Production Analysis and Compensation
Policy
Production function:
Production function is an equation showing the maximum output that a
firm can produce per period of time with each set of inputs.
Thus the general equation of this simple production function is :-
Q = f (X, Y)
Q=no. of commodity produced
input X & Y= represent the resources
such as labor, capital or energy and raw
materials
Discrete production functions- production function
with distinct input patterns or lumpy patterns input
combination.
Continuous production functions- Production function
where inputs can be varied in unbroken marginal function.
Returns to scale- output effect of increasing in all
inputs.
Returns to a factor- relationship between output and
variation in only one output.
Total product (TP): The total amount of output resulting
from a given production function.
Marginal product of a factor of production is defined as
change in output resulting from a very small change in
one factor input, keeping the other factor inputs constant.
MPL = dQ/dL
Average productivity of a factor of production is defined
as the total productivity divided by its quantity
APL = Q/L
Law of diminishing returns:
As the quantity of a variable input increases the resulting
rate of output increases eventually diminishes
Isoquants
The word isoquant is derived from the Greek word iso,
meaning equal. Hence it represents equal in
quantity.
In economics, isoquant is used to represent those set of
input combinations that give the same output.
Properties of Isoquants
Two isoquants can never cross. Since each isoquant refers to a
specific level of output, no two isoquants intersect, for such an
intersection would indicate that the same combination of resources
could, with equal efficiency, produce two different amounts of
output.
Every possible combination of inputs is on an isoquant.
Isoquants further from the origin represent greater output levels
Isoquants slope down to the right. Consider the capital vs. labor
isoquant. In any practical situation, the quantity of labor employed
is inversely related to the quantity of capital employed, so
isoquants have negative slopes.
Isoquants are usually convex to the origin, meaning that the slope
of the isoquant gets flatter down along the curve.
Technical Efficiency
Least-cost production of target level of output
Input Substitution
Systematic replacement of productive factors
Marginal Rate of technical Substitution
The firm has the ability to substitute between the two
different inputs at will in order to produce the same level
of output.
The slope of an isoquant gives us the marginal rate of
technical substitution (MRTS)
MRTSXY = -Y / X
MRTSLK indicates the rate at which additional units of labour
(L) can be substituted for fewer units of capital (K) while
keeping output constant.
MRTS Example
Following graph shows the isoquant for making 4 units of
output
MRTSA = - (8 4) / (4 2)
=-2
A
MRTSB = - (4 2) / (8 4)
B
= - 0.5
Ridge Line
Graphic bounds for
positive marginal
products
Marginal Revenue Product
MRPL is the revenue gain after all variable costs except
labor costs.
MRP=
=MPx MRq
Optimal Level of a Single Input
MCL = MRL
PL= MPL MRQ= MRPL
Economic Efficiency
Achieved when all firms equate input marginal revenue
product and marginal cost ( maximize profits ).
Net Marginal Revenue
Marginal revenue after all variable cost.
Budget Line
Budget
line is a graphical
representation of all possible
combinations of two goods which
can be purchased with given
income and prices, such that the
cost of each of these combinations
is equal to the money income of the
consumer. Alternately, Budget Line
is locus of different combinations of
the two goods which the consumer
consumes and which cost exactly
his income.
B=PX X + PY Y
Expansion Path
Optimal input
combinations as the
scale of production
expands.
Increasing Returns to Scale
When the proportional increase in output is larger than
the underlying proportional increase in input.
Constant Returns to Scale
When a given percentage increase in all inputs leads to
an identical percentage increase in output.
Decreasing Returns to Scale
When the output increase at a rate less than the
proportionate increase in inputs.
Output Elasticity
Percentage change in output associated with 1 percent
change in all outputs.
Power Production Function
Multiplicative relation between input and output.
Productivity Growth
Rate increase in output per unit of input.
Efficiency Gains
Improvements in how well labor and capital are used
Capital Deepening
Growth in the amount of capital that workers have
available for use.
Productivity Growth Jumped in the Late 1990s
