2 17 14 Test 2 Information AGEC 2003 Terms Production a process by which resources are transformed into products and services that are usable by consumers Resource input a factor that can be used to produce a product that can satisfy a human want or desire Land all the physical characteristics of this input to yield a product including the soil and the natural environment it is contained within Labor the physical act or effort of performing a task by humans Management humans who are responsible for decision making o Includes entrepreneurial functions of Risk bearing Organizing resources Resource decision choice Capital the physical or tangible resources used to aid or enhance production machinery buildings things part of the production process Production function the particular set or combination of resources inputs used to produce a given level of product output o A relationship between those inputs and what the output is going to be o Example If we want to grow more than 3 pounds of tomatoes we can adjust the resources inputs in one of two ways o Graphing the production function Change all of the inputs in the same proportion e g the doubling of ingredients of a cake recipe Change the proportion of inputs used to produce output e g increase the amount of one input while leaving the other inputs at the same level When output Y doubles when all inputs are doubled as shown above this relationship is known as constant returns We can graph the relationship between inputs and output from the production function Output depicted on the graph is known as total physical product or TPP we often interchange Y or TPP in the notes they are synonyms Straight line on a graph means constant returns to scale Curved line includes both and is what a typical real life example means increasing and decreasing returns to scale Typical of what we would expect for a production function Total physical product o In graph B there is an area of the graph where the TPP curve is convex and an area where it is concave o In the area where the TPP curve is convex Output Y increases at a faster rate than the rate of increase in the input X Increasing at an increasing rate o In the area where the TPP curve is concave Output Y increases at a slower rate than the o The shape of graph B indicates that the law of diminishing returns is in effect o Law of Diminishing Returns As successive amounts of a variable input are combined with a fixed input in a production process the total physical product will increase reach a maximum and eventually decline o Marginal physical product MPP An amount added to total physical product when another unit of the variable input is added This is equivalent to the change in output divided by the change in the variable input Different at different points on the total physical products curve Intersects average physical product o Average physical product APP How productive the variable input is on the average or per unit of X 1 Is a maximum o Relationship between total physical product marginal physical product and average physical product Inflection point output continues to increase but at a decreasing rate At the point of inflection that s where marginal physical product is at a maximum That is where stage 2 of production starts 2 24 14 Marginal value product is equal to marginal factor cost MVP MFC Milk the last little bit of profits out of the activity until we equal those two That s why we maximize profits at that point Test question pick where it s the closet it can be to equal but it has to be greater than Downward sloping comes from the idea that these producers are trying to maximize products Marginal revenue marginal cost where profit is maximized Same as saying MVP MFC Terms Isoquant a curve that shows all combinations of the two variable inputs that can be used to produce a given quantity of output o An isoquant is the graphical equivalent in production economics to what the indifference curve is to consumption economics o Basically means equal quantities of output but it s various combinations of inputs o Further from the origin means a greater level of output Chapter 5 Understanding Producer Decisions 2 26 14 In many cases a producer faces the decision of varying multiple inputs to produce a given output Mathematical Two Variable Production Function Using the same symbols as in Chapter 4 we can define a production function with only two inputs as Or as a production function with two variable inputs and all other inputs fixed Graphical Two Variable Production Function As the TPP curve was the graphical representation of the one variable input production function the isoquant equal quantities is the graphical representation of the two variable input production function Isoquant equal level of output for different combinations of inputs o A curve that shows all combos of the two variable inputs that can be used to produce a given quantity of output o An isoquant is the graphical equivalent in production economics to what the indifference curve is to consumption economics Terms Resource substitution o The technical relationship that occurs when one input can be substituted for another in production while yielding the same level of output You can substitute labor for machinery and other things like that Substitution of inputs in that production process isoquant Special Forms of Resource Substitution Perfect substitutes o One to one trade off Perfect complements o A form of resource input substitution where one input can be exactly substituted for another in production o A form of resource input substitution where two inputs can only be used in production in a fixed ratio and cannot be substituted for one another o Jeans and the hardware that goes into them both are needed in certain quantities Imperfect substitutes o A form of resource input substitution where larger and larger amounts of a second variable resource input are required to replace equal incremental reductions of the first resource input while maintaining the same level of output o Typical in the production of any good trying to make a decision Marginal Rate of Substitution MRS Interpreted the number of units of X2 that X1 can replace without changing output This is analogous to the indifference curve where we choose different consumption bundles but the level of utility is held constant MRS means that if we decrease X2 by a certain amount how much do I have to increase X1 Equal level of outputs and shows different