1. Firms and Production
Perloff Chapter 6

2. Firms
An organisation that converts inputs into outputs which it sells.
Ownership of the firm may be separated from its control creating a potential conflict of interest.
Owners aim to maximise profits.
Managers may maximise non profit objectives.
We concentrate on models of the firm where there is no conflict of interest, we assume that decisions are taken in such a way as to maximise profit.

3. Production Function
The relationship between the quantities of inputs and the maximum level of output produced.
Short-run: the period of time in which at least one input is fixed.
Central to the firms activities is the transformation of inputs into outputs. The technical process by which this is achieved is described by the production function
Long-run: the period of time in which all inputs are variable.

4. Total product, marginal product and average product in the SR
Source: Perloff

5. Production relationships in the SR
Output, q ,
Units per day C
110 90 B 56 A 4 6 11 L
, Workers per day AP , MP L L a 20 b 15
Average product, AP L
56/4=14
90/6=15
Marginal product, MP L c
Source: Perloff 4 6 11 L
, Workers per day

6. The long-run: 2 inputs variable
Source: Perloff

7. Isoquant map K
, Units of
capital per day
Combinations of inputs which can be used to produce the same level of output. 6 a b 3 e c f 2 q
= 35 d 1 q
= 24 q
= 14
Source: Perloff 1 2 3 6 L
, Workers per day

8. Properties of Isoquants
Further from the origin:higher output
Cannot cross
Slope downward
Convex to the origin K e b a d f c 6 3 2 1 L q
= 14
= 24
= 35
Firms produce efficiently, they don’t waste inputs
Higher indiff curves: higher output if b and e were the same level of output it would mean inputs are wasted.
Cannot cross: Means two output levels can be produced with same input levels, why produce the lower level.
Slope downwards: If upwards same output with high or low input levels, why?
Source: Perloff

9. Substitutability of inputs 1
, Dutch potatoes
per day q
= 1 q
= 2 q
= 3
Source: Perloff x
, British potatoes per day

10. Substitutability of inputs 2
Boxes
per day q
= 3 q
= 2 q
= 1 45
line
Source: Perloff
Cereal per day

11. Marginal rate of technical substitutionK
, Units of
capital per year a 39 D K = – 18 b 21 D L = 1 – 7
The extra input quantity of input on the y-axis required when the quantity of the input on the horizontal axis is reduced by one. c 14 1 – 4 d 10 1 – 2 e 8 q
= 10 1
Source: Perloff 2 3 4 5 6 L
, Workers per day

12. MRTS and marginal product

13. Constant Returns to Scale
Constant returns to scale: Doubling all inputs leads to a doubling of output.
Potato Salad Production:

14. Returns to scale in the Cobb-Douglas Production Function
Constant returns to scale
Why might we have decreasing returns to scale? Double output by adding a identical factory. Organisational problems may arise.
Increasing returns to scale
Decreasing returns to scale

15. Example: Thread Mill a+b=0.82K
, Units of
capital per year
600 q
= 177 q
= 200
500 q =
100
400
300
200
100 50
100
150
200
250
300
350
400
450
500
Source: Perloff L
, Units of labor per year

16. Varying Scale EconomiesK
, Units of
capital per year d 8 q
= 8 c  d
: Decreasing returns to scale c 4 q
= 6 b 2 b  c
: Constant returns to scale a 1 q
= 3 q = 1 a  b
: Increasing returns to scale
Source: Perloff 1 2 4 8 L
, Work hours per year

17. Technical Progress
An increase in the volume of output produced with the same volume of inputs.

18. Neutral technical progressK
, Units of
capital per year 39 21 14 10 q
= 11 8 q
= 10
Source: Perloff 2 3 4 5 6 L
, Workers per day

19. Non-neutral technical progressK
, Units of q
= 10 q
= 11
Results in the substitution of one input for another. 39 21 14 10 8
Source: Perloff 2 3 4 5 6 L
, Workers per day