ECON 101 Introduction to Economics1

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1 ECON 101 Introduction to Economics1 Session 9 Production Lecturer: Mrs. Hellen A. Seshie-Nasser, Department of Economics Contact Information: haseshie@ug.edu.gh College of Education School of Continuing and Distance Education 2014/ /2017

2 Session Overview This session seeks to discuss output of firms. Slide 2

3 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. Slide 3

4 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

5 Reading List Lipsey R. G. and K. A. Chrystal. (2007). Economics. 11 th Edition. Oxford University Press. Bade R. and M. Parkin. (2009). Foundations of Microeconomics. 4 th Edition. Boston: Pearson Education Inc., Begg. D. Fischer S. and R. Dornbusch. (2003). Economics. 7 th Edition. McGraw-Hill Slide 5

6 The Firm 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 oneman table-top business to a very large conglomerate with thousands of owners Slide 6

7 Types of Firms Sole proprietorship Partnership Joint-stock companies Slide 7

8 The Firm in Theory 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 decisionmaking unit. Slide 8

9 PRODUCTION 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. Slide 9

10 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

11 Production in the Short Run 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. Slide 11

12 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

13 Production in the Short Run Total product/output is the total quantity of good produced in a given period. It increases with the variable input (labour), then falls # workers TP Slide 13

14 Total Product Curve TP # workers Slide 14

15 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. where V= the variable input MPL = change in TP change in labour Slide 15

16 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

17 TP, MP: Chair Production # workers TP MP Slide 17

18 MP Q = # workers Slide 18

19 Law of Decreasing Returns As firm uses more labour with capital fixed, MP of labour will eventually fall Slide 19

20 Law of Diminishing Marginal Returns 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 Slide 20

21 Average Product (AP) APinput = TP Input APL = TP labour = productivity Slide 21

22 TP, MP & AP # workers TP MP AP Slide 22

23 Relationship between MP and AP MP 3 0 AP Slide 23 3 # workers

24 The Law of Diminishing Returns 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. Slide 24

25 Relationship between Product Curves K Assuming capital is fixed and labour is variable; TPPL 0 L2 L3 Slide 25 MPPL L APPL

26 Relationship between Product curves 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. Slide 26

27 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 Slide 27

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