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9 Pages

### CHAPTER 06

Course: ECON 105, Spring 2011
School: Indian School of Business
Rating:

Word Count: 847

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PINDYCK PHALL-82241 CHAPTER 06 page 4 of 12 FIGURE 6.1 Production with One Variable Input Output per month D 112 C Total Product B 60 A 0 1 2 3 4 5 6 7 8 9 10 Labor per Month (a) 30 Output per worker 20 per month E Average Product 10 Marginal Product 0 1 2 3 4 5 6 (b) 7 8 9 Labor per month The total product curve in (a) shows the output produced for different amounts of labor...

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PINDYCK PHALL-82241 CHAPTER 06 page 4 of 12 FIGURE 6.1 Production with One Variable Input Output per month D 112 C Total Product B 60 A 0 1 2 3 4 5 6 7 8 9 10 Labor per Month (a) 30 Output per worker 20 per month E Average Product 10 Marginal Product 0 1 2 3 4 5 6 (b) 7 8 9 Labor per month The total product curve in (a) shows the output produced for different amounts of labor input. The average and marginal products in (b) can be obtained (using the data in Table 6.1) from the total product curve. At point A in (a), the marginal product is 20 because the tangent to the total product curve has a slope of 20. At point B in (a) the average product of labor is 20, which is the slope of the line from the origin to B. The average product of labor at point C in (a) is given by the slope of the line 0C. To the left of point E in (b), the marginal product is above the average product and the average is increasing; to the right of E, the marginal product is below the average product and the average is decreasing. As a result, E represents the point at which the average and marginal products are equal, when the average product reaches its maximum. Fig 06-01.EPS 10 PHALL-82241 PINDYCK CHAPTER 06 page 5 of 12 FIGURE 6.2 The Effect of Technological Improvement Output per time period C O3 100 B A O2 50 O1 0 1 2 3 4 5 6 7 8 9 10 Labor per time period Labor productivity (output per unit of labor) can increase if there are improvements in technology, even though any given production process exhibits diminishing returns to labor. As we move from point A on curve O1 to B on curve O2 to C on curve O3 over time, labor productivity increases. Fig 06-02.EPS PHALL-82241 PINDYCK CHAPTER 06 page 6 of 12 FIGURE 6.3 Cereal Yields and the World Price of Food 350 3.6 3.4 Food price index (1990 = 100) 3.2 Cereal Yield 3 250 2.8 200 2.6 2.4 150 Food Price Index 2.2 2 100 1.8 50 1.6 1970 1975 1980 1985 1990 1995 2000 2005 Cereal yields have increased. The average world price of food increased temporarily in the early 1970s but has declined since. Fig 06-03.EPS Cereal yields (metric tons per hectare) 300 PHALL-82241 PINDYCK CHAPTER 06 page 7 of 12 FIGURE 6.4 Production with Two Variable Inputs Capital per year E 5 4 3 A B C q3 90 2 q2 75 D 1 q1 55 1 2 3 4 5 Labor per year Production isoquants show the various combinations of inputs necessary for the firm to produce a given output. Aset of isoquants, or isoquant map, describes the firms production function. Output increases as we move from isoquant q1 (at which 55 units per year are produced at points such as A and D), to isoquant q2 (75 units per year at points such as and B) to isoquant q3 (90 units per year at points such as C and E). Fig 06-04.EPS PHALL-82241 PINDYCK CHAPTER 06 page 8 of 12 FIGURE 6.5 Marginal Rate of Technical Substitution Capital per year 5 K = 2 4 L = 1 3 K = 1 K = 2 3 2 L = 1 L = 1 q3 = 90 1 K = 3 1 q2 = 75 L = 1 q1 = 55 0 1 2 3 4 5 Labor per year Like indifference curves, isoquants are downward sloping and convex. The slope of the isoquant at any point measures the marginal rate of technical substitution-the ability of the firm to replace capital with labor while maintaining the same level of output. On isoquant q2, the MRTS falls from 2 to 1 to 2/3 to 1/3. Fig 06-05.EPS PHALL-82241 PINDYCK CHAPTER 06 page 9 of 12 FIGURE 6.6 Isoquants When Inputs Are Perfect Substitutes Capital per year A B C q1 q2 q3 Labor per year When the isoquants are straight lines, the MRTS is constant. Thus the rate at which capital and labor can be substituted for each other is the same no matter what level of inputs is being used. Points A, B, and C represent three different capital-labor combinations that generate the same output q3. Fig 06-06.EPS PHALL-82241 PINDYCK CHAPTER 06 page 10 of 12 FIGURE 6.7 Fixed-Proportions Production Function Capital per year q3 C q2 B K1 A L1 q1 Labor per year When the isoquants are L-shaped, only one combination of labor and capital can be used to produce a given output (as at point A on isoquant q1, point B on isoquant q2, and point C on isoquant q3). Adding more labor alone does not increase output, nor does adding more capital alone. Fig 06-07.EPS PHALL-82241 PINDYCK CHAPTER 06 page 11 of 12 FIGURE 6.8 Isoquant Describing the Production of Wheat Capital (machine hours per year) 120 A 100 K = 10 90 B 80 Output = 13,800 Bushels per Year L = 260 40 250 500 760 1000 Labor (hours per year) A wheat output of 13,800 bushels per year can be produced with different combinations of labor and capital. The more capital-intensive production process is shown as point A, the more labor-intensive process as point B. The marginal rate of technical substitution between A and B is 10/260 = 0.04. Fig 06-08.EPS PHALL-82241 PINDYCK CHAPTER 06 page 12 of 12 FIGURE 6.9 Returns to Scale Capital (machine hours) Capital (machine hours) A A 6 30 4 20 4 2 30 2 20 10 0 5 10 (a) 10 15 Labor (hours) 0 5 10 Labor (hours) (b) When a firms production process exhibits constant returns to scale as shown by a movement along line 0A in part (a), the isoquants are equally spaced as output increases proportionally. However, when there are increasing returns to scale as shown in (b), the isoquants move closer together as inputs are increased along the line. Fig 06-09.EPS
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