Managerial Economics in a Global Economy, 5th EditionbyDominick SalvatoreChapter 6Production Theoryand Estimation

The Organization of ProductionInputsLabor, Capital, LandFixed InputsVariable InputsShort RunAt least one input is fixedLong RunAll inputs are variable

Production FunctionWith Two InputsQ = f(L, K)

Production FunctionWith Two InputsDiscrete Production Surface

Production FunctionWith Two InputsContinuous Production Surface

Production FunctionWith One Variable InputTotal ProductMarginal ProductAverage ProductProduction orOutput ElasticityTP = Q = f(L)

Production FunctionWith One Variable InputTotal, Marginal, and Average Product of Labor, and Output Elasticity

Production FunctionWith One Variable Input

Production FunctionWith One Variable Input

Optimal Use of theVariable InputMarginal RevenueProduct of LaborMRPL = (MPL)(MR)Marginal ResourceCost of LaborMRCL =Optimal Use of LaborMRPL = MRCL

Optimal Use of theVariable InputUse of Labor is Optimal When L = 3.50

Optimal Use of theVariable Input

Production With TwoVariable InputsIsoquants show combinations of two inputs that can produce the same level of output.Firms will only use combinations of two inputs that are in the economic region of production, which is defined by the portion of each isoquant that is negatively sloped.

Production With TwoVariable InputsIsoquants

Production With TwoVariable InputsEconomic Region of Production

Production With TwoVariable InputsMarginal Rate of Technical SubstitutionMRTS = -K/L = MPL/MPK

Production With TwoVariable InputsMRTS = -(-2.5/1) = 2.5

Production With TwoVariable InputsPerfect SubstitutesPerfect Complements

Optimal Combination of InputsIsocost lines represent all combinations of two inputs that a firm can purchase with the same total cost.

Optimal Combination of InputsIsocost LinesABC = $100, w = r = $10ABC = $140, w = r = $10ABC = $80, w = r = $10AB*C = $100, w = $5, r = $10

Optimal Combination of InputsMRTS = w/r

Optimal Combination of InputsEffect of a Change in Input Prices

Returns to ScaleProduction Function Q = f(L, K)Q = f(hL, hK)If = h, then f has constant returns to scale.If > h, then f has increasing returns to scale.If < h, the f has decreasing returns to scale.

Returns to ScaleConstant Returns to ScaleIncreasing Returns to ScaleDecreasing Returns to Scale

Empirical Production FunctionsCobb-Douglas Production FunctionQ = AKaLbEstimated using Natural Logarithmsln Q = ln A + a ln K + b ln L

Innovations and Global CompetitivenessProduct InnovationProcess InnovationProduct Cycle ModelJust-In-Time Production SystemCompetitive BenchmarkingComputer-Aided Design (CAD)Computer-Aided Manufacturing (CAM)