Behind The Supply Curve:

Production Function I
 1. Production - short run
– Productive efficiency
– The Law of diminishing marginal returns
 2. Production - long run
– isoquants & isocosts
– least cost method of production
 Background

 Firms seek to maximise profit (π )

π = R-C
 How do firms produce output and
minimise costs (C)?
 What is production?
 “…production is simply the process of
transforming inputs and outputs.”
 inputs = capital (K) and labour (L)
 A production function

 Functional relationship
Q = f(K, L , T)
 T changes over time

 At a point in time T is fixed

 Productive efficiency
 “Amethod of production is efficient if, for a
given level of factor inputs, it is impossible
to obtain a higher level of output, given the
existing state of technology.”
 The short run

 Period of time over which one factor is

fixed
 Capital - machines, factory, etc.
 Total and Marginal Physical Product
 “…marginal product is the additional output
produced by an additional unit of labour
 MPP = ∆ TPP / ∆ L

 See Figure
Wheat production per year from a particular
farm
40

TPP
Tonnes of wheat produced per year

30

20

10

0
0 1 2 3 4 5 6 7 8

fig
Number of farm workers
Wheat production per year from a particular
farm 40

Tonnes of wheat per year

TPP
30

20

10

0
0 1 2 3 4 5 6 7 8

Number of
farm workers (L)
14
Tonnes of wheat per year

12

10

0
0 1 2 3 4 5 6 7 8
-2
Number of
farm workers (L)
fig MPP
 Law of Diminishing Returns

 Definition
 “…asunits of one input are added (with all
other inputs held constant), a point will be
reached where the resulting additions to
output will begin to decrease; that is
marginal product will decline.”

 On figure - between 2 and 3 workers

 2. The Long Run

 All
factors are variable
 Decisions
 Scale

 Location

 Technique

 Choice of technique
 Isoquants

 Isocosts
 Isoquants

 An isoquant
 “…is a contour line which joins together the
different combinations of two factors of
production that are just physically able to
produce a given quantity of a good.”
 Construction, slope and maps
 45
An isoquant
40
Units Units
35 of K of L
40 5
30
20 12
Units of capital (K)

25 10 20
6 30
20 4 50
15

10

0
0 5 10 15 20 25 30 35 40 45 50

fig
Units of labour (L)
 Diminishing marginal rate of factor substitution
14

12 g
10 ∆ K = 2
MRS = 2 MRS = ∆ K / ∆ L
Units of capital (K)

h
8
∆ L=1
6

0
0 2 4 6 8 10 12 14 16 18 20 22
isoquant

fig
Units of labour (L)
 An isoquant map
30

20
Units of capital (K)

10

I5
0
I4
0 10 20 I3
I2
I1

fig
Units of labour (L)
 Isocosts

 Actual output also depends on costs

 isocosts
 joincombinations of K & L - same cost
 assuming constant factor prices

 Construction, slope & map

 An isocost
30

25 Assumptions

20 PK = £20 000
W = £10 000
Units of capital (K)

TC = £300 000
15

10

0
0 5 10 15 20 25 30 3 5= £300
TC 4 0 000

fig
Units of labour (L)
 Finding the least-cost method of production
35

30 Assumptions

PK = £20 000
25
W = £10 000
Units of capital (K)

20
TC = £200
15
000
TC = £300 000
10
TC = £400 000
5
TC = £500 000

0
0 10 20 30 40 50

fig
Units of labour (L)
 Finding the least-cost method of production
35

30

25
Units of capital (K)

20

15

10

0 TPP1
0 10 20 30 40 50

fig
Units of labour (L)
 Least cost method of production

 Tangency between isoquant and

isocost

 Where:
 Slope of isoquant = slope of isocost

 Successivepoints of tangency - scale

expansion path