Production

  10. Managerial Economics, Lecture 10: Production Law of Diminishing Marginal Returns • As a firm increases an input, holding all other inputs and technology constant, • the marginal product of that input will eventually diminish, • which shows up as an MPL curve that slopes downward above some level of output.

  11. Managerial Economics, Lecture 10: Production Long-Run Production: Two Variable Inputs • Both capital and labor are variable. • A firm can substitute freely between L and K. • Many different combinations of L and K produce a given level of output.

  12. Managerial Economics, Lecture 10: Production Isoquant • An isoquant is a curve that shows efficient combinations of labor and capital that can produce a single (iso) level of output (quantity): • Examples: • A 10-unit isoquant for a Norwegian printing firm 10 = 1.52 L0.6 K0.4 • Table 6.2 shows four (L, K)pairs that produce q = 24

  13. Managerial Economics, Lecture 10: Production

  14. Managerial Economics, Lecture 10: Production Figure 6.2 Family of Isoquants K , Units of capital per day a 6 b 3 c f e 2 q = 35 d 1 q = 24 q = 14 L , Workers per day 0 1 2 3 6

  15. Managerial Economics, Lecture 10: Production Isoquants and Indifference Curves • Isoquants and indifference curves have most of the same properties. • The biggest difference: • An isoquant holds something measurable (quantity) constant • An indifference curve holds something that is unmeasurable (utility) constant

  16. Managerial Economics, Lecture 10: Production Three Key Properties of Isoquants • The further an isoquant is from the origin, the greater is the level of output. • Isoquants do not cross. • 3. Isoquants slope downward.

  17. Managerial Economics, Lecture 10: Production The Shape of Isoquants • The slope of isoquant shows how readily a firm can substitute one input for another • Extreme cases: • perfect substitutes: q = x + y • fixed-proportions (no substitution): q = min(x, y) • Usual case: bowed away from the origin

  18. Managerial Economics, Lecture 10: Production Figure 6.3a Perfect Substitutes: Fixed Proportions y , Idaho potatoes per day q = 1 q = 2 q = 3 x , Maine potatoes per day

  19. Managerial Economics, Lecture 10: Production Figure 6.3b Perfect Complements Boxes per day q = 3 q = 2 q = 1 45 ° line Cereal per day

  20. Managerial Economics, Lecture 10: Production Figure 6.3c Substitutability of Inputs K , Capital per unit of time q = 1 L , Labor per unit of time

  21. Managerial Economics, Lecture 10: Production Marginal Rate of Technical Substitution • The slope of an isoquant tells how much a firm can increase one input and lower the other without changing quantity. • The slope is called the marginal rate of technical substitution (MRTS). • The MRTS varies along a curved isoquant, and is analogous to the MRS.

  22. Managerial Economics, Lecture 10: Production K , Units of Figure 6.4 How the Marginal Rate of Technical Substitution Varies Along an Isoquant capital per year a 39 = – D K 18 b 21 = D L 1 – 7 c 14 1 – 4 d 10 e 1 – 2 8 q = 10 1 0 2 3 4 5 6 L , Workers per day

  23. Managerial Economics, Lecture 10: Production The Slope of an Isoquant • If firm hires L more workers, its output increases by MPL = q/L • A decrease in capital by K causes output to fall by MPK = q/K • To keep output constant, q = 0: • or

  24. Managerial Economics, Lecture 10: Production Returns to Scale • Returns to scale (how output changes if all inputs are increased by equal proportions) can be: • Constant: when all inputs are doubled, output doubles, • Increasing: when all inputs are doubled, output more than doubles, or • Decreasing: when all inputs are doubled, output increase < 100%.

  25. Managerial Economics, Lecture 10: Production (c) Concrete Blocks and Bricks: Increasing Returns to Scale K , Units of capital per year 100 600 q = = 200 q q = 251 500 400 300 200 100 0 50 100 150 200 250 300 350 400 450 500 L , Units of labor per year

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