Firms and Production

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.

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.
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
11
6
4
0
L
, Workers per day
AP
,
MP
L
L
a
20
b
15
Average product,
AP
L
Marginal product,
MP
L
c
11
6
4
0
Source Perloff
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.
a
6
b
3
f
c
e
2
q
35
d
1
q
24
q
14
Source Perloff
L
, Workers per day
6
3
2
1
0
8
Properties of Isoquants

• Further from the originhigher output
• Cannot cross
• Slope downward
• Convex to the origin

Source Perloff
9
Substitutability of inputs 1
y
, Dutch potatoes
per day
q
3
q
2
q
1
x
, British potatoes per day
Source Perloff
10
Substitutability of inputs 2
Boxes
per day
q
3
q
2
q
1
45

line
Cereal per day
Source Perloff
11
Marginal rate of technical substitution
K
, Units of
capital per year
a
39


D
K


18
b
21

D
L


1

7
c
14
1

4
d
10
e

2
1
8
q
10
1
Source Perloff
6
3
4
5
2
0
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
Increasing returns to scale
Decreasing returns to scale
15
Example Thread Mill ab0.82
K
, Units of
capital per year
600
q
200
q
177
q

100
500
400
300
200
100
500
400
300
200
100
450
350
250
150
50
0
Source Perloff
L
, Units of labor per year
16
Varying Scale Economies
K
, 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
?
4
1
2
8
L
, Work hours per year
0
Source Perloff
17
Technical Progress
An increase in the volume of output produced with
the same volume of inputs.
18
Neutral technical progress
K
, Units of
capital per year
39
21
14
10
8
Source Perloff
6
3
4
5
2
0
L
, Workers per day
19
Non-neutral technical progress
K
, Units of
Results in the substitution of one input for
another.
39
21
14
10
8
Source Perloff
6
3
4
5
2
0
L
, Workers per day