basic production economics deffinitions aec 303_Page_6

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Unformatted text preview: APP reaches a maximum at an input level greater than the level of input use that maximizes MPP. This point can be found by drawing a line out of the origin with a constant slope that just touches (becomes tangent to) the production function. This point of tangency illustrates the level of input use for which the ratio of y/x that represents APP is greatest. The slope of this line is the maximum possible ratio of y to x. Before this point, APP is increasing: After this point, APP is declining. Unlike MPP, APP never becomes negative because the smallest output (y or TPP) can become is zero. Therefore the ratio of y/x can become no smaller than zero, since x is nonnegative (no negative pounds of fertilizer or bushels of corn!) APP intersects MPP from above at the same input quantity that maximizes MPP. More input (x) is required for maximum APP than for maximum MPP. When MPP is greater than APP, APP is increasing. When APP is declining, MPP is also declining. When MPP is negative, APP is still positive. The elasticity of production measures the responsiveness of the output to changes in the level of the input use. The elasticity of production is the percentage change in output (y) divided by the percentage change in input (x). Like other elasticities, the elasticity of production is a pure number that has no units. For example, an elasticity of production of 0.5 indicates that a one percent increase in input use will be accompanied by one-half of one percent increase in output. Another way of defining the elasticity of production is as the ratio of MPP/APP. If the elasticity of production is greater then 1, a 1 percent increase in input use will result in greater than a 1 percent increase in output. Hence, if the elasticity of production is greater than one, MPP must be greater than APP. If the elasticity of production is less than one, a 1 percent increase in input use will result in less than a 1 percent increase in output. Hence, this is the region where MPP is less than APP. When MPP equals APP, a 1 percent increase in input results in exactly a 1 percent increase in output. When MPP is zero, the elasticity of production is also zero. When MPP is negative, the elasticity of production is also negative, indicating that additional input will cause output (y, TPP) to decline. Finding the quantity of input required to maximize profits requires a number of assumptions. These assumptions are: 1. The producer can purchase as much or as little ' input as is needed at a constant price. (Two implications of this assumption are no "quantity discounts," and the producer does not need to increase wages paid in order to obtain more workers.) 2. The output price is constant and known with certainty. (The price might be "locked in" using the futures market. The individual producers are not "big enou " to individually affect the market price by individual output decisions.) 3. The production fimction is known with certainty. (Droughts and disease do not occur. The fannerknows exactly how much corn will be produced from each incremental pound of fertilizer. This assumption is not very realistic for agriculture.)Profit (H) is total revenue (TR) less total cost (TC). Total revenue may be obtained by multiplying the price of the product (y) by the quantity produced. Output and input are linked through the production function y = f(x). Total value of the product (T VP) is total physical product (TPP or y) multiplied by the price of the product. Another way of writing total value of the product 6 ...
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