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Flashcards in Managerial Econ 2 Deck (30):

Production and Cost Initial Questions

1. how can you tell when a combination of labor, machines, tools and other inputs are ok?
2. when should we expand or stop?
3. are there laws on how various combinations of inputs turn into commodities or services?


Production Function

A descriptive statement that relates to Inputs and Outputs - show the maximum output attainable with given amounts of various inputs - fixed and variable
- depends on a) accessibility and b) cost combination


Inputs of Production

1. Fixed inputs - do not change within the levels of output - e.g. machines, tools, buildings, etc.
2. Variable inputs - employment or usage vary with the levels of output - e.g. labor, electricity, etc.


Law of Diminishing Returns

Business decisions are made on marginal characteristic
- As the level of variable inputs increases, the output increases for a while, then starts to decrease due to over-capacity of usage of the fixed inputs
e.g. the use of fertilizer improves crop production; but at some point, adding more and more fertilizer improves the yield less per unit of fertilizer, and excessive quantities can even reduce the yield.


Returns to Scale

It explains the behavior of rate of increase in the output/production to the subsequent increase in the inputs. Depending on the level of production, level of machinery, etc., can be:
1. Decreasing
2. Constant
3. Increasing


Returns to Factor

The return attributable to a particular common factor. Can be:
1. Decreasing
2. Constant
3. Increasing



- Flexibility in production is essentially an issue of substitution of one input - how easy is it to substitute?
- Some productions are more capital-intensive, some more labor-based.


Rate of Factor Substitution

- rate you can substitute without impacting utility
- elasticity of substitution is important and also time frame for such flexibilities


Relevant Factors of Production Function

1. Total Product
2. Average Product - total output per unit of variable output
3. Marginal Product - per unit contribution by the last level of input (the question: should I use one more unit?)


Stages of Production

Stage 1: Marginal product is above the average product - it may be rising or falling. The beginning - production is slow - it must expand to utilize the input factor effectively
Stage 2: Marginal product falls below the average product - the average product has reached its max and is falling. Production spikes so increasing but at a slower rate - decision to employ a particular level of the factor is market driven
Stage 3: Marginal product is negative or total product has reached its maximum and is declining - production should not extend to this stage


Input Combinations

- management deciding most levels of fixed and variable input to create desired level of output
- how efficient can be and how can prices can be managed given these levels


Isoquant (equal quantity) Curve

combinations of inputs, fixed and variable, capable of producing a particular level of output
I = ab + lk (Investment = labor cost + capital cost) = curve


Isocost (equal cost) Curve

combinations of inputs, fixed and variable, producing a particular level of output that cost the same
k = a - bl = linear


Operational Feasibility

Where the isoquant curve and the isocost curve cross


Factor Substitution

- for a variety of reasons (variation in cost, availability, etc.), may want to replace one factor of production with another
e.g. labor is too expensive and therefore, use automation to cut labor cost


Marginal Rate of Technical Substitution (MRTS)

the amount of one input required to replace another input without impacting the level of output
e.g. need two robots to replace one worker...MRTS = -1L/2R


Marginal Revenue Product (MRP)

the revenue generated by using an additional input


Marginal Resource Cost (MRC)

additional cost of employing one more unit of input


Optimum Use of Singe Input Factor



Input Demand Function

what determines the demand for a factor? the input factor's MRP


Input Supply Function

supply of a factor is not easily determined - price is the best determinant


Optimum Combination of Multiple Inputs

employ factors to the point that the ratio of their MRP to their prices is the same
For two factors L and K
MRPl/w = MRPk/r
w = price of L
r = price of k


Expansion Path

production expand along a path consistent with the optimum combination rule


Elasticity of Factor Substitution

- some factors of production can be changed easily (e.g. unskilled workers) and some cannot (e.g. technical workers)
- relative sensitivity of output to variations in an input is the elasticity of output to that input


Labor Elasticity

- Formula:
%change TP/%change L
- E > 1 - increasing
- E = 1 - constant
- E < 1 - decreasing


Production: An Example



Cost of Production

amount of money (out-of-pocket expenses) and other resources you need to pay for to produce different levels of output
Accounting (money changing hands) vs. Economic (includes objects not able to value) Costs


Relevant Costs

1. Opportunity Cost - what else could you have been doing?
2. Explicit Costs
3. Implicit Costs - not measurable (include sunk cost like R&D)


Time and Production

"time" in business refers to the periods needed to change one or more factors of production


Short-Run Cost