Unit 2 prodn

Producer Equilibrium

A firm or an organization is an economic unit that converts inputs (labor, materials, and capital) into outputs (goods and services) by employing various factors of production.

It carries out the following functions:1.Employment of FOP2.Production of goods and services3.Profit maximisation

Also called as Inputs, refers to the resources consisting of land, labour, capital, technology, information, organization etc… which are collectively employed in the process of

manufacturing a specific product or delivering a defined service.

Products 1. Tangible 2. Durable3. Homogeneous4. Consumption can

be postponed

Services 1. Intangible 2. Non durable3. Heterogeneous 4. Simultaneous

production & consumption

Once the product decision is taken, producer has to look at main major areas pertaining to production. They are:

1.Quantity of output2.Optimal combination of inputs for a

specified level of output. In order to do the above mentioned, a

producer has to define the production function & optimal input employment rate.

production process: transform inputs or factors of production into outputs

common types of inputs:• capital (K): buildings and equipment• labor services (L)• materials (M): raw goods• Orgnisiation: organising various fop in one place for the purpose of producing products .

It explains the functional relationship between quantities of inputs used and maximum quantity of output that can be produced, given current knowledge about technology and organization.

Note: We assume in our discussion that the

producer employs only two factors of production, usually labor or capital.

In simple words, firm’s production function for a particular good (q) shows the maximum amount of the good that can be produced using alternative combinations of capital (k) and labor (l)

a production function that uses only labor and capital:

q = f (L, K, A, M, T…) to produce the maximum amount of

output given efficient production.Here, q is quantity of output f denotes the functional relationship

L denotes unit of Labor K denotes unit of capital A denotes unit of land M denotes management or organising T denotes Technology

Shows max level of output that can be produced by employing one and all input combinations.

It defines max level of output for all or any combination of inputs.

It does not tell about the least cost combination.

It does not trace out the profit max output levels.

5 500 1000 1500 2000 2500

4 400 800 1200 1600 2000

3 300 600 900 1200 1500

2 200 400 600 800 1000

1 100 200 300 400 500

0 1 2 3 4 5

CAPITAL

RATE OF LABOR

one of the most widely estimated production functions is the Cobb-Douglas:

q = AL K

A, , are positive constants Q is the quantity of output K & L are units of Capital & LaborEg: Q = 100L K

Cobb-Douglas production function helps in taking decision on method of prodn:

1.Labor intensive 2.Capital intensive Eg: from the table it is evident that 1L &

5C or 5L & 1C gives 500 units of output. The decision on the method depends on

the cost of production. Least cost combination is the tool to take

production decision.

Explains the relationship between the factors of production (land, labor, capital, entrepreneurs) and output of goods and services.

Short run – change in one input & other units are kept constant due to less time

Long run – change in more or all variables or inputs i:e land & capital

This is a short run production theory. Here, only one input is made variable

and all other inputs are constant. This is so because, short run does not

allow many factors to get altered.Assumptions:1.Short run2.Constant technology3.Homogeneous - marginal product

The Law is defined as proportion of one factor in a combination of factors is increased, marginal & average outputs will increase then after a point, first marginal and then average output will diminish”.

It explains how total & marginal output is affected by change in one input keeping other inputs constant.

NO OF MACHINE

NO OF WORKERS

TOTAL PRODUCTION

AVERAGE PRODUCTION

MARGINAL PRODUCTION

1 1 8 8 8

1 2 20 10 12

1 3 36 12 16

1 4 48 12 12

1 5 55 11 8

1 6 60 10 5

1 7 60 8.6 0

1 8 56 7 - 4

NO OF WORKERS

TOTAL PRODUCTION

AVERAGE PRODUCTION

MARGINAL PRODUCTION

STAGES OF PRODUCTION

1 8 8 8 I stage

2 20 10 12 I

3 36 12 16 I

4 48 12 12 II stage

5 55 11 8 II

6 60 10 5 II

7 60 8.6 0 III stage

8 56 7 - 4 III

Stage I – Increasing returns output rises at an increasingly faster rate

(each new worker makes more than the previous worker did)

Stage II – Diminishing returns output rises at a diminishing rate (each

new worker increases output, but not as much as the previous worker did)

Stage III – Negative returns output decreases as each new worker is

added

no of aircraft taking part in bombing mission and destruction sought.

no of guns allotted to neutralise a target and effect achieved.

amount of time allocated to training and standards achieved.

no of men allocated to a task and output.

in short, in situations where one factor is increased, while others remain constant.

Measures the change in output for a proportionate change in both inputs.

It deals with effect on output, when all inputs change simultaneously in same ratio - double, treble etc…

Returns to scale can be:1.Increasing 2.Constant 3.Decreasing

explains how output changes if all inputs are increased by equal proportions

how much does output change if a firm increases all its inputs proportionately?

answer to this question helps a firm to determine its scale or size in LR

FACTORS OF PRODN EMP TOTAL PRODUCTS/RETURNS

MARGINAL PRODUCT/

RETURNS

STAGE OF RETURN TO SCALE

FACTORS OF PRODN EMP TOTAL PRODUCTS/RETURNS

MARGINAL PRODUCT/

RETURNS

STAGE OF RETURN TO SCALE

1 WORKER+3 hrs

FACTORS OF PRODN EMP TOTAL PRODUCTS/RETURNS

MARGINAL PRODUCT/

RETURNS

STAGE OF RETURN TO SCALE

1 WORKER+3 hrs

2 WORKERS + 6 hrs

FACTORS OF PRODN EMP TOTAL PRODUCTS/RETURNS

MARGINAL PRODUCT/

RETURNS

STAGE OF RETURN TO SCALE

1 WORKER+3 hrs

2 WORKERS + 6 hrs

3 WORKERS + 9hrs

4 WORKERS+ 12 hrs

5 WORKERS +15 hrs

6 WORKERS + 18 hrs.

7 WORKERS + 21 hrs

8 WORKERS + 24 hrs

9 WORKERS + 27 hrs

FACTORS OF PRODN EMP TOTAL PRODUCTS/RETURNS

MARGINAL PRODUCT/

RETURNS

STAGE OF RETURN TO SCALE

1 WORKER+3 hrs 200

2 WORKERS + 6 hrs 500

3 WORKERS + 9hrs 900

4 WORKERS+ 12 hrs 1400

5 WORKERS +15 hrs 1900

6 WORKERS + 18 hrs. 2400

7 WORKERS + 21 hrs 2800

8 WORKERS + 24 hrs 3100

9 WORKERS + 27 hrs 3200

FACTORS OF PRODN EMP TOTAL PRODUCTS/RETURNS

MARGINAL PRODUCT/

RETURNS

STAGE OF RETURN TO SCALE

1 WORKER+3 hrs 200 200

2 WORKERS + 6 hrs 500 300

3 WORKERS + 9hrs 900 400

4 WORKERS+ 12 hrs 1400 500

5 WORKERS +15 hrs 1900 500

6 WORKERS + 18 hrs. 2400 500

7 WORKERS + 21 hrs 2800 400

8 WORKERS + 24 hrs 3100 300

9 WORKERS + 27 hrs 3200 100

FACTORS OF PRODN EMP TOTAL PRODUCTS/RETURNS

MARGINAL PRODUCT/

RETURNS

STAGE OF RETURN TO SCALE

1 WORKER+3 hrs 200 200 STAGE OF INCREASING RETURNS

2 WORKERS + 6 hrs 500 300

3 WORKERS + 9hrs 900 400

4 WORKERS+ 12 hrs 1400 500

5 WORKERS +15 hrs 1900 500 STAGE OF CONSTANT RETURNS

6 WORKERS + 18 hrs. 2400 500

7 WORKERS + 21 hrs 2800 400 STAGE OF DECREASING RETURNS

8 WORKERS + 24 hrs 3100 300

9 WORKERS + 27 hrs 3200 100

STAGE 1

STAGE 3

STAGE 2

1 2 3 4 5 6 7 8 9 10 11

marginal

output

no of composite units of factors of production

4

3

2

1

0

6

5

MARGINAL PRODUCT CURVE

OPTIMAL POINT IN

EMPLOYMENT OF FACTORS

curve that shows efficient combinations of labor and capital that can produce a single or equal (iso) level of output (quantity).

Iso cost on the other hand, describes the various combinations of capital and labor inputs that can be employed at a given cost limit.

It can be expressed as:C= RK + WL, where C is the cost, R is the

rate of interest, K is the capital, W is wage rate, L is the labor unit.

1 2 3 4 5 6

4

3

2

1

0

DIFFERENT ISOQUANT FOR

DIFFERENT OUTPUTS

LABOR

CAPITAL

0 20 40 60 80 100

100

80

60

40

20

0

XX

YY YY11

VARIOUS COMBINATIONS OF

INPUTS AT A GIVEN BUDGET

1. Further an isoquant is from the

origin, the greater is the level of output

2. Isoquants do not cross 3. Isoquants slope down 4. Convex in nature5. Never intersect each other.

We can find a producer at his equilibrium at the point of intersection between isoquant curve and the isocost line.

Expansion path is the set of combinations of inputs that meet the equilibrium condition.

0 20 40 60 80 100

100

80

60

40

20

0

E1E

A

BD

39

An Expansion Path

L

K

TC0/w TC1/w TC2/w

TC2/r

TC1/r

TC0/r

Isoquant Q = Q0••

•

Expansion path, normal inputs