Course Code: BUS 504

Course title: Managerial Economics (Section 1)

Presented By:
S.M.Imran 201701078

MD. ASHEKE RABBI 201701054

 Production Function
 Production Function:
The basic relationship between factors of production and the
output
q= f(K,L)
 Production Function in Long Run
and in Short Run
 Long-run production function
Refers to the period of time over which it is possible to
vary the inputs of all factors of production
All the factors of production becomes variable.

 Short-run production function

The short run is defined as the period during which at
least one of the inputs is fixed. According to the
following short-run production function, labor is the only
variable input while the rest of the inputs are regarded as
fixed.
Stages of production curve
Shifting of production function

Shifting of production function

 Law of Diminishing Marginal Returns

• The law of diminishing

marginal returns states
that: As the use of an
input increases in equal
increments with other
inputs fixed, the
resulting additions to
output will eventually
decrease.
 Three stages of production in LDMR

• Stage 1: average
product rising.
• Stage 2: average
product declining (but
marginal product
positive).
• Stage 3: marginal
product is negative, or
total product is
declining
 RETURNS TO SCALE

• Returns to scale is the rate at which output

increases in response to proportional
increases in all inputs .
• In production, returns to scale refers to
changes in output subsequent to a
proportional change in all inputs (where
all inputs increase by a constant factor).
 TYPES OF RETURNS TO SCALE

• Increasing
returns to scale
• Constant
returns to scale
• Decreasing
returns to scale
 Increasing returns to scale

• Increasing returns to
scale occurs if a
proportional increase
in all inputs under
the control of a firm
results in a greater
than proportional
increase in
production.
 Constant returns to scale

• Constant returns to
scale occurs if a
proportional increase
in all inputs under the
control of a firm
results in an equal
proportional increase
in production.
 Decreasing returns to scale

• Decreasing returns to
scale occurs if a
proportional increase
in all inputs under
the control of a firm
results in a less than
proportional increase
in production.
 Isoquant

• Isoquant indicates various

combinations of
two factors of production
which give the same
level of output per unit of
time.
• An isoquant is also known
as Production-
Indifference curve.
 Characteristics of Isoquant

• An Isoquant Slopes
Downward from Left
to Right
• Isoquants are Convex
to the Origin
 Characteristics of Isoquant (CONTD.)

• Two Iso-Product Curves Never Cut Each Other

 Characteristics of Isoquant (CONTD.)

• Higher Iso-Product • No Isoquant can Touch

Curves Represent Either Axis
Higher Level of Output
 The main points of difference between
indifference curve and Iso-quant curve are
explained below:
• 1. Iso-quant curve expresses the quantity of output. Each curve refers to
given quantity of output while an indifference curve to the quantity of
satisfaction. It simply tells that the combinations on a given indifference
curve yield more satisfaction than the combination on a lower indifference
curve of production.
• 2. Iso-quant curve represents the combinations of the factors whereas
indifference curve represents the combinations of the goods.
• 3. Iso-quant curve gives information regarding the economic and
uneconomic region of production. Indifference curve provides no
information regarding the economic and uneconomic region of
consumption.
• 4. Slope of an iso-quant curve is influenced by the technical possibility of
substitution between factors of production. It depends on marginal rate of
technical substitution (MRTS) whereas slope of an indifference curve
depends on marginal rate of substitution (MRS) between two
commodities consumed by the consumer.
 Isoquant Map

• When a number of
Isoquants are combined
in a single graph, used
to describe a
production function, is
known as Isoquant
map.
Marginal rate of Technical Substitution
(MRTS)
The Marginal Rate of Technical
Substitution (MRTS)—or Technical
Rate of Substitution (TRS)—is the
amount by which the quantity of one
input has to be reduced when one
extra unit of another input is used so
that output remains constant.

It is the negative slope of Isoquant

curve.

Change in capital input

∴ 𝑀𝑅𝑇𝑆 = − Change in Labor input
[for a fixed level of Output]
∆𝑲
∴ 𝑴𝑹𝑻𝑺 = −
∆𝑳
 Types of Iso-quant Curves

The iso-quant curves can be classified on the

basis of the substitutability of factors of
production
For perfect • Linear isoquant
Substitutability

For No Substitution • Leontief Iso-quant

Substitutability of • Convex Isoquant curve

inputs but not perfect
 Linear Isoquant Curve

Electric
Power
produced Oil used Gas used
(Units) (Units) (Units)

100 0 4

100 1 3

100 2 2

100 3 1

100 4 0
 Leontief Iso-quant

Engine Wheel Motorbike

Used Used Produced
1 2 1
1 4 1 ∆ Engine
1 6 1 MRTS in Vertical line=− = infinite
∆ wheel (0)
1 8 1

Engine Wheel Motorbike

Used Used Produced
1 2 1
2 2 1
3 2 1 ∆ Engine (0)
MRTS in horizontal line=− =0
4 2 1 ∆ wheel
 Convex Isoquant curve

Labor Machine
Used used Output

2 8 5

3 5 5

6 2 5

10 1 5
 Cobb Douglas Production Function
Charles W. Cobb and Paul H. Douglas studied the relationship of
inputs and outputs and formed an empirical production function,
popularly known as Cobb-Douglas production function.

The Cobb-Douglas production function is expressed by

Q = AKαLβ
Where,
Q = total production
L = labor input
K = capital input
A = that part of output which cannot be explained by L and К is
explained by A which is the ‘residual’, often called technical
change.
α , β = are the output elasticities of capital and labor, respectively.
Cobb Douglas Production Function (Cont.)

Cobb Douglas function characterizes the returns to scale:

• α + β >1: Increasing returns to scale

• α + β =1: Constant returns to scale

• α +β <1: Decreasing returns to scale.

[For perfect competition , α + β = 1]

 How to Estimate Cobb Douglas Production
Function
Output Capital ln(Q) ln(K) ln(L)
(Q) (K) Labor(L) Cobb Douglas Production can be 5.4161 2.302585 2.995732274
225 10 20 converted into linear form 5.480639 2.484907 3.091042453
240 12 22
278 10 26
Q= 𝐴𝐾 α 𝐿β 5.627621 2.302585 3.258096538
5.356586 2.639057 2.890371758
212 14 18 Or, ln(𝑄) = ln(𝐴𝐾 α 𝐿β )
5.293305 2.484907 2.772588722
199 12 16
Or, ln 𝑄 = ln 𝐴 + αln(𝐾) + βln(𝐿) 5.693732 2.772589 3.17805383
297 16 24
242 16 20 5.488938 2.772589 2.995732274
155 10 14 5.043425 2.302585 2.63905733
215 8 20 5.370638 2.079442 2.995732274
160 8 14 5.075174 2.079442 2.63905733

Regression Model:
ln 𝑄 = ln 𝐴 + α ln(𝐾) + β ln 𝐿 + 𝐸𝑟𝑟𝑜𝑟
 How to Estimate Cobb Douglas Production
Function
Result from Stata:
. regress lnq lnk lnl ln(A)= 2.329508
A= 10.27289
Source SS df MS Number of obs = 10
F( 2, 7) = 142.99 Coefficient of 𝐥𝐧 𝑲 , α= 0.193088
Model .387693985 2 .193846992 Prob > F = 0.0000 Coefficient of 𝐥𝐧 𝑳 , β= 0.878423
Residual .009489568 7 .001355653 R-squared = 0.9761
Adj R-squared = 0.9693 .19 𝐿.88
Total .397183553 9 .044131506 Root MSE = .03682
Q= 10.27 𝐾

α+ β = .19 + .88
lnq Coef. Std. Err. t P>|t| [95% Conf. Interval] = 1.07 > 1

lnk .1930887 .0515949 3.74 0.007 .0710862 .3150911 [𝑆𝑂, 𝐼𝑅𝑆]

lnl .8784226 .061938 14.18 0.000 .7319625 1.024883
_cons 2.329507 .1824247 12.77 0.000 1.898141 2.760873
Conclusion…
ANY QUESTION?