Managerial Economics in a Global Economy

Chapter 6 Production Theory and Estimation

PowerPoint Slides by Robert F. Brooker

Copyright (c) 2001 by Harcourt, Inc. All rights reserved.

The Organization of Production

Inputs
Labor, Capital, Land

Fixed Inputs Variable Inputs Short Run

At least one input is fixed

Long Run
All inputs are variable
PowerPoint Slides by Robert F. Brooker Copyright (c) 2001 by Harcourt, Inc. All rights reserved.

Production Function With Two Inputs

Q = f(L, K)
K 6 5 4 3 2 1 Q 10 12 12 10 7 3 1 24 28 28 23 18 8 2 31 36 36 33 28 12 3 36 40 40 36 30 14 4 40 42 40 36 30 14 5 39 40 36 33 28 12 6 L

PowerPoint Slides by Robert F. Brooker

Copyright (c) 2001 by Harcourt, Inc. All rights reserved.

Production Function With Two Inputs

Discrete Production Surface

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Production Function With Two Inputs

Continuous Production Surface

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Production Function With One Variable Input

Total Product TP = Q = f(L) TP MPL = L TP APL = L MPL EL = AP L
Copyright (c) 2001 by Harcourt, Inc. All rights reserved.

Marginal Product
Average Product Production or Output Elasticity
PowerPoint Slides by Robert F. Brooker

Production Function With One Variable Input

Total, Marginal, and Average Product of Labor, and Output Elasticity

L 0 1 2 3 4 5 6

Q 0 3 8 12 14 14 12

MPL 3 5 4 2 0 -2

APL 3 4 4 3.5 2.8 2

EL 1 1.25 1 0.57 0 -1

PowerPoint Slides by Robert F. Brooker

Copyright (c) 2001 by Harcourt, Inc. All rights reserved.

Production Function With One Variable Input

PowerPoint Slides by Robert F. Brooker

Copyright (c) 2001 by Harcourt, Inc. All rights reserved.

Production Function With One Variable Input

PowerPoint Slides by Robert F. Brooker

Copyright (c) 2001 by Harcourt, Inc. All rights reserved.

Optimal Use of the Variable Input

Marginal Revenue Product of Labor Marginal Resource Cost of Labor MRPL = (MPL)(MR) TC MRCL = L

Optimal Use of Labor MRPL = MRCL

PowerPoint Slides by Robert F. Brooker Copyright (c) 2001 by Harcourt, Inc. All rights reserved.

Optimal Use of the Variable Input

Use of Labor is Optimal When L = 3.50
L 2.50 3.00 3.50 4.00 4.50 MPL 4 3 2 1 0 MR = P $10 10 10 10 10 MRPL $40 30 20 10 0 MRCL $20 20 20 20 20

PowerPoint Slides by Robert F. Brooker

Copyright (c) 2001 by Harcourt, Inc. All rights reserved.

Optimal Use of the Variable Input

PowerPoint Slides by Robert F. Brooker

Copyright (c) 2001 by Harcourt, Inc. All rights reserved.

Production With Two Variable Inputs

Isoquants show combinations of two inputs that can produce the same level of output. Firms will only use combinations of two inputs that are in the economic region of production, which is defined by the portion of each isoquant that is negatively sloped.
PowerPoint Slides by Robert F. Brooker Copyright (c) 2001 by Harcourt, Inc. All rights reserved.

Production With Two Variable Inputs

Isoquants

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Production With Two Variable Inputs

Economic Region of Production

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Production With Two Variable Inputs

Marginal Rate of Technical Substitution

MRTS = -K/L = MPL/MPK

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Production With Two Variable Inputs

MRTS = -(-2.5/1) = 2.5

PowerPoint Slides by Robert F. Brooker

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Production With Two Variable Inputs

Perfect Substitutes Perfect Complements

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Optimal Combination of Inputs

Isocost lines represent all combinations of two inputs that a firm can purchase with the same total cost.
C wL rK
C w K L r r
PowerPoint Slides by Robert F. Brooker

C Total Cost w Wage Rate of Labor ( L) r Cost of Capital ( K )

Copyright (c) 2001 by Harcourt, Inc. All rights reserved.

Optimal Combination of Inputs

Isocost Lines AB C = $100, w = r = $10

AB
AB AB*

C = $140, w = r = $10
C = $80, w = r = $10 C = $100, w = $5, r = $10

PowerPoint Slides by Robert F. Brooker

Copyright (c) 2001 by Harcourt, Inc. All rights reserved.

Optimal Combination of Inputs

MRTS = w/r

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Copyright (c) 2001 by Harcourt, Inc. All rights reserved.

Optimal Combination of Inputs

Effect of a Change in Input Prices

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Returns to Scale
Production Function Q = f(L, K)
Q = f(hL, hK) If = h, then f has constant returns to scale. If > h, then f has increasing returns to scale. If < h, the f has decreasing returns to scale.
PowerPoint Slides by Robert F. Brooker Copyright (c) 2001 by Harcourt, Inc. All rights reserved.

Returns to Scale
Constant Returns to Scale Increasing Returns to Scale Decreasing Returns to Scale

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Innovations and Global Competitiveness

Product Innovation Process Innovation Product Cycle Model Just-In-Time Production System Competitive Benchmarking Computer-Aided Design (CAD) Computer-Aided Manufacturing (CAM)
PowerPoint Slides by Robert F. Brooker Copyright (c) 2001 by Harcourt, Inc. All rights reserved.