Ec2204 tutorial 7(2)

CENTRE FOR POLICY STUDIESUNIVERSITY COLLEGE CORK

EC2204TUTORIAL 7

W\S 26\11\2012

Academic Year: 2012/2013 Instructors: Brenda Lynch and PJ Hunt

Contact: brendalynch@ucc.ie p.hunt@ucc.ie

Production and Cost

Production Function is the relationship between the maximum output attainable for a given quantity of variable inputs (such as capital and labour), for a given technology.

Average Product is total output divided by the number of inputs (workers).

Marginal Product: is the additional output generated from hiring 1 additional worker.

Total Product: The total output produced by a firm in a given period of time.

The Stages of Production.

Stage 1: Average product rising. Total Product is rising. Marginal product is beginning to turn.

Stage 2: Average product declining, marginal product positive but is declining while total product reaches its peak.

Stage 3: Marginal product is negative, average product is declining and total product is declining.

Stage 1 Stage 2 Stage 3 Ep > 1 Ep < 1 Ep < 0

Ep = 1

Ep = 0 TP

Increasing Returns Decreasing Returns Negative Returns

Total OutputQ (Units)

Point of maximum marginal returns

Avg. Output,MarginalOutput, (units of output perunit of input

X1 X2 X3

X1 X2 X3

AP

MP

Inputs

Inputs

Production Elasticity.

When MPL > APL, labour elasticity EL > 1

When MPL < APL, labour elasticity EL < 1

Law of diminishing marginal returns;

As a firm uses more of a variable input, with a given quantity of fixed input, the marginal output of the variable input eventually diminishes.

Technical and Economic Efficiency. All points on a production function are

said to be technically efficient. However economic efficiency occurs only at one point, at the output level where MR = MC.

Do the following functions exhibit increasing, decreasing or constant returns to scale?

Q = 3L + 2K

This function exhibits constant returns to scale. For example if L = 2 and K = 2, Q = 10. If L = 4 and K = 4 then Q = 20. Hence when input is doubled output is doubled.

Q = (2L + 2K) ½ (to the power of a half)

The function exhibits decreasing returns to scale. For example when L = 2 and K = 2 then Q = 2.8. If L= 4 and K = 4 then Q = 4. Hence when inputs are doubled output is less than double.

Q = (3LK)²

This function exhibits increasing returns to scale. For example if L = 2 and K = 2 then Q = 144. If L= 4 and K = 4 then Q = 2,304. When inputs are doubled output will more than double.