THEORY OF PRODUCTION-2 - THEORY OF PRODUCTION Production...

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THEORY OF PRODUCTION
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Production theory forms the foundation for the theory of supply Managerial decision making involves four types of production decisions: 1.Whether to produce or to shut down 2.How much output to produce 3.What input combination to use 4.What type of technology to use
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Production involves transformation of inputs such as capital, equipment, labor, and land into output - goods and services Production theory can be divided into short run theory or long run theory.
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Long run and short run: The Long Run is distinguished from the short run by being a period of time long enough for all inputs, or factors of production, to be variable as far as an individual firm is concerned The Short Run , on the other hand, is a period so brief that the amount of at least one input is fixed The length of time necessary for all inputs to be variable may differ according to the nature of the industry and the structure of a firm
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Production Function A production function is a table or a mathematical equation showing the maximum amount of output that can be produced from any specified set of inputs, given the existing technology. The total product curve for different technology is given below. x Q Q = output x = inputs
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Production Function continued Q = f(X 1 , X 2 , …, X k ) where Q = output X 1 , …, X k = inputs For our current analysis, let’s reduce the inputs to two, capital (K) and labor (L): Q = f(L, K)
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DEFINITIONS: In the short run, capital is held constant. Average product is total product divided by the number of units of the input Marginal product is the addition to total product attributable to one unit of variable input to the production process fixed input remaining unchanged. MP = TP N – TP N-1
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Short run labour Total product Average product Marginal product 1 10 10 10 2 24 12 14 3 39 13 15 4 52 13 13 5 61 12.2 9 6 66 11 5 7 66 9.4 0 8 64 8 -2
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Marginal and Average product: Marginal product at any point is the slope of the total product curve Average product is the slope of the line joining the point on the total product curve to the origin. When Average product is maximum, the slope of the line joining the point to the origin is also tangent to it.
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P: Maximum Average Product Q & R : Same Average Product
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Both AP and MP first rise, reach a maximum and then fall. MP = AP when AP is maximum. MP may be negative if Variable input is used too intensively. Law of diminishing marginal productivity states that in the short run if one input is fixed, the marginal product of the variable input eventually starts falling
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Law of Diminishing Returns (Diminishing Marginal Product) Holding all factors constant except one , the law of diminishing returns says that: As additional units of a variable input are combined with a fixed input, at some point the additional output (i.e., marginal product) starts to diminish e.g. trying to increase labor input without also increasing capital will bring diminishing returns
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Three stages of production: Stage 1: Till average product becomes maximum Stage 2: till MP =zero Stage 3: MP is negative
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Three Stages of Production in Short Run AP,MP X Stage I Stage II Stage III AP X MP X
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Long run production: Section 2:
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