Chapter 4-new

nullproduction and business organizationproduction and business organizationChapter 4 Topics To Be CoveredTopics To Be CoveredFactors of Production Production Function Productivity Isoquant Isocost Minimum Cost Rule Returns to ScaleProductionProductionProduction is the process that combines inputs or factors of production to achieve an outputFactors of ProductionFactors of ProductionCapital (Physical Capital) Labor (Human Capital) Land (Natural Resources) Technological KnowledgePhysical CapitalPhysical CapitalPhysical capital is the stock of equipment and structures that are used to produce goods and services. Tools used to build or repair automobiles. Tools used to build furniture. Office buildings, schools, etc.Human CapitalHuman CapitalHuman capital is the economic term for the knowledge and skills that workers acquire through education, training, and experience. Like physical capital, human capital raises a nation’s ability to produce goods and services.Natural ResourcesNatural resources are inputs used in production that are provided by nature, such as land, rivers, and mineral deposits. Renewable resources include trees and forests. Nonrenewable resources include petroleum and coal.Natural ResourcesNatural ResourcesNatural ResourcesNatural resources can be important but are not necessary for an economy to be highly productive in producing goods and services.Technological KnowledgeTechnological Knowledge Technological knowledge is the understanding of the best ways to produce goods and services. The Production FunctionThe Production FunctionThe production function shows the relationship between quantity of inputs used to make a good and the quantity of output of that good.The Production FunctionThe Production Function Q = quantity of output A = available production technology L = quantity of labor K = quantity of capital N = quantity of natural resourcesQ= A F(L, K, N)Production Function for Two InputsProduction Function for Two Inputs Q = F(K,L) Q = Output K = Capital L = LaborProduction with One Variable Input (Labor) Amount Amount Total Average Marginal of Labor (L) of Capital (K) Output (Q) Product ProductProduction with One Variable Input (Labor) 0 10 0 --- --- 1 10 10 10 10 2 10 30 15 20 3 10 60 20 30 4 10 80 20 20 5 10 95 19 15 6 10 108 18 13 7 10 112 16 4 8 10 112 14 0 9 10 108 12 -4 10 10 100 10 -8Total Product With additional workers, output or total product (Q, TP) increases, reaches a maximum, and then decreases.Total ProductMaximum ProductLabor per MonthOutput per Month60112023456789101Maximum ProductAverage ProductThe average product of labor (AP), or output per worker, increases and then decreases.Average ProductAP = slope of line from origin to a point on TPAP and TPLabor per MonthOutput per Month601120234567891AP and TPMarginal ProductMarginal ProductThe marginal product of labor (MP), or output of the additional worker, increases rapidly initially and then decreases and becomes negative.MP = slope of tangent to a point on TPMP and TPLabor per MonthOutput per Month601120234567891MP and TPThe Law of Diminishing Marginal ProductThe Law of Diminishing Marginal Product states that the marginal product (MP) of an input declines as the quantity of the input increases. When the input is small, MP increases due to specialization. When the input is large, MP decreases due to inefficiencies.The Law of Diminishing Marginal ProductMP and APMP and AP81020Output per Month02345679101Labor per Month30E: MP = AP and AP is at its maximum Left of E: MP > AP and AP is increasing Right of E: MP < AP and AP is decreasingTP, AP, and MPLabor per MonthOutput per Month60112023456791TP, AP, and MPWhen MP = 0, TP is at maximum When MP > AP, AP is increasing When MP < AP, AP is decreasing When MP = AP, AP is at maximumThe Effect of Technological ImprovementThe Effect of Technological ImprovementLabor per time periodOutput per time period50100023456789101ProductivityProductivityProductivity is the amount of goods and services produced from each hour of a worker’s time.Higher productivity ð Higher standard of livingMalthus and the Food CrisisMalthus predicted mass hunger and starvation as diminishing returns limited agricultural output and the population continued to grow. Why did Malthus’ prediction fail?Malthus and the Food CrisisIndex of World Food Consumption Per CapitaIndex of World Food Consumption Per Capita 1948-1952 100 1960 115 1970 123 1980 128 1990 137 1995 135 1998 140Year IndexLabor ProductivityLabor ProductivityIsoquantsIsoquantsThere is a relationship between production and productivity. Long-run production K& L are variable. Isoquants analyze and compare the different combinations of K & L and output.IsoquantsIsoquants Isoquants are curves that show all possible combinations of inputs that yield the same outputIsoquantsIsoquants1 20 40 55 65 75 2 40 60 75 85 90 3 55 75 90 100 105 4 65 85 100 110 115 5 75 90 105 115 120 Capital 1 2 3 4 5 InputLabor InputThe Isoquant MapThe Isoquant MapLabor per year1234123455Q1 = 55The isoquants are derived from the production function for output of of 55, 75, and 90.ADBQ2 = 75Q3 = 90CECapital per yearSubstituting among InputsManagers want to determine what combination if inputs to use. They must deal with the trade-off between inputs. The slope of each isoquant gives the trade-off between two inputs while keeping output constant.Substituting among InputsMarginal Rate of Technical SubstitutionMRTS is the rate at which one input is substituted for another along an isoquant.Marginal Rate of Technical SubstitutionMarginal Rate of Technical SubstitutionMarginal Rate of Technical SubstitutionLabor per month1234123455Capital per yearIsoquants are downward sloping and convex like indifference curves.Diminishing MRTSIncreasing labor in one unit increments from 1 to 5 results in a decreasing MRTS from 1 to 1/2. Diminishing MRTS occurs because of diminishing returns and implies isoquants are convex.Diminishing MRTSMRTS and Marginal ProductivityThe change in output from a change in labor equals:MRTS and Marginal ProductivityThe change in output from a change in capital equals:MRTS and Marginal ProductivityMRTS and Marginal ProductivityIf output is constant and labor is increased, then:Isoquants When Inputs are Perfectly SubstitutableIsoquants When Inputs are Perfectly SubstitutableLabor per monthCapital per monthPerfect SubstitutesWhen inputs are perfectly substitutable, the MRTS is constant at all points on the isoquant. For a given output, any combination of inputs can be chosen (A, B, or C) to generate the same level of output.Perfect SubstitutesFixed-Proportions Production FunctionFixed-Proportions Production FunctionLabor per monthCapital per monthIsocost LineIsocost Line The isocost line is one that shows all combinations of inputs that can be purchased for the same cost. Isocost LineIsocost LineAssume inputs are labor (L) and capital (K) and wage and capital price are w and r respectively, then:Isocost Line(C/r) = 40Isocost LineLabor (units)406080 = (C/w)201020300Capital (units)r = $2 w = $1 C = $80Isocosts and IsoquantsIsocosts and IsoquantsLabor per yearCapital per yearFor output Q1, point A is of least costIsocosts and IsoquantsIsocosts and IsoquantsTo maintain Q1, the minimum cost point shifts from A to B, which requires more cost than C1.C1K1L1AQ1If the price of labor increases, the isocost curve becomes steeper due to the change in the slope: -(w/r).Labor per yearCapital per yearMinimum Cost CombinationMinimum Cost CombinationMinimum Cost RuleMinimum Cost RuleThe minimum cost rule states that the cost of producing a specific level of output is minimized when the ratio of the marginal product of each input to the price of that input is the same for all inputs.Expansion PathA firm’s expansion path shows the minimum cost combinations of labor and capital at each level of output.Expansion PathExpansion PathExpansion PathLabor per yearCapital per year25507510015010050150300200Returns to ScaleReturns to ScaleThe returns to scale is the rate which output increases when all inputs are increased proportionately. If all the inputs double: the output is exactly doubled, that process is said to exhibit constant returns to scale. the output grows by less than 100 percent, the press shows decreasing returns to scale. the output more than doubles, the process demonstrates increasing returns to scale.Constant Returns to ScaleConstant Returns to ScaleLabor (hours)Capital (machine hours)Decreasing Returns to ScaleDecreasing Returns to ScaleLabor (hours)Capital (machine hours)0Increasing Returns to ScaleIncreasing Returns to ScaleLabor (hours)Capital (machine hours)0Business OrganizationsProprietorship Partnership CorporationBusiness OrganizationsAssignmentAssignmentReview Chapter 6 Answer questions on P122-123 Preview Chapter 7