CHAPTER 8 - CHAPTER 8. BEHIND THE SUPPLY CURVE: INPUTS AND...

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CHAPTER 8. BEHIND THE SUPPLY CURVE: INPUTS AND COSTS THE PRODUCTION FUNCTION The production function is a technical relationship between the quantity of inputs used and the quantity of output obtained. The production function indicates the maximum amount of output that can be obtained using a given amount of inputs. This relationship assumes that inputs are used in its most efficient way. In other words, a given production function summarizes the way in which a firm can “squeeze” the most out of its inputs. When we talk about production it is necessary to make a distinction between the short run and the long run. In the short run at least one input remains fixed . In the short run, for example, a firm can hire more workers, but cannot expand the area of the plant. On the other hand, in the long run NO input remains fixed. Two years from now, for example, a firm can work with more employees, more machines, and a larger plant. The short run and the long run are not measured by the calendar, but they rather depend on the type of industry. The long run for a small business can be a year, while for a nuclear plant can be 5 or 10 years. PRODUCTION IN THE SHORT RUN For the purpose of simplifying the analysis, in the short run we assume that only one input can be varied, and all other inputs remain fixed. For example, in the short run we analyze how the total product changes as we hire more employees while keeping the same number of machines as well as the same size of plant. Keeping everything else constant makes the analysis easier because any changes in total output can be attributed only to changes in the input that we assume variable. Here is an important concept that must be introduced: marginal productivity ( same as marginal product or marginal output). Marginal product is the additional output produced by one additional unit of input . Ex: A firm has 20 workers and they altogether produce 200 tons of cotton. If with an additional worker (the 21 st worker) total output goes up to 215 tons, then the marginal product of the last worker would be 15 tons. Sometimes the information about production does not come in increments of one worker. For example, you know that 15 workers produce 500 tons of corn, and 20 workers produce 600 tons of corn. In this case the marginal productivity of labor should be calculated as follows:
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MP L = Change in Total Product Change in the Number of Workers MP L = 600 - 500 20 - 15 MP L = 100 / 5 = 20 Production functions are increasing (more workers produce more) but the marginal product is decreasing (the marginal product of the 21 st worker is 15 tons, the marginal product of the 22 nd worker is 13 tons, the marginal product of the 23 rd worker is 10 tons, and so on). Thus, as you add workers the product increases at a decreasing rate. This property of the marginal product is known as diminishing marginal returns (in other texts also known as decreasing marginal productivity ). Why is the marginal product decreasing?
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This note was uploaded on 04/08/2008 for the course ECON 120 taught by Professor Serpa during the Spring '08 term at Ill. Chicago.

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CHAPTER 8 - CHAPTER 8. BEHIND THE SUPPLY CURVE: INPUTS AND...

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