Presentation Transcript
THEORY OF PRODUCTION 1 :THEORY OF PRODUCTION 1 Production theory forms the foundation for the theory of supply
Managerial decision making involves four types of production decisions:
1. Whether to produce or to shut down
2. How much output to produce
3. What input combination to use
4. What type of technology to use Ch 5
Ch 4
Slide 2 :Production involves transformation of inputs such as capital, equipment, labor, and land into output - goods and services
In this production process, the manager is concerned with efficiency in the use of the inputs
- technical vs. economical efficiency
Two Concepts of Efficiency :Two Concepts of Efficiency Economic efficiency:
occurs when the cost of producing a given output is as low as possible
Technological efficiency:
occurs when it is not possible to increase output without increasing inputs
Slide 4 :The objective of efficiency will provide us with some basic rules about the manner in which firms should utilize inputs to produce goods and services
You will see that basic production theory is simply an application of constrained optimization: :You will see that basic production theory is simply an application of constrained optimization: the firm attempts either to minimize the cost of producing a given level of output
or
to maximize the output attainable with a given level of cost.
Both optimization problems lead to same rule for the allocation of inputs and choice of technology
Production Function :Production Function A production function is a table or a mathematical equation showing the maximum amount of output that can be produced from any specified set of inputs, given the existing technology f2(x)
f1(x)
f0(x) x Q Improvement of technology
f0(x) - f2(x) Q = output
x = inputs
Production Function continued :Production Function continued Q = f(X1, X2, …, Xk)
where
Q = output
X1, …, Xk = inputs
For our current analysis, let’s reduce the inputs to two, capital (K) and labor (L):
Q = f(L, K)
Production Table :Production Table Same Q can be produced with different combinations of inputs, e.g. inputs are substitutable in some degree
All of these outputs are assumed to be technically efficient :All of these outputs are assumed to be technically efficient But which one is economically efficient?
That is the question facing the DM
Short-Run and Long-Run Production :Short-Run and Long-Run Production In the short run some inputs are fixed and some variable
e.g. the firm may be able to vary the amount of labor, but cannot change the amount of capital
in the short run we can talk about factor productivity
Slide 11 :In the long run all inputs become variable
e.g. the long run is the period in which a firm can adjust all inputs to changed conditions
in the long run we can talk about returns to scale (compare latter with economies of scale, which is a cost related concept)
Short-Run Changes in ProductionFactor Productivity :Short-Run Changes in ProductionFactor Productivity How much does th