CHAPTER 6 * Productive Capacity is determined by the size and quality of the labor force, by the quantity and quality

of capital stock, by the nations technical knowledge along with the ability to use that knowledge, and by the nature of public and private institutions. BASIC CONCEPTS The production function specifies the maximum output that can be produced with a given quantity of inputs. It is defined for a given state of engineering and technical knowledge. Relationship between the amount of input required and the ampint of output that can be obtained. Useful way of describing the productive capabilities of a firm.

Total product Designates the total amount of output produced

Marginal Product Extra output produced by additional unit of that input while other inputs are held constant.

Average Product Equals total output divided by total units of input.

The a! of "i#ini$hing Return$ !olds that we will get less and less extra output when we add additional doses of an input while holding other inputs fixed. o "he marginal product of each unit of input will decline as the amount of that input increases# holding all other inputs constant. o $s more of an input such as labor is added to a fixed amount of land# machinery# and other inputs the labor has less and less of the other factors to work with. o %arginal product curve declines as labor inputs increase Return$ to Scale

Effects of scale increases of inputs on the quantity produced. &'hat is the effect when all inputs are increased( o )onstant returns to scale* case where change in all inputs leads to a proportional change in output. o Increasing returns to scale &economies of scale(* arise when an increase in all inputs leads to a more*than*proportional increase in the level of output. o Decreasing returns to scale* occur when a balanced increase of all inputs leads to a less*than*proportional increase in total output. o +caling up may eventually reach a point beyond which inefficiencies set in.

SHORT R%N and ON& R%N Short run ,eriod in which firms can ad-ust production by changing variable factors such as materials and labor but cannot change fixed factors such as capital. .nly variable factors can be ad-usted# fixed factors&i.e. plant and equipment( cannot be fully modified or ad-usted.

ong run ,eriod sufficiently long that all factors including capital can be ad-usted. ,eriod of time over which all inputs# fixed and variable# can be ad-usted.

'aria(le factor$* factors which are increased in the short run )i*ed factor$* those that cannot be changed in the short run because of physical condition or legal contracts. Technological change Improves productivity and raises living standards. o $ process of innovation is equivalent to a shift in the production function * hen there are market failures, technological regress might occur even in a market economy.

Productivit+ )oncept measuring the ratio of total output to a weighted average input o a(or productivit+* calculates the amount of output per unit labor

o Total factor productivit+* measures output per unit of total inputs &typically of capital and labor(. economies of scale and mass production have been important elements of productivity growth over the last century if increasing returns prevailed, the larger scale of inputs and production would lead to greater productivity Aggregate Production )unction

total output to the quantity of inputs &like labor# capital and

land( and to toal productivity. Bu$ine$$ fir#$

$re speciali/ed organi/ations devoted to managing the

process of production.

"hey exploit economies of mass production# raise funds and

organi/e factors of production.

Production is organized in firms because efficiency generally

requires large-scale production, the raising of significant financial resources and careful management and monitoring of ongoing activities.

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