Chapter 8

PRODUCTION AND SUPPLY

  • Production

    • production is the process that transform inputs (factors of production) in outputs (goods or services)

    • production function is the relationship that describes how input are transformed into outputs

      • Q=F(L, K) where K is capital and L is labour

  • Fixed and variable inputs

    • long run —> the shortest period of time required to alter the amounts of all inputs used in a production process (we consider the long run since the moment when a firm can used all their inputs)

    • Short run —> the period of time during which at least one one of the inputs used in a production process can not be varied

      • Variable input: an input that can be varied in the short run

      • fixed input: an input that can not vary in the short run

  • Law of the diminishing returns: if other inputs are fixed, the increase in output from an increase in the variable input must eventually decline

  • in this graph it is shown how additional units of the variable input give rise to smaller and smaller increments in output, before getting to the point where the total production decreases as units of variable input are added

  • Short-run production function components

    • total product curve —> a curve showing the amount of output as a function of the amount of variable input

    • marginal product —> change in total product due to a 1-unit change in the variable input

    • average product —> total output divided by the quantity of variable input

  • Relationship among total, marginal and average product curves

    • When the marginal product curve lies above the average product curve, the average product curve must be rising

    • When the marginal product curve lies below the average product curve, the average product curve must be falling.

    • The two curves intersect at the maximum value of the average product curve.

  • Production in the long run

    • Isoquant: the isoquant is the set of all input combinations that yield a given level of output

    • MARGINAL RATE OF TECHNICAL SUBSTITUTION (MRTS): the MRTS is the rate at which one input can be exchanged for another input for another without altering the total level of output

  • Returns to scale

    • increasing returns to scale: the property of a production process whereby a proportional increase in every input yields a more than proportional increase in output.