MICROECONOMICS: Theory &
Applications
Chapter 7 Production
•By Edgar K. Browning & Mark A.
Zupan
•John Wiley & Sons, Inc.
•9th Edition, copyright 2006
•PowerPoint prepared by Della L.
Sue, Marist College
Learning Objectives
• Establish the relationship between inputs and
output.
• Distinguish between variable and fixed inputs.
• Define total, average, and marginal product.
• Understand the Law of Diminishing Marginal
Returns.
(Continued)
Learning Objectives (continued)
• Investigate the ability of a firm to vary its output
in the long run when all inputs are variable.
• Explore returns to scale: how a firm’s output
response is affected by a proportionate change
in all inputs.
• Overview how production relationships can be
estimated and some difference potential
functional forms for those relationships.
Relating Output to Inputs
• Factors of production – inputs or ingredients
mixed together by a firm through its technology
to produce output
• Production function – a relationship between
inputs and output that identifies the maximum
output that can be produced per time period by
each specific combination of inputs
Q = f(L,K)
• Technologically efficient – a condition in which
the firm produces the maximum output from any
given combination of labor and capital inputs
Production When Only One
Input is Variable: The Short Run
• Fixed inputs - resources a firm cannot feasibly
vary over the time period involved
• Total product - the total output of the firm
• Average product - the total output divided by the
amount of the input used to produce that output
• Marginal product - the change in total output that
results from a one-unit change in the amount of
an input, holding the quantities of other inputs
constant
Total, Average, and Marginal Product Curves
[Figure 7.1]
Production Output Table
Production Table - Table 7.1
Capital
3
3
3
3
3
3
3
3
3
3
Labor
0
1
2
3
4
5
6
7
8
9
TP
0
5
18
30
40
45
48
49
49
45
MP of
Labor
AP
5
5
9
13
10
12
10
10
9
5
8
3
7
1
6.125
0
5
-4
The Relationship Between Average and
Marginal Product Curves
• When the marginal product is greater than
average product, average product must be
increasing.
• When the marginal product is less than
average product, average product must be
decreasing.
• When the marginal and average products
are equal, average product is at a
maximum.
[Figure 7.2]
The Law of Diminishing
Marginal Returns
• A relationship between output and input
that holds that as the amount of some
input is increased in equal increments,
while technology and other inputs are held
constant, the resulting increments in
output will decrease in magnitude
Production When All Inputs Are
Variable: The Long Run
• Short run – a period of time in which
changing the employment levels of some
inputs is impractical
• Long run – a period of time in which the
firm can vary all its inputs
• Variable inputs – all inputs in the long run
Production Isoquants
• Isoquant – a curve that shows all the
combinations of inputs that, when used in a
technologically efficient way, will produce a
certain level of output
• Characteristics:
– Isoquants must slope downward as long as both input
are productive (I.e., marginal products > 0)
– Isoquants lying farther to the northeast identify
greater levels of output
– Two isoquants can never intersect.
– Isoquants will generally be convex to the origin.
Marginal Rate of Technical
Substitution (MRTS)
• The amount by which one input can be
reduced without changing output when
there is a small (unit) increase in the
amount of another input
• When the MRTS diminishes along an
isoquant, the isoquant is convex.
Production Isoquants
[Figure 7.3]
MRTS and the Marginal
Products of Inputs
MRTSLK = (-) ΔK/ΔL = MPL/MPK
Returns to Scale
• Constant returns to scale – a
situation in which a
proportional increase in all
inputs increases output in the
same proportion
• Increasing returns to scale – a
situation in which output
increases in greater proportion
than input use
• Decreasing returns to scale –
a situation in which output
increases less than
proportionally to input use
• Figure 7.5
Factors Giving Rise to
Increasing Returns
• Specialization and division of labor
• “Volume” capacity increases faster than
“area” dimensions (arithmetic relationship)
• Available of techniques that are unique to
large-scale operation
Factors Giving Rise to
Decreasing Returns
• Inefficiency of managing large operations:
– Coordination and control become difficult
– Loss or distortion of information
– Complexity of communication channels
– More time is required to make and implement
decisions
Functional Forms and Empirical Estimation of
Production Functions
• Functional Forms
– Linear
• Q = a + bL + cK
– Multiplicative
• Cobb-Douglas production function: Q = aLbKc
• Empirical Estimation Techniques
– Survey
– Regression analysis