ME11--Ch. 8
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Transcript of ME11--Ch. 8
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MANAGERIALMANAGERIAL
ECONOMICS 11ECONOMICS 11thth EditionEdition
ByBy
Mark HirscheyMark Hirschey
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Production Analysis andProduction Analysis and
Compensation PolicyCompensation PolicyChapter 8Chapter 8
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Chapter8Chapter8
OVERVIEWOVERVIEW Production Functions
Total, Marginal, and Average Product
Law of Diminishing Returns to a Factor
InputCombination Choice
Marginal Revenue Product and Optimal Employment
Optimal Combination of Multiple Inputs
Optimal Levels of Multiple Inputs
Returns to Scale
Production Function Estimation
Productivity Measurement
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Chapter8 KEY CONCEPTSChapter8 KEY CONCEPTS
production function
discrete production function
continuous production function
returns to scale
returns to a factor
total product
marginal product
average product
law of diminishing returns isoquant
technical efficiency
input substitution
marginal rate of technical
ridge lines marginal revenue product economic efficiency net marginal revenue
isocost curve (or budget line) constant returns to scale expansion path increasing returns to scale decreasing returns to scale output elasticity power production function productivity growth labor productivity multifactor productivity
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Production Functions
Properties ofProduction Functions
Production functions are determined by
technology, equipment and input prices. Discrete production functions are lumpy.
Continuous production functions employ
inputs in small increments.
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Returns to Scale and Returns to a
Factor Returns to scale measure output effect of
increasing all inputs.
Returns to a factor measure output effectof increasing one input.
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Total, Marginal, and Average
Product Total Product
Total product is total output.
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Marginal Product
Marginal product is the change in outputcaused by increasing input use.
If MPX=Q/X> 0, total product is rising.
If MPX=Q/X< 0, total product is falling(rare).
Average product
APX=Q/X.
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Law of Diminishing Returns to a
Factor Diminishing Returns to a Factor Concept
MPX tends to diminish as Xuse grows.
If MPX grew with use ofX, there would be nolimit to input usage.
MPX< 0 implies irrational input use (rare).
Illustration of Diminishing Returns to a
Factor
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Input Combination Choice
Production Isoquants
Technical efficiency is least-cost production.
Input Factor Substitution Isoquant shape shows input substitutability.
C-shaped isoquants are common and implyimperfect substitutability.
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Marginal Rate ofTechnical
Substitution MRTSXY=-MPX/MPY
Rational Limits of Input Substitution
MPX
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Marginal Revenue Product and
Optimal Employment Marginal Revenue Product
MRPL is the revenue gain after all variablecosts except labor costs.
MRPL= MPL x MRQ=TR/L.
Optimal Level of a Single Input
Set MRPL=PL to get optimal employment.
Illustration of Optimal Employment
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Optimal Combination of Multiple
Inputs Budget Lines
Least-cost production occurs when MPX/PX= MPY/PYand PX/PY= MPX/MPY
Expansion Path Shows efficient input combinations as output grows.
Illustration of Optimal InputProportions
Input proportions are optimal when no additionaloutput could be produce for the same cost.
Optimal input proportions is a necessary but notsufficient condition for profit maximization.
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Optimal Levels of Multiple Inputs
Optimal Employment and ProfitMaximization
Profits are maximized when MR
PX=
PX for allinputs.
Profit maximization requires optimal inputproportions plus an optimal level of output.
Illustration of Optimal Levels of MultipleInputs
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Returns to Scale
Evaluating Returns to Scale Returns to scale show the output effect of increasing
all inputs.
Output Elasticity and Returns to Scale Output elasticity is Q =Q/Q Xi/Xi where Xi is
all inputs (labor, capital, etc.)
Q> 1 implies increasing returns.
Q=
1 implies constant returns. Q< 1 implies decreasing returns.
Returns to Scale Estimation
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Production Function Estimation
Cubic Production Functions
Display variable returns to scale.
First increasing, then decreasing returns arecommon.
Power Production Functions
Allow marginal productivity of each input to
vary with employment of all inputs.
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Productivity Measurement
How Is Productivity Measured?
Productivity measurement is the responsibility of theBureau of Labor Statistics (since 1800s).
Productivity growth is the rate of change in outputper unit of input.
Labor productivity is the change in output per workerhour.
Uses and Limitations ofProductivity DataData Quality changes make productivity measurementQuality changes make productivity measurement
difficult.difficult.
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