6

CHAPTER
Production
 CHAPTER 3 OUTLINE

6.1 The Technology of Production

6.2 Production with One Variable Input (Labor)

6.3 Production with Two Variable Inputs

6.4 Returns to Scale

Chapter 6: Production

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 Production

The theory of the firm describes how a firm makes cost-

minimizing production decisions and how the firm’s
resulting cost varies with its output.

The Production Decisions of a Firm

The production decisions of firms are analogous to the

purchasing decisions of consumers, and can likewise be
understood in three steps:
1. Production Technology
2. Cost Constraints
Chapter 6: Production

3. Input Choices

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 6.1 THE TECHNOLOGY OF PRODUCTION

● factors of production Inputs into the production

process (e.g., labor, capital, and materials).

The Production Function

q = F (K , L) (6.1)

Remember the following:

Inputs and outputs are flows.

Chapter 6: Production

Equation (6.1) applies to a given technology

Production functions describe what is technically feasible

when the firm operates efficiently.

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 6.1 THE TECHNOLOGY OF PRODUCTION

The Short Run versus the Long Run

● short run Period of time in which quantities of one or

more production factors cannot be changed.

● fixed input Production factor that cannot be varied.

● long run Amount of time needed to make all

production inputs variable.
Chapter 6: Production

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 6.2 PRODUCTION WITH ONE VARIABLE INPUT (LABOR)

TABLE 6.1 Market Baskets and the Budget Line

Amount Amount Total Average Marginal
of Labor (L) of Capital (K) Output (q) Product (q/L) Product
0 10 0 — ∆L)
(∆q/—
1 10 10 10 10
2 10 30 15 20
3 10 60 20 30
4 10 80 20 20
5 10 95 19 15
Chapter 6: Production

6 10 108 18 13
7 10 112 16 4
8 10 112 14 0
9 10 108 12 -4
10 10 100 10 -8

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 6.2 PRODUCTION WITH ONE VARIABLE INPUT (LABOR)

Average and Marginal Products

● average product Output per unit of a particular input.

● marginal product Additional output produced as an input is

increased by one unit.

Average product of labor = Output/labor input = q/L

Marginal product of labor = Change in output/change in labor input
= Δq/ΔL
Chapter 6: Production

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 6.2 PRODUCTION WITH ONE VARIABLE INPUT (LABOR)

The Slopes of the Product Curve

Figure 6.1

Production with One Variable Input

The total product curve in (a) shows

the output produced for different
amounts of labor input.
The average and marginal products
in (b) can be obtained (using the
data in Table 6.1) from the total
product curve.
At point A in (a), the marginal
product is 20 because the tangent
to the total product curve has a
Chapter 6: Production

slope of 20.
At point B in (a) the average product
of labor is 20, which is the slope of
the line from the origin to B.
The average product of labor at
point C in (a) is given by the slope
of the line 0C.

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 6.2 PRODUCTION WITH ONE VARIABLE INPUT (LABOR)

The Slopes of the Product Curve

Figure 6.1
Production with One Variable Input
(continued)
To the left of point E in (b), the
marginal product is above the
average product and the average is
increasing; to the right of E, the
marginal product is below the
average product and the average is
decreasing.
As a result, E represents the point
at which the average and marginal
products are equal, when the
Chapter 6: Production

average product reaches its

maximum.
At D, when total output is
maximized, the slope of the tangent
to the total product curve is 0, as is
the marginal product.

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 6.2 PRODUCTION WITH ONE VARIABLE INPUT (LABOR)

The Law of Diminishing Marginal Returns

● law of diminishing marginal returns Principle that as the
use of an input increases with other inputs fixed, the resulting
additions to output will eventually decrease.

Figure 6.2

The Effect of Technological

Improvement
Labor productivity (output
per unit of labor) can
increase if there are
improvements in technology,
even though any given
production process exhibits
Chapter 6: Production

diminishing returns to labor.

As we move from point A on
curve O1 to B on curve O2 to
C on curve O3 over time,
labor productivity increases.

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 6.2 PRODUCTION WITH ONE VARIABLE INPUT (LABOR)

The law of diminishing marginal returns was central to the thinking

of political economist Thomas Malthus (1766–1834).
Malthus believed that the world’s limited amount of land would not be able
to supply enough food as the population grew. He predicted that as both
the marginal and average productivity of labor fell and there were more
mouths to feed, mass hunger and starvation would result.
Fortunately, TABLE 6.2 Index of World Food Production Per Capita
Malthus was wrong Year Index
(although he was right 1948-1952 100
about the diminishing
Chapter 6: Production

1960 115
marginal returns to
1970 123
labor).
1980 128
1990 138
2000 150
2005 156

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 6.2 PRODUCTION WITH ONE VARIABLE INPUT (LABOR)

Figure 6.3
Cereal Yields and the World
Price of Food
Chapter 6: Production

Cereal yields have increased. The average world price of food increased
temporarily in the early 1970s but has declined since.

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 6.2 PRODUCTION WITH ONE VARIABLE INPUT (LABOR)

Labor Productivity

● labor productivity Average product of labor for an entire

industry or for the economy as a whole.

Productivity and the Standard of Living

● stock of capital Total amount of capital available for

use in production.

● technological change Development of new

technologies allowing factors of production to be used
Chapter 6: Production

more effectively.

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 6.2 PRODUCTION WITH ONE VARIABLE INPUT (LABOR)

TABLE 6.3 Labor Productivity in Developed Countries

UNITED UNITED
STATES JAPAN FRANCE GERMANY KINGDOM
Real Output per Employed Person (2006)
$82,158 $57,721 $72,949 $60,692 $65,224
Years Annual Rate of Growth of Labor Productivity (%)

1960-1973 2.29 7.86 4.70 3.98 2.84

1974-1982 0.22 2.29 1.73 2.28 1.53
1983-1991 1.54 2.64 1.50 2.07 1.57
Chapter 6: Production

1992-2000 1.94 1.08 1.40 1.64 2.22

2001-2006 1.78 1.73 1.02 1.10 1.47

The level of output per employed person in the United States in 2006 was higher than in
other industrial countries. But, until the 1990s, productivity in the United States grew on
average less rapidly than productivity in most other developed nations. Also, productivity
growth during 1974–2006 was much lower in all developed countries than it had been in
the past.
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 6.3 PRODUCTION WITH TWO VARIABLE INPUTS

Isoquants TABLE 6.4 Production with Two Variable Inputs

LABOR INPUT
Capital 1 2 3 4 5
Input
1 20 40 55 65 75
2 40 60 75 85 90
3 55 75 90 100 105
4 65 85 100 110 115
5 75 90 105 115 120

● isoquant Curve showing

Chapter 6: Production

all possible combinations

of inputs that yield the
same output.

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 6.3 PRODUCTION WITH TWO VARIABLE INPUTS

Isoquants
● isoquant map Graph combining a number of
isoquants, used to describe a production function.
Figure 6.4
Production with Two Variable Inputs
(continued)

A set of isoquants, or isoquant

map, describes the firm’s
production function.
Output increases as we move
from isoquant q1 (at which 55
units per year are produced at
points such as A and D),
Chapter 6: Production

to isoquant q2 (75 units per year at

points such as B) and
to isoquant q3 (90 units per year at
points such as C and E).

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 6.3 PRODUCTION WITH TWO VARIABLE INPUTS

Diminishing Marginal Returns

Figure 6.4
Production with Two Variable Inputs
(continued)
Diminishing Marginal Returns
Holding the amount of capital
fixed at a particular level—say 3,
we can see that each additional
unit of labor generates less and
less additional output.
Chapter 6: Production

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 6.3 PRODUCTION WITH TWO VARIABLE INPUTS
Substitution Among Inputs
● marginal rate of technical substitution (MRTS) Amount by
which the quantity of one input can be reduced when one extra
unit of another input is used, so that output remains constant.
Figure 6.4
MRTS = − Change in capital input/change in labor input
Marginal rate of technical = − ΔK/ΔL (for a fixed level of q)
substitution

Like indifference curves,

isoquants are downward
sloping and convex. The
slope of the isoquant at any
point measures the
marginal rate of technical
substitution—the ability of
Chapter 6: Production

the firm to replace capital

with labor while maintaining
the same level of output.
On isoquant q2, the MRTS
falls from 2 to 1 to 2/3 to
1/3.
(MP ) /(MP ) = -(DK / DL) = MRTS
L K

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 6.2 PRODUCTION WITH TWO VARIABLE INPUTS
Production Functions—Two Special Cases

Figure 6.6
Isoquants When Inputs Are
Perfect Substitutes

When the isoquants are

straight lines, the MRTS is
constant. Thus the rate at
which capital and labor can
be substituted for each
other is the same no matter
what level of inputs is being
used.
Chapter 6: Production

Points A, B, and C
represent three different
capital-labor combinations
that generate the same
output q3.

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 6.2 PRODUCTION WITH TWO VARIABLE INPUTS
Production Functions—Two Special Cases
● fixed-proportions production function Production function
with L-shaped isoquants, so that only one combination of labor
and capital can be used to produce each level of output.
Figure 6.7
Fixed-Proportions
Production Function
When the isoquants are L-
shaped, only one
combination of labor and
capital can be used to
produce a given output (as at
point A on isoquant q1, point
B on isoquant q2, and point
Chapter 6: Production

C on isoquant q3). Adding

more labor alone does not
increase output, nor does
adding more capital alone.
The fixed-proportions
production function describes
situations in which methods
of production are limited.
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 6.2 PRODUCTION WITH TWO VARIABLE INPUTS

Figure 6.8

Isoquant Describing the

Production of Wheat
A wheat output of 13,800
bushels per year can be
produced with different
combinations of labor and
capital.
The more capital-intensive
production process is
shown as point A,
the more labor- intensive
process as point B.
Chapter 6: Production

The marginal rate of

technical substitution
between A and B is 10/260
= 0.04.

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 6.4 RETURNS TO SCALE

● returns to scale Rate at which output increases as

inputs are increased proportionately.

● increasing returns to scale Situation in which output

more than doubles when all inputs are doubled.

● constant returns to scale Situation in which output

doubles when all inputs are doubled.

● decreasing returns to scale Situation in which output

Chapter 6: Production

less than doubles when all inputs are doubled.

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 6.4 RETURNS TO SCALE
Describing Returns to Scale
Figure 6.9

Returns to Scale
Chapter 6: Production

When a firm’s production process exhibits However, when there are increasing
constant returns to scale as shown by a returns to scale as shown in (b), the
movement along line 0A in part (a), the isoquants move closer together as
isoquants are equally spaced as output inputs are increased along the line.
increases proportionally.

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 6.4 RETURNS TO SCALE

Over time, the major carpet manufacturers

have increased the scale of their operation
by putting larger and more efficient tufting
machines into larger plants. At the same
time, the use of labor in these plants has
also increased significantly. The result? Proportional increases
in inputs have resulted in a more than proportional increase in
output for these larger plants.

TABLE 6.5 The U.S. Carpet Industry

Carpet Sales, 2005 (Millions of Dollars per Year)
Chapter 6: Production

1. Shaw 4346
2. Mohawk 3779
3. Beaulieu 1115
4. Interface 421
5. Royalty 298

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