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 Inputs: Factors of Production
Factors of production:
‡ Land Labor Capital
‡ Intermediate goods
‡ (Entrepreneurial Services )

‡ Production Costs = Costs of Inputs

 Production in the Short Run
versus Production in the Long Run
‡ In the short run at least one of the factors of
production remains unchanged (˜
).
‡ In the long run all factors of production are
 .
‡ In a two-input production process, in the short
run, only
 input is  .
‡ In a two-input production model, in the short
run, the changes in the output (physical
product) are the result of changes in the
  input.
 Production in the Long Run
‡ In the long run 
  used in the
production process by the firm are  .
‡ In a two-input production model, in the long
run, both inputs (say, capital and labor) are
 .
‡ In the long run the level of the output of a
firm can change as a result of changes in
any or all inputs.
 v Short-Run Production (Function)
vnalysis
Our model:
v firm using two inputs:
Capital (K); Fixed Input
Labor (L); Variable input
We examine the relationship between the variable
input (labor) and the output.

We examine how m 
 in labor (the variable input)
affect the out put.
 Output Measures
‡ Total (Physical) Product (output), TPP: The total
amount of output produced by the firm over a
certain period
‡ vverage (Physical) Product (of the variable
input), vPP: Total (Physical) Product divided by
the number units of the variable input
‡ Marginal (Physical) Product (of the variable
input), MPP: The change in total product
resulting from employing one additional unit of
the variable input
 Production in the Short Run

Inputs: Capital (K) and Labor (L)

K = 20 (Fixed) Labor: Variable
Total Marginal Average
Labor (L) P. Product P. Product P. Product
0 0
1 10 10 10.0
2 25 15 12.5
3 35 10 11.7
4 44 9 11.0
5 51 7 10.2
6 56 5 9.3
7 60 4 8.6
8 62 2 7.8
9 62 0 6.9
 Total (Physical) Product and
Marginal Physical Product
  

2
   









 

    

 vverage (Physical) Product and

Marginal Physical Product

v







 v



  MP



           
 MPP and vPP
Change in TPP
Marginal Physical Product = MPP =
Change in V. Input

Total Physical Product

vverage Physical Product = vPP =
Total V. Input
 The ³Law´ of Diminishing Return
‡ Increases in the amount of any

 ,
holding the amounts all other inputs constant,
would eventually result in decreasing marginal
product of the variable input.

Explanation: Unless all inputs are perfectly and

infinitely substitutable, as we increase the
amount of one input, while keeping other inputs
constant, at some point the productive
effectiveness of that input starts to decline.
 Isoquant and Isocost
Q = f ( K, L)

Cost = rK + w L

where r = price of capital

w = wage
 Isoquant
K

Slope = MPL/MPK = MRTS

Q4
Q3
Q2
Q1 L
0
 Isocost
K
Cost = r.K +w. L
Cost/r

Slope = w/r

L
0 Cost/w
 Isocost
K
Cost = r.K +w. L
Cost/r

Slope = w/r

Q2

Q1
L
0 Cost/w
 Input Optimizing Rule
MPL MPK MPM
--------- = --------- = ---------
w r PM

or, MPL w MPL w

------ = -------- , ---------- = ---------
MPK r MPM PM
 X path

Cost/r

Q2

Q1
L
0 Cost/w
 VTC LTC

Q
o
V LTC

LvC = LTC/Q
LMC
LMC = dLTC/dQ

LvC LMC

LvC= LMC
MC

Q
 V
LMC

LvC

Q
o Q1 Q*
Inputs: Capital (K) and Labor (L) Cap Price = 2
K= 20 Lab: Varia ble Wage = 6
Total T.Fixed T. Var Total Average Average Average Marginal
Labor (L) Product Cost Cost Cost F.Cost V.Cost T.cost Cost
0 0 40 0 40
1 10 40 6 46 4.00 0.60 4.60 0.60
2 25 40 12 52 1.60 0.48 2.08 0.40
3 35 40 18 58 1.14 0.51 1.66 0.60
4 44 40 24 64 0.91 0.55 1.45 0.67
5 51 40 30 70 0.78 0.59 1.37 0.86
6 56 40 36 76 0.71 0.64 1.36 1.20
7 60 40 42 82 0.67 0.70 1.37 1.50
8 62 40 48 88 0.65 0.77 1.42 3.00
9 62 40 54 94 0.65 0.87 1.52
 P     C   
  

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A C
 


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Long un v g o o LATC)
ã
 
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 Long-Run Average Total Cost
ATC ATC ATC K=3 0
K=10 K=20

2. 5 2.5 2.5

2 2 2

1. 5 1 .5 1.5

1 1 1

0. 5 0.5 0.5

0 0 0
0 50 100 0 50 1 00 1 50 200 0 100 200 300
 LvTC

K= 10
L= 6
.82
K= 20
L= 7 K= 30
.53 L=8
LvTC
.51

Q
o 61 141 195
 Long un Av g To Co
(
ATC)1

ATC)2

ATC)3

LATC

)
 ¢
n
o

(
Con
n
¢
n
o 

LATC

n  ng ¢
n
o 
 ng ¢
n
o 

)
 Return to Scale
‡ Output elasticity: İQ
% Change in Output
%Change in all inputs
Increasing Return: İQ > 1
Constant Return: İQ = 1
Diminishing Return: İQ < 1
Cobb-Douglas function: Q = a Kb1Lb2
b1+ b2 >1 b1 + b2 = 1 b1 + b2 < 1
 Input Optimization Revisited
Marginal revenue product of an input is the value
of the output produced from applying one
additional unit of that input:
MRPL = MPL .Price of output = MPL. MR
MRPK = MPK.Price of output = MPK. MR
Input-optimizing rule: v firm will hire/buy each
input to the point where the marginal revenue
product the input is equal to its price.
MRPL = MPL. MR = w
MRPK = MPK . MR= r
Input optimization and demand for input:
Wage

6.00

4.30

3.10
DL: MRPL=MPL.MR
2.00

L
o 10 22 45 90
 vnother look at optimization rule:

MPL . MR = MRPL= w
MPL/MPK = MRTS = w/r

MPK . MR = MRPK = r
vlternatively:

MPL. MR = w ÷ MR = MC
MPL MPL