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Topic 02 - Production- Michael

# Topic 02 - Production- Michael - BUAD 350 Topic 02...

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BUAD 350 Topic 02 – Production

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Keywords The production function Productivity Marginal products of capital and labor Labor demand curve Capital demand curve Economic Profit
Motivation We want to understand how the economy works We are going to develop a mathematical model of the economy throughout the course, piece by piece The very first step is to create a model of firms, so we can understand production (i.e. GDP!)

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The Production Function Recall that a production function relates the amount of output that can be produced to the amount of inputs and the level of productivity General form: Y = A F(K, L) The inputs are called factors of production . e.g. A commonly used specification of the production function is the Cobb-Douglas (C-D) function.
The Production Function (contd.) The Cobb-Douglas production function is: Y = A K α L 1-α where α is a parameter, with 0< α < 1 Example: Choose α = 0.3 Y = A K 0.3 L 0.7 1% in K ( ceteris paribus ) will Y by 0.3% 1% in L will Y by 0.7% 1% in K and L will Y by (0.3 %+0.7 %=) 1%

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The Production Function (contd.) If doubling all inputs doubles output, the production function is said to exhibit constant returns to scale (CRS) If output less than doubles, production is said to be decreasing returns, and if it more than doubles, increasing returns The C-D function exhibits constant returns
Figure 3.1 The Production Function Relating Output and Capital

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The Production Function (contd.) “K”, “L”, and “Y” can be in any convenient units, since “A” can chosen to be in the right unit to connect the three “L” can be raw labor hours, especially if “A” includes labor quality, or “L” can be effective labor hours, adjusted for labor quality (a.k.a. human capital) It is common to take “K” and “L” as raw quantities and factor quality into “A”
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Topic 02 - Production- Michael - BUAD 350 Topic 02...

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