Production Drives Supply  Factors of Production  Total Product, Average Product & Marginal Product  Short Run vs. Long Run  Scale of Production & Returns to Scale

Warm-Up Questions 1. What is a “factor of production”? 2. What are the 4 factors of production, and what does each represent? 3. In a free market economy, who owns most of the factors of production? 4. Why do people get involved in production? In other words, what is their incentive?

The Critical Question How does a firm decide how much of each of the various inputs to buy?

The Critical Answer The combination of inputs that enables it to produce whatever output it decides upon at minimum cost, and, therefore, maximum profitability.

Input vs. Output OutputInputs

How to Measure Production  use units instead of dollars (b/c prices change over time)  total product (TP): all units of a product produced in a given period of time  average product (AP): # units of output produced per unit of input

How to Measure Production cont…  marginal product (MP): amount that TP ↑ or ↓ as a result of adding 1 more unit of input important for deciding whether or not to add the input … add if $ value of added output > cost of added input

Florence Farmer’s Poultry: TP Flo’s Total Product Schedule Corn Input (40-lb. bags) Chicken Output (lbs.)

Florence Farmer’s Poultry: TP Quantity of Corn (bags per week) Total Output (pounds of chicken per week)

Florence Farmer’s Poultry: AP AP = 100 lbs. of chicken = 25 lbs. per bag 4 bags of corn

Florence Farmer’s Poultry: AP Flo’s Total Product & Average Product Schedule Corn Input (40-lb. bags)Chicken Output (lbs.)Average Product (lbs. per bag)

Florence Farmer’s Poultry: MP MP = 100 – 66 lbs. of chicken = 34 = 34 lbs. per bag 4 – 3 bags of corn 1

Florence Farmer’s Poultry: MP Flo’s Total Product & Average Product Schedule Corn Input (40-lb. bags)Chicken Output (lbs.)Marginal Product (lbs. per bag)

Florence Farmer’s Poultry: MP Quantity of Corn Input (bags per week) Marginal Product (pounds of chicken per week) Increasing Marginal Returns Diminishing Marginal Returns Negative Marginal Returns

“Law” of Diminishing Marginal Returns An increase in the amount of any one input, holding the amounts of all others constant, ultimately leads to lower marginal returns to the expanding input. In other words: In the short run, eventually it’s not worth it to keep adding more input because the output will decrease. (does not hold true in the long run!!!)

Short Run vs. Long Run  short run: period in which the usable amount of at least 1 input is fixed while the usable amount of at least 1 input can change  long run: period in which the amounts of all inputs can be changed

Returns to Scale  scale of production: overall level of use of all factors of production  returns to scale: relationships b/t changes in scale of production and corresponding change in output increasing: output  more rapidly than rate of  of inputs decreasing: output  less rapidly than rate of  of inputs constant: output  at same rate of  of inputs

Returns to Scale Examples Identify whether returns to scale are increasing, decreasing or constant: 1. Inputs increase 66% and output increases 66% 2. Inputs are tripled and output doubles 3. Inputs are increased by 15% and output increases by 25%