econ 101 introduction to economics1 - · pdf fileecon 101 introduction to economics1 session 9...

College of Education

School of Continuing and Distance Education 2014/2015 – 2016/2017

ECON 101

Introduction to Economics1

Session 9 – Production

Lecturer: Mrs. Hellen A. Seshie-Nasser, Department of Economics Contact Information: [email protected]

Session Overview

• This session seeks to discuss output of firms.

Mrs. Hellen Seshie-Nasser, Dept .of Economics, University of Ghana

Slide 2

Session Objectives

• At the end of the session, the student should be able to: – Appreciate what a firm is and the types of firms.

– Understand the Firm in theory and the firm in reality.

– Understand Production and the Production function.

– Differentiate between production in the short and long run.

– Calculate Total Product, Average Product and Marginal product in the short run.

– Demonstrate each of the above with diagrams, demonstrating the shapes of each.

– Understand the relationship between product curves.

– Understand and explain the Law of Diminishing Marginal Returns.

Mrs. Hellen Seshie-Nasser, Dept .of Economics, University of Ghana Slide 3

Session Outline

The key topics to be covered in the session are as follows:

• The Firm in Theory

• Production

• Short Run Production Curves

• Law of Decreasing Returns

• Law of Diminishing Marginal Returns

• Relationship between product curves

Slide 4 Mrs. Hellen Seshie-Nasser, Dept .of Economics, University of Ghana

Reading List

• Lipsey R. G. and K. A. Chrystal. (2007). Economics. 11th Edition. Oxford University Press.

• Bade R. and M. Parkin. (2009). Foundations of Microeconomics. 4th Edition. Boston: Pearson Education Inc.,

• Begg. D. Fischer S. and R. Dornbusch. (2003). Economics. 7th Edition. McGraw-Hill


• The firm is the agent in the economy that makes decisions about production. It constitutes the economic entity which combines the factors of production in a process to produce goods and services for consumption.

• It is made up of various sizes ranging from a micro one-man table-top business to a very large conglomerate with thousands of owners

The Firm


Slide 6

• Sole proprietorship

• Partnership

• Joint-stock companies

Types of Firms


• The firm in theory includes all business organizations ranging from sole proprietorship to companies.

• In theory, two assumptions are made about the firm;

1. That all firms are profit maximizers; seeking to make as much profit for their owners as possible

2. Each firm is considered as a single, consistent decision-making unit.

The Firm in Theory


Slide 8

• Production is the process of combining economic inputs to come up with output.

• Production Function is a table, graph or equation showing the maximum output that can be achieved from a given combination of inputs.

• The production function shows the technological relationship between inputs and outputs.

PRODUCTION


Short Run vs. Long Run

• Short Run (SR) – time frame where some resources are fixed -- plants, equipment – some inputs variable -- labour – SR decisions are reversible

• Long Run (LR) – time frame where all inputs are variable --build a bigger plant – LR decisions are hard to reverse -- cannot easily get rid of capital -- sunk cost

Slide 10 Mrs. Hellen Seshie-Nasser, Dept .of Economics,

University of Ghana

• It is a process in which at least one of the inputs is fixed while all the other are variable within a given production period.

• Fixed inputs are resources or factors that a firm cannot feasibly vary over the time period involved.

• Variable inputs are factors of production that a firm can feasibly vary over the time period involved.

Production in the Short Run


• Total product (TP) is the total amount produced during some period of time by all the inputs that the firm uses.

• Average Product (AP) is the total product per unit of the variable input, say labour.

• Marginal product (MP) is the change in total product resulting from the use of one more (or one less) unit of the variable input.



Slide 12


# workers TP

0 1 2 3 4 5 6 7

0 1 3 6 8 9 9 8

Total product/output is the total quantity of good produced in a given period. It increases with the variable input (labour), then falls


TP

# workers 5 6

9

Total Product Curve


Slide 14

Marginal Product (MP)

• Marginal product (MP) is the change in total product resulting from the use of one more (or one less) unit of the variable input.

= change in TP

change in labour

where V= the variable input

MPL


Slide 15

Shape of the MP curve

• Marginal product rises, reaches a maximum and falls.

• For example, when a firm adds more workers, greater specialization results in larger MP of each worker than the previous worker’s MP. Hence, increasing marginal returns.

• However, the fixed input (capital) remains the same. As a result, MP of more workers become smaller than MP of previous workers, leading to decreasing marginal returns


Slide 16

TP, MP: Chair Production

3

# workers TP

0 1 2 3 4 5 6 7

0 1 3 6 8 9 9 8

MP

1

2

-1

0

1

2


MP

Q = # workers

0

3

3 Mrs. Hellen Seshie-Nasser, Dept .of Economics, University of Ghana

Slide 18

Law of Decreasing Returns

• As firm uses more labour

– with capital fixed,

– MP of labour will eventually fall


• As the amount of some input is increased in equal increments, while technology and other inputs are held constant, the resulting increments in output will eventually begin to decrease.

• Two conditions for the law to hold:

• Some inputs must be fixed

• Technology is held constant

Law of Diminishing Marginal Returns


Average Product (AP)

=

TP

labour

= productivity

APL

APinput = TP

Input


# workers TP

0 1 2 3 4 5 6 7

0 1 3 6 8 9 9 8

MP

1

2

3

-1

0

1

2

AP

1 1.5 2 2 1.8 1.5 1.1

TP, MP & AP


Slide 22

MP

# workers

0

3

3

AP

Relationship between MP and AP


• The law of diminishing returns states that, if increasing quantities of a variable input are applied to a given quantity of a fixed input, the marginal product, and the average product, of the variable input will eventually decrease.

• The law of diminishing returns is also called the “law of variable proportions” because it predicts the consequences of varying the proportions in which input types are used.

The Law of Diminishing Returns


Relationship between Product Curves

TPPL

APPL

L

MPPL

0

K

L2 L3

Assuming capital is fixed and labour is variable;


Slide 25

• When total product (TP) reaches maximum, marginal product (MP) reaches zero.

• As long as MP is positive, TP will rise. Thus, as long as extra units of the variable inputs produce some extra output, total output increases

• A rational producer will not operate where MP is negative because production at that point is technologically inefficient.

Relationship between Product curves


• MP intersects AP at max of AP. That is, at the maximum of AP, MPL=APL

• When MP is greater than AP, (MPL>APL), AP will be rising

• When MP is less than AP, (MPL<APL), AP will be falling

Relationship between Product Curves


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