Principles of Microeconomics

Theory of Production

PRODUCTION FUNCTION

Inputs
Land, labor, capital, and so forth

Outputs
(cars, vaccines, gadgets,
TV broadcasts, and so forth)

The Production Function

Short run and Long run

Short run

Long run

A period when there are

both ___________
fixed inputs and
variable
inputs
_____________.

A period when all factors

variable
are ________.

A firm can expand output

by employing more
variable inputs only.
______________

A firm can expand output

by increasing the use of
__________.
all inputs

Fixed and Variable Input

Fixed Input

Variable Input

Its employment
Definition Its employment
remains constant when increases
_______________
________ as output
output increases.
increases.
Examples factory buildings, land,
capital tools and
entrepreneurial skills

raw materials, labour,

fuel and electricity

Input-output relationship in the short run

Assume there are two factors only: capital (fixed) and
labor (variable). Technology is constant.
Labor
1
2
3
4
5
6
7
8
9
10

Total product
(units)
4
10
20
28
34
38
40
40
39
37

Why do diminishing marginal returns occur ?

Law of Diminishing Marginal Returns

As more and more variable factors are added to a given
quantity of fixed factors, holding technology constant,
marginal product eventually drops
Output

MP

Variable factor

Lessons of Diminishing Returns

1.The size of a resource, given the rest as fixed,
should not go beyond its product maximizing
point.
2.Plant capacity can only increase with more of all
resources unless technology changes.
3.Resources are basically complementary.

Input-output relationship in the short run

Average product (AP) = TP/n
Labour
1
2
3
4
5
6
7
8
9
10

Total product
(units)
4
10
20
28
34
38
40
40
39
37

Average product
(units)
4.00
5.00
6.60
7.00
6.80
6.34
5.72
5.00
4.34
3.70

Input-output relationship in the short run

Marginal product (MP) = a result of a change in
input
Labour
1
2
3
4
5
6
7
8
9
10

Total product
(units)
4
10
20
28
34
38
40
40
39
37

Marginal product
(units)
4
6
10
8
6
4
2
0
-1
-2

Production Costs in the Long Run

ISOQUANT
AN ISOQUANT OR ISO PRODUCT CURVE OR EQUAL PRODUCT
CURVE OR A PRODUCTION INDIFFERENCE CURVE SHOW THE
VARIOUS COMBINATIONS OF TWO VARIABLE INPUTS RESULTING
IN THE SAME LEVEL OF OUTPUT.

IT IS DEFINED AS A CURVE PASSING THROUGH THE PLOTTED

POINTS REPRESENTING ALL THE COMBINATIONS OF THE TWO
FACTORS OF PRODUCTION WHICH WILL PRODUCE A GIVEN
OUTPUT.

Labour
(Units)
1

Capital
(Units)
5

Output
(Units)
10

10

10

10

10

SLOPE OF ISOQUANT
THE SLOPE OF AN ISOQUANT HAS A TECHNICAL
NAME CALLED THE MARGINAL RATE OF
TECHNICAL SUBSTITUTION (MRTS)
OR THE
MARGINAL RATE OF SUBSTITUTION IN
PRODUCTION. THUS IN TERMS OF CAPITAL
SERVICES K AND LABOUR L
MRTS = Dk/DL

TYPES OF ISOQUANTS
1. LINEAR ISOQUANT
2. RIGHT-ANGLE ISOQUANT
3. CONVEX ISOQUANT

LINEAR ISOQUANT
IN LINEAR ISOQUANTS THERE
SUBSTITUTABILTY OF INPUTS.

IS

PERFECT

RIGHT-ANGLE ISOQUANT
IN RIGHT-ANGLE ISOQUANTS THERE IS COMPLETE
NON- SUBSTITUTABILTY BETWEEN INPUTS.

CONVEX ISOQUANT
IN CONVEX ISOQUANTS THERE IS SUBSTIUTABILTY
BETWEEN INPUTS BUT IT IS NOT PERFECT.

PROPERTIES OF ISOQUANTS
1. AN ISOQUANT IS DOWNWARD SLOPING TO THE
RIGHT.
2. A HIGHER ISOQUANT REPRESENTS LARGER
OUTPUT.
3. NO TWO ISOQUANTS INTERSECT OR TOUCH
EACH OTHER.
4. ISOQUANT IS CONVEX TO THE ORIGIN.

RETURNS TO SCALE
DIMINISHING RETURNS REFER TO RESPONSE OF OUTPUT TO AN

INCREASE OF A SINGLE INPUT WHILE OTHER INPUTS ARE HELD

CONSTANT.
WE HAVE TO SEE THE EFFECT BY INCREASING ALL INPUTS.

WHAT WOULD HAPPEN IF THE PRODUCTION OF WHEAT IF LAND,

LABOUR, FERTILISERS, WATER ETC,. ARE ALL DOUBLED. THIS
REFERS TO THE RETURNS TO SCALE OR EFFECT OF SCALE
INCREASES OF INPURTS ON THE QUANTITY PRODUCED.

CONSTANT RETURNS TO SCALE

THIS DENOTES A CASE WHERE A CHANGE IN ALL
INPUTS LEADS TO A PROPORTIONAL CHANGE IN
OUTPUT.

INCREASING RETURNS TO SCALE

THIS IS ALSO CALLED ECONOMIES OF SCALE. THIS ARISES WHEN
AN INCREASE IN ALL INPUTS LEADS TO A MORE-THANPROPORTIONAL INCREASE IN THE LEVEL OF OUTPUT.

DECREASING RETURNS TO SCALE

THIS OCCURS WHEN A BALANCED INCREASE OF ALL INPUTS
LEADS TO A LESS THAN PORPORTIONAL INCREASE IN TOTAL
OUTPUT.

IMPORTANCE OF RETURNS TO SCALE

CONCEPT
IF AN INDUSTRY IS CHARACTERIZED BY INCREASING RETURNS TO
SCALE, THERE WILL BE A TENDENCY FOR EXPANDING THE SIZE
OF THE FIRM AND THUS THE INDUSTRY WILL BE DOMINATED BY
LARGE FIRMS.
THE OPPOSITE WILL BE TRUE IN INDUSTRIES WHERE
DECREASING RETURNS TO SCALE PREVAIL.
IN CASE OF INDUSTRIES WITH CONSTANT RETURNS TO SCALE,
FIRMS OF ALL SIZES WOULD SURVIVE EQUALLY WELL.

RD VELASCO, MM

http://istudyguide.weebly.com

Photo Sources

http://abhinavpmp.com/wp-content/uploads/market-competition-advantages.jpg
http://www.clker.com/cliparts/9/6/f/7/1206558524578237244johnny_automatic_frame_goes_on_the_assembly_line.svg.h
i.png
http://www.usagold.com/publications/images/diminishingreturns.jpeg

Graphs and Quick Activity Source:

http://www.google.com/url?sa=t&rct=j&q=&esrc=s&source=web&cd=1&cad=rja&uact=8&sqi=2&ved=0CB0QFjAA&url=http
%3A%2F%2Fwww.ylmass.edu.hk%2F~econ%2FCE%2520Law%2520of%2520DMP.ppt&ei=ULi9VObsJYWxmwXei4HYAg&usg=
AFQjCNHOLNl6utHLa72lVAQ03l5gUYBG3g&bvm=bv.83829542,d.dGY