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Production Drives Supply

Production Drives Supply. Factors of Production Total Product, Average Product & Marginal Product Short Run vs. Long Run Scale of Production & Returns to Scale. Warm-Up Questions. What is a “factor of production”? What are the 4 factors of production, and what does each represent?

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Production Drives Supply

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  1. Production Drives Supply Factors of Production Total Product, Average Product & Marginal Product Short Run vs. Long Run Scale of Production & Returns to Scale

  2. Warm-Up Questions • What is a “factor of production”? • What are the 4 factors of production, and what does each represent? • In a free market economy, who owns most of the factors of production? • Why do people get involved in production? In other words, what is their incentive?

  3. Capital? Land? Labor? Entrepreneurship? The Critical Question How does a firm decide how much of each of the various inputs to buy?

  4. The Critical Answer The combination of inputs that enables it to produce whatever output it decides upon at minimum cost, and, therefore, maximum profitability.

  5. Output Inputs Input vs. Output

  6. How to Measure Production • use units instead of dollars (b/c prices change over time) • total product (TP): all units of a product produced in a given period of time • average product (AP): # units of output produced per unit of input

  7. How to Measure Production cont… • marginal product (MP): amount that TP ↑ or ↓ as a result of adding 1 more unit of input • important for deciding whether or not to add the input … add if $ value of added output > cost of added input

  8. Florence Farmer’s Poultry: TP

  9. Florence Farmer’s Poultry: TP Total Output (pounds of chicken per week) Quantity of Corn (bags per week)

  10. Florence Farmer’s Poultry: AP AP = 100 lbs. of chicken = 25 lbs. per bag 4 bags of corn

  11. Florence Farmer’s Poultry: AP

  12. Florence Farmer’s Poultry: MP MP = 100 – 66 lbs. of chicken = 34 = 34 lbs. per bag 4 – 3 bags of corn 1

  13. Florence Farmer’s Poultry: MP

  14. Florence Farmer’s Poultry: MP Increasing Marginal Returns Diminishing Marginal Returns Negative Marginal Returns Marginal Product (pounds of chicken per week) Quantity of Corn Input (bags per week)

  15. “Law” of Diminishing Marginal Returns An increase in the amount of any one input, holding the amounts of all others constant, ultimately leads to lower marginal returns to the expanding input. In other words: In the short run, eventually it’s not worth it to keep adding more input because the output will decrease. (does not hold true in the long run!!!)

  16. Short Run vs. Long Run • short run: period in which the usable amount of at least 1 input is fixed while the usable amount of at least 1 input can change • long run: period in which the amounts of all inputs can be changed

  17. Returns to Scale • scale of production: overall level of use of all factors of production • returns to scale: relationships b/t changes in scale of production and corresponding change in output • increasing: output  more rapidly than rate of  of inputs • decreasing: output  less rapidly than rate of  of inputs • constant: output  at same rate of  of inputs

  18. Returns to Scale Examples Identify whether returns to scale are increasing, decreasing or constant: • Inputs increase 66% and output increases 66% • Inputs are tripled and output doubles • Inputs are increased by 15% and output increases by 25%

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