Comm220 Ch 6 - CHAPTER 6 PRODUCTION Key Concepts and Topics...

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Source: Pindyck and Rubinfeld (2009), Microeconomics , 7 th Ed., Pearson Prentice Hall, Chapter 6. 1 CHAPTER 6 – PRODUCTION Key Concepts and Topics The Technology of Production Production with One Variable Input (Labor) Isoquants Production with Two Variable Inputs Returns to Scale Introduction Theory of the firm Explains how a firm makes cost-minimizing production decisions and how its costs vary with output . Costs of production change with changes in both input prices and level of output Production Decisions of a Firm Production decisions of a firm can be broken down into three steps: 1. Production Technology 2. Cost Constraints 3. Input Choices Production Technology Describe how inputs can be transformed into outputs Inputs : land, labor, capital and raw materials Outputs : cars, desks, books, etc. Firms can produce different amounts of outputs using different combinations of inputs Cost Constraints Firms must consider prices of labor, capital and other inputs Firms want to minimize total production costs partly determined by input prices Firms must be concerned about costs of production Input Choices Given input prices and production technology, the firm must choose how much of each input to use in producing output
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Source: Pindyck and Rubinfeld (2009), Microeconomics , 7 th Ed., Pearson Prentice Hall, Chapter 6. 2 Given prices of different inputs, the firm may choose different combinations of inputs to minimize costs If labor is cheap , may choose to produce with more labor and less capital If a firm’s costs of production are at its minimization , we can study How total costs of production varies with output How does the firm choose the quantity to maximize its profits We can represent the firm’s production technology in the form of a production function The Technology of Production Production Function Describes the maximum output ( q ) that a firm can produce for every specified combination of inputs at a given state of technology For simplicity, we will consider only labor ( L ) and capital ( K ) Shows what is technically feasible when the firm operates efficiently The production function for two inputs: q = F(K,L) Output ( q ) is a function of capital ( K ) and labor ( L ) Both inputs and output are flows The production function is true for a given technology If technology increases, more output can be produced for a given level of inputs Short Run versus Long Run It takes time for a firm to adjust production from one set of inputs to another Firms must consider not only what inputs can be varied but over what period of time that can occur We must distinguish between long run and short run Short run and long run are not time specific Short Run Period of time in which at least one of the inputs is fixed For example, when K is fixed , firms vary the intensity with which they utilize a given plant and machinery Long-run
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