MANAGERIAL ECONOMICS 11th Edition

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MANAGERIAL ECONOMICS 11th Edition

• By
• Mark Hirschey

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Production Analysis and Compensation Policy

• Chapter 8

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Chapter 8OVERVIEW

• Production Functions
• Total, Marginal, and Average Product
• Law of Diminishing Returns to a Factor
• Input Combination Choice
• Marginal Revenue Product and Optimal Employment
• Optimal Combination of Multiple Inputs
• Optimal Levels of Multiple Inputs
• Returns to Scale
• Production Function Estimation
• Productivity Measurement

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Chapter 8 KEY CONCEPTS

• ridge lines
• marginal revenue product
• economic efficiency
• net marginal revenue
• isocost curve (or budget line)
• constant returns to scale
• expansion path
• increasing returns to scale
• decreasing returns to scale
• output elasticity
• power production function
• productivity growth
• labor productivity
• multifactor productivity

• production function
• discrete production function
• continuous production function
• returns to scale
• returns to a factor
• total product
• marginal product
• average product
• law of diminishing returns
• isoquant
• technical efficiency
• input substitution
• marginal rate of technical

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Production Functions

• Properties of Production Functions
• Production functions are determined by
  technology, equipment and input prices.
• Discrete production functions are lumpy.
• Continuous production functions employ inputs in
  small increments.

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Returns to Scale and Returns to a Factor

• Returns to scale measure output effect of
  increasing all inputs.
• Returns to a factor measure output effect of
  increasing one input.

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Total, Marginal, and Average Product

• Total Product
• Total product is total output.

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Marginal Product

• Marginal product is the change in output caused
  by increasing input use.
• If MPX?Q/?Xgt 0, total product is rising.
• If MPX?Q/?Xlt 0, total product is falling (rare).
• Average product
• APXQ/X.

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Law of Diminishing Returns to a Factor

• Diminishing Returns to a Factor Concept
• MPX tends to diminish as X use grows.
• If MPX grew with use of X, there would be no
  limit to input usage.
• MPXlt 0 implies irrational input use (rare).
• Illustration of Diminishing Returns to a Factor

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Input Combination Choice

• Production Isoquants
• Technical efficiency is least-cost production.
• Input Factor Substitution
• Isoquant shape shows input substitutability.
• C-shaped isoquants are common and imply imperfect
  substitutability.

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Marginal Rate of Technical Substitution

• MRTSXY-MPX/MPY
• Rational Limits of Input Substitution
• MPXlt0 or MPYlt0 are never observed.

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Marginal Revenue Product and Optimal Employment

• Marginal Revenue Product
• MRPL is the revenue gain after all variable costs
  except labor costs.
• MRPL MPL x MRQ ?TR/?L.
• Optimal Level of a Single Input
• Set MRPLPL to get optimal employment.
• Illustration of Optimal Employment

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Optimal Combination of Multiple Inputs

• Budget Lines
• Least-cost production occurs when MPX/PX MPY/PY
  and PX/PY MPX/MPY
• Expansion Path
• Shows efficient input combinations as output
  grows.
• Illustration of Optimal Input Proportions
• Input proportions are optimal when no additional
  output could be produce for the same cost.
• Optimal input proportions is a necessary but not
  sufficient condition for profit maximization.

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Optimal Levels of Multiple Inputs

• Optimal Employment and Profit Maximization
• Profits are maximized when MRPX PX for all
  inputs.
• Profit maximization requires optimal input
  proportions plus an optimal level of output.
• Illustration of Optimal Levels of Multiple Inputs

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Returns to Scale

• Evaluating Returns to Scale
• Returns to scale show the output effect of
  increasing all inputs.
• Output Elasticity and Returns to Scale
• Output elasticity is eQ ?Q/Q ?Xi/Xi where Xi
  is all inputs (labor, capital, etc.)
• eQ gt 1 implies increasing returns.
• eQ 1 implies constant returns.
• eQ lt 1 implies decreasing returns.
• Returns to Scale Estimation

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Production Function Estimation

• Cubic Production Functions
• Display variable returns to scale.
• First increasing, then decreasing returns are
  common.
• Power Production Functions
• Allow marginal productivity of each input to vary
  with employment of all inputs.

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Productivity Measurement

• How Is Productivity Measured?
• Productivity measurement is the responsibility of
  the Bureau of Labor Statistics (since 1800s).
• Productivity growth is the rate of change in
  output per unit of input.
• Labor productivity is the change in output per
  worker hour.
• Uses and Limitations of Productivity Data
• Quality changes make productivity measurement
  difficult.

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