1. MICROECONOMICS: Theory & Applications
Chapter 7: Production
By Edgar K. Browning & Mark A. Zupan
John Wiley & Sons, Inc.
11th Edition, Copyright 2012
PowerPoint prepared by Della L. Sue, Marist College

2. 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)
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3. 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.
Describe how production relationships can be estimated and some difference potential functional forms for those relationships.
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4. 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
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5. 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
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6. Table 7.1
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7. Figure 7.1 - Total, Average, and Marginal Product Curves
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8. 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.
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9. The Geometry of Product Curves
Average product of labor (at a point)
slope of a straight line from the origin to that point on the total product curve
Marginal product of labor (at a point):
change in total product with a small change in the use of an input
slope of the total product curve at that point
steeper total product curve => output rises faster as more input is used => larger marginal product
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10. Figure 7.2 – Deriving Average and Marginal Product
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11. 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
Copyright 2012
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12. 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
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13. 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.
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14. 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.
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15. Figure 7.3 - Production Isoquants
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16. MRTS and the Marginal Products of Inputs
MRTSLK = (-) ΔK/ΔL = MPL/MPK
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17. MRTS and the Marginal Products of Inputs (Derivation)
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18. Figure 7.4 - Isoquants Relating Gasoline and Commuting Time
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19. 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
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20. Factors Giving Rise to Increasing Returns
Specialization and division of labor within the firm
“Volume” capacity increases faster than “area” dimensions (arithmetic relationship)
Available of techniques that are unique to large-scale operation
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21. 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
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22. Figure 7.5 - Returns to Scale
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23. Functional Forms and Empirical Estimation of Production Functions
Linear
Q = a + bL + cK
Multiplicative
Cobb-Douglas production function: Q = aLbKc
Empirical Estimation Techniques
Survey
Experimentation
Regression analysis
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24. Linear Forms of Production Functions
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25. Multiplicative Forms of Production Functions: Cobb-Douglas as an Example
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26. Exponents and Cobb-Douglas Production Functions
b + c > increasing returns to scale
b + c = constant returns to scale
b + c < decreasing returns to scale
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27. The Mathematics behind Production Theory: The Marginal-Average Product Relationship
(continued)
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28. Marginal-Average Product Relationship
The Mathematics behind Production Theory: The Marginal-Average Product Relationship
Marginal-Average Product Relationship
Whenever MPL>APL, APL is increasing.
Whenever MPL<APL, APL is decreasing.
Whenever MPL=APL, APL is at a maximum.
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29. The Mathematics behind Production Theory: MRTS and the Ratio of Inputs’ Marginal Products
(continued)
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30. MRTS equals the ratio of marginal products.
The Mathematics behind Production Theory: MRTS and the Ratio of Inputs’ Marginal Products
Summary
Marginal product measures the additional output produced when only one input is varied and other inputs are held constant.
The slope of an isoquant (dK/dL), equals (minus) the ratio of the marginal products of the inputs.
MRTS equals the ratio of marginal products.
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John Wiley & Sons, Inc.

31. Cobb-Douglas production function (example):
The Mathematics behind Production Theory: Some Additional Properties of Constant Returns to Scale Production Functions
“Linear Homogeneous Function” – a production function that exhibits constant returns to scale
Cobb-Douglas production function (example):
where 0<α<1
(continued)
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32. The Mathematics behind Production Theory: Some Additional Properties of Constant Returns to Scale Production Functions
Properties:
Marginal product of each input depends only on the proportion in which inputs are used (K/L)
MRTS depends only on the proportion in which inputs are used (K/L)
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