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Unformatted text preview: CHAPTER 6 - PRODUCTION CASE STUDY: Office equipment company uses its salesforce of 18 to find new customers, renew existing contracts, and capture customers from rivals. Production Issue: How to allocate salesforce efficiently to maximize/increase total sales. Production and cost are closely linked, since more (less) efficient production decreases (increases) a firm's cost of production. Production goal : Produce a given output (Q S ) at the minimum cost, i.e. maximize output and minimize inputs. PRODUCTION TECHNOLOGY Production is the process of transforming inputs (factors of production) into outputs (goods and services). Example: GM produces vehicles from raw materials, parts, labor, capital equipment, land, financial capital, electricity, etc. Production function: Q S = f (M, L, K), where M = materials L = labor K = capital Example: GM plans to produce 3m vehicles (Q) using materials (M = $15B), capital (K = $10B), and labor (L = 80,000 workers). The output goal of Q = 3m could be achieved with various other combinations of M, K and L. How? Firm's production function typically assumes: a) profit maximization and b) technical efficiency (state- of-the-art production) at a given point in time, i.e. no waste. With advances in technology over time, the production function will change. Pursuit of profits will lead to increased efficiency in production. Production Function for Auto Parts, p. 217-219. Q S = f (L and K), where L = # workers, and K = plant size. Firm has no choice over materials in the short-run (SR), because each part requires a fixed amount of raw materials, but it can vary number of workers (L) and plant size (K) in SR to produce various levels of Q. See Production Function in Table 6.1 (p. 217), where the numerical values are: parts (Q) per day, as a function of L (workers) and K (plant size). PRODUCTION WITH ONE VARIABLE INPUT Long run: Period long enough for a firm to vary ALL of its inputs (M, L, K), make major expansions OR contractions in output. Exact time for LR varies by industry, could be 6 months to 5 years, depending on how long it takes to make a MAJOR change in Q. Example : building a new Starbucks or Wal-Mart versus a new car factory or sports stadium or mall. ECN 469: Managerial Economics Professor Mark J. Perry 1 Short Run: Period of time during which one or more inputs is FIXED, so there is no (or limited) production flexibility. Examples: Long-term labor contract makes L fixed in SR. Time-to-build (or contract/shrink output) makes K fixed in SR. Marginal Product (MP) of a Variable Input: Total Product = Q, and Q = f (L) or Q = f (K), ceteris paribus. MP L = TP / L = Q / L; or MP K = TP / K = Q / K. (Note: TP = Q) Example: Holding M and K (plant size) constant, we vary ONE INPUT (L) and determine the change in TP (Q) with a one-unit change in L = MP L ....
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- Fall '11