Production Drives Supply

Production Drives Supply Factors of Production Total Product, Average Product &

Marginal Product Short Run vs. Long Run Scale of Production & Returns to Scale

Warm-Up Questions1. What is a “factor of production”?2. What are the 4 factors of production,

and what does each represent? 3. In a free market economy, who owns

most of the factors of production?4. Why do people get involved in

production? In other words, what is their incentive?

The Critical Question

How does a firm decide how much of each of the various

inputs to buy?

The Critical Answer

The combination of inputs that enables it to produce whatever

output it decides upon at minimum cost, and, therefore,

maximum profitability.

Input vs. OutputOutput Inputs

How to Measure Production use units instead of dollars (b/c prices

change over time) total product (TP): all units of a product

produced in a given period of time average product (AP): # units of output

produced per unit of input

units of outputAP =

units of input

How to Measure Production cont… marginal product (MP): amount that

TP ↑ or ↓ as a result of adding 1 more unit of input important for deciding whether or not to

add the input … add if $ value of added output > cost of added input

outputMP

input

Florence Farmer’s Poultry: TP

Flo’s Total Product Schedule

Corn Input (40-lb. bags)

Chicken Output (lbs.)

0 0.0

1 14.0

2 36.0

3 66.0

4 100.0

5 130.0

6 156.0

7 175.0

8 184.0

9 185.4

10 180.0

11 165.0

12 144.0

Florence Farmer’s Poultry: TP

020406080

100120140160180200

0 1 2 3 4 5 6 7 8 9 101112

Total Product

Quantity of Corn (bags per week)

Tota

l O

utp

ut

(pou

nd

s of

ch

icken

per

week)

Florence Farmer’s Poultry: AP

AP = 100 lbs. of chicken = 25 lbs. per bag

4 bags of corn

units of outputAP =

units of input

Florence Farmer’s Poultry: AP

Flo’s Total Product & Average Product Schedule

Corn Input (40-lb. bags)

Chicken Output (lbs.) Average Product (lbs. per bag)

0 0.0 ---

1 14.0 14.0

2 36.0 18.0

3 66.0 22.0

4 100.0 25.0

5 130.0 26.0

6 156.0 26.0

7 175.0 25.0

8 184.0 23.0

9 185.4 20.6

10 180.0 18.0

11 165.0 15.0

12 144.0 12.0

Florence Farmer’s Poultry: MP

MP = 100 – 66 lbs. of chicken = 34 = 34 lbs. per bag

4 – 3 bags of corn 1

outputMP

input

Florence Farmer’s Poultry: MP

Flo’s Total Product & Average Product Schedule

Corn Input (40-lb. bags)

Chicken Output (lbs.) Marginal Product (lbs. per bag)

0 0.0 14.0

22.0

30.0

34.0

30.0

26.0

19.0

9.0

1.4

-5.4

-15.0

-21.0

1 14.0

2 36.0

3 66.0

4 100.0

5 130.0

6 156.0

7 175.0

8 184.0

9 185.4

10 180.0

11 165.0

12 144.0

Florence Farmer’s Poultry: MP

-30

-20

-10

0

10

20

30

40

1 2 3 4 5 6 7 8 9 10 11 12

MarginalProduct

Quantity of Corn Input (bags per week)

Marg

inal

Pro

du

ct

(pou

nd

s of

ch

icken

per

week)

Increasing Marginal Returns

Diminishing Marginal Returns

Negative Marginal Returns

“Law” of Diminishing Marginal Returns

An increase in the amount of any one input, holding the amounts of all others constant,

ultimately leads to lower marginal returns to the expanding input.

In other words: In the short run, eventually it’s not worth it to

keep adding more input because the output will decrease.

(does not hold true in the long run!!!)

Short Run vs. Long Run short run: period in which the

usable amount of at least 1 input is fixed while the usable amount of at least 1 input can change

long run: period in which the amounts of all inputs can be changed

Returns to Scale scale of production: overall level of use of all

factors of production returns to scale: relationships b/t changes in

scale of production and corresponding change in output increasing: output more rapidly than rate of

of inputs decreasing: output less rapidly than rate of

of inputs constant: output at same rate of of inputs

Returns to Scale ExamplesIdentify whether returns to scale are

increasing, decreasing or constant:1. Inputs increase 66% and output

increases 66%2. Inputs are tripled and output

doubles3. Inputs are increased by 15% and

output increases by 25%