Microeconomics. Robert S. Pindyck Daniel L. Rubinfeld

Transcription

1 Global edition Microeconomics Eighth edition Robert S. Pindyck Daniel L. Rubinfeld

2 Microeconomics

3 much more (so that the marginal product, while positive, would be below the average product). Once there were more than 40 workers, additional workers would simply get in each other s way and actually reduce output (so that the marginal product would be negative). The Average Product of Labor Curve The geometric relationship between the total product and the average and marginal product curves is shown in Figure 6.1 (a). The average product of labor is the total product divided by the quantity of labor input. At B, for example, the average product is equal to the output of 60 divided by the input of 3, or 20 units of output per unit of labor input. This ratio, however, is exactly the slope of the line running from the origin to B in Figure 6.1 (a). In general, the average product of labor is given by the slope of the line drawn from the origin to the corresponding point on the total product curve. The Marginal Product of Labor Curve As we have seen, the marginal product of labor is the change in the total product resulting from an increase of one unit of labor. At A, for example, the marginal product is 20 because the tangent to the total product curve has a slope of 20. In general, the marginal product of labor at a point is given by the slope of the total product at that point. We can see in Figure 6.1 (b) that the marginal product of labor increases initially, peaks at an input of 3, and then declines as we move up the total product curve to C and D. At D, when total output is maximized, the slope of the tangent to the total product curve is 0, as is the marginal product. Beyond that point, the marginal product becomes negative. The Relationship between the Average and Marginal Products Note the graphical relationship between average and marginal products in Figure 6.1 (a). At B, the marginal product of labor (the slope of the tangent to the total product curve at B not shown explicitly) is greater than the average product (dashed line 0B). As a result, the average product of labor increases as we move from B to C. At C, the average and marginal products of labor are equal: While the average product is the slope of the line from the origin, 0C, the marginal product is the tangent to the total product curve at C (note the equality of the average and marginal products at point E in Figure 6.1 (b)). Finally, as we move beyond C toward D, the marginal product falls below the average product; you can check that the slope of the tangent to the total product curve at any point between C and D is lower than the slope of the line from the origin. Chapter 6 Production 223 The Law of Diminishing Marginal Returns A diminishing marginal product of labor (as well as a diminishing marginal product of other inputs) holds for most production processes. The law of diminishing marginal returns states that as the use of an input increases in equal increments (with other inputs fixed), a point will eventually be reached at which the resulting additions to output decrease. When the labor input is small (and capital is fixed), extra labor adds considerably to output, often because workers are allowed to devote themselves to specialized tasks. Eventually, however, the law of diminishing marginal returns applies: When there are too many workers, some workers become ineffective and the marginal product of labor falls. The law of diminishing marginal returns usually applies to the short run when at least one input is fixed. However, it can also apply to the long run. 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.

4 224 PART 2 Producers, Consumers, and Competitive Markets Even though inputs are variable in the long run, a manager may still want to analyze production choices for which one or more inputs are unchanged. Suppose, for example, that only two plant sizes are feasible and that management must decide which to build. In that case, management would want to know when diminishing marginal returns will set in for each of the two options. Do not confuse the law of diminishing marginal returns with possible changes in the quality of labor as labor inputs are increased (as would likely occur, for example, if the most highly qualified laborers are hired first and the least qualified last). In our analysis of production, we have assumed that all labor inputs are of equal quality; diminishing marginal returns results from limitations on the use of other fixed inputs (e.g., machinery), not from declines in worker quality. In addition, do not confuse diminishing marginal returns with negative returns. The law of diminishing marginal returns describes a declining marginal product but not necessarily a negative one. The law of diminishing marginal returns applies to a given production technology. Over time, however, inventions and other improvements in technology may allow the entire total product curve in Figure 6.1 (a) to shift upward, so that more output can be produced with the same inputs. Figure 6.2 illustrates this principle. Initially the output curve is given by O 1, but improvements in technology may allow the curve to shift upward, first to O 2, and later to O 3. Suppose, for example, that over time, as labor is increased in agricultural production, technological improvements are being made. These improvements might include genetically engineered pest-resistant seeds, more powerful and effective fertilizers, and better farm equipment. As a result, output changes from A (with an input of 6 on curve O 1 ) to B (with an input of 7 on curve O 2 ) to C (with an input of 8 on curve O 3 ). The move from A to B to C relates an increase in labor input to an increase in output and makes it appear that there are no diminishing marginal returns when in fact there are. Indeed, the shifting of the total product curve suggests that there may be no negative long-run implications for economic growth. In fact, as Output per time period C Figure 6.2 The Effect of Technological Improvement 100 B O 3 Labor productivity (output per unit of labor) can increase if there are improvements in technology, even though any given production process exhibits diminishing returns to labor. As we move from point A on curve O 1 to B on curve O 2 to C on curve O 3 over time, labor productivity increases. 50 A O 2 O Labor per time period

5 we can see in Example 6.1, the failure to account for long-run improvements in technology led British economist Thomas Malthus wrongly to predict dire consequences from continued population growth. Chapter 6 Production 225 E x a m p l e 6. 1 A Production Function for Health Care Expenditures on health care have increased rapidly in many countries. This is especially true in the United States, which has been spending 15% of its GDP on health care in recent years. But other countries also devote substantial resources to health care (e.g., 11% of GDP in France and Germany and 8% of GDP in Japan and the United Kingdom). Do these increased expenditures reflect increases in output or do they reflect inefficiencies in the production process? Figure 6.3 shows a production function for health care in the United States. 5 The vertical axis utilizes one possible measure of health output, the average increase in life expectancy for the population. (Another measure of output might be reductions in the average numbers of heart attacks or strokes.) The horizontal axis measures thousands of dollars spent on health care inputs, which include expenditures on doctors, nurses, administrators, hospital equipment, and drugs. The production function represents Increased Life Expectancy (years) 8 7 B C 6 4 A D Figure 6.3 A Production Function for Health Care Additional expenditures on health care (inputs) increase life expectancy (output) along the production frontier. Points A, B, and C represent points at which inputs are efficiently utilized, although there are diminishing returns when moving from B to C. Point D is a point of input inefficiency Input Expenditures per person ($000) 5 This example is based on Alan M. Garber and Jonathan Skinner, Is American Health Care Uniquely Inefficient? Journal of Economic Perspectives, Vol. 22, No. 4 (Fall 2008):

6 226 PART 2 Producers, Consumers, and Competitive Markets the maximum achievable health outcome for the population as a whole, as a function of the dollars spent per capita on health care inputs. Points on the production function such as A, B, and C are by construction inputs that are being used as efficiently as possible to produce output. Point D, which lies below the production function, is inefficient in that the health care inputs associated with D do not generate the maximum possible health output. Notice that the production function exhibits diminishing returns: it becomes relatively flat as more and more money is spent on health care. For example, the health output at point B is quite a bit higher than the output at point A since the marginal productivity of health care expenditures is high. Starting at point A, an additional $20,000 of health expenditures (from $10,000 to $30,000) increases life expectancy by 3 years. However, output at C is only slightly higher than the output at B, even though the difference in health inputs is large. In moving from B to C, an additional $20,000 of health expenditures increases life expectancy by only 1 year. Why is this? The answer is that given current medical technologies, additional expenditures on medical procedures and/or the use of newer drugs has only a minimal effect on life expectancy rates. Thus the marginal productivity of dollars expended on health has become less and less effective as the expenditure level increases. We can now see one possible explanation for the high level of health-care expenditures in the United States. The United States is relatively wealthy, and it is natural for consumer preferences to shift toward more health care as incomes grow, even as it becomes more and more expensive to obtain even modest increases in life expectancy. (Recall our discussion of health care choice in Example 3.4.) Thus, Americans may have been seeking better and better medical outcomes, but with limited success, given the shape of the health care production function. In other words, compared to other countries, the United States may be operating farther to the right along the flat portion of the health-care production function. There is another explanation, however. It may be that the production of health care in the United States is inefficient, i.e., higher medical outputs could be achieved with the same or similar input expenditures if those expenditures were more effectively utilized. In Figure 6.3, this is shown as a move from point D to point B; here with no additional expenditure life expectancy is increased by 1 year by using inputs more efficiently. A comparison of various measures of health and health care across a number of developed countries suggests that this may indeed be the case. First, only 28 percent of primary care physicians use electronic health records in the United States, compared to 89 percent in the United Kingdom and 98 percent in the Netherlands. Second, the percentage of chronically ill patients that did not pursue care, did not follow recommended treatments, or did not take fully recommended medications was 42 percent in the United States compared to 9 percent in the United Kingdom and 20 percent in Germany. Third, the billing, insurance, and credentialing system is more complex and burdensome in the United States than in many other countries, so the number of health care administrative personnel per capita is greater. Both explanations for U.S. health care spending probably have some validity. It is likely that the United States indeed suffers from inefficiency in health care production. It is also likely that as U.S. incomes grow, people will demand more and more health care relative to other goods, so that with diminishing returns, the incremental health benefits will be limited. E x a m p l e 6.2 Malthus and the Food Crisis The law of diminishing marginal returns was central to the thinking of political economist Thomas Malthus ( ). 6 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, 6 Thomas Malthus, Essay on the Principle of Population, 1798.

7 Chapter 6 Production 227 Malthus was wrong (although he was right about the diminishing marginal returns to labor). Over the past century, technological improvements have dramatically altered food production in most countries (including developing countries, such as India). As a result, the average product of labor and total food output have increased. These improvements include new high-yielding, disease-resistant strains of seeds, better fertilizers, and better harvesting equipment. As the food production index in Table 6.2 shows, overall food production throughout the world has outpaced population growth continually since This increase in world agricultural productivity is also illustrated in Figure 6.4, which shows average cereal yields from 1970 through 2005, along with a world price index for food. 8 Note that cereal yields have increased steadily over the period. Because growth in agricultural productivity led to increases in food supplies that Table 6.2 Year Index of World Food Production per Capita Index Food price index (2000 = 100) Cereal Yield Food Price Index Cereal yields (metric tons per hectare) Figure 6.4 Cereal Yields and the World Price of Food Cereal yields have increased. The average world price of food increased temporarily in the early 1970s but has declined since. 7 World per capita food production data are from the United Nations Food and Agriculture Organization (FAO). See also 8 Data are from the United Nations Food and Agriculture Organization and the World Bank. See also