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ECON 201 - Midterm 2 Review

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ECON 201
Kathleen Rybczynski

Lecture 9: PRODUCTION Production Function for a Single Product Production function: maximum output that can be produced using all possible combinations of inputs on the basis of a given technology Output = f (L, K, land, raw materials, efficiency parameter, returns to scale) Capital = K, land, raw materials; land and raw materials “absorbed” into K for analysis simplicity Technology = efficiency parameters, returns to scale; assume held constant General form of production function: y = f (K, L) Short-Run Production Function, Marginal Product, and Average Product Short-run production function: labour variable, K and Tech fixed MP = slope of TP (Lotal product of labour), AP = y / L Law of Diminishing Marginal Returns (Short-Run) As L ↑ (K constant) → eventually MP ↓ aLd AP ↓ L Technological Efficiency in the Short-Run Realized when MP andLMP are bKth positive. The Long Run Production Function A process is technologically efficient if it cannot be shown to be inefficient. Isoquants Isoquant: locus of all technologically efficient processes for producing a given quantity of output - Vertical and horizontal segments simply represent constant output General Properties of Isoquants Property 1: an isoquant to right of another isoquant represents a higher level of output Property 2: isoquants are downward sloping Property 3: isoquants do no intersect each other Property 4: isoquants are convex from the origin Marginal Rate of Technical Substitution MRS LK = - ΔK / ΔL = MP / MP = MRTS = slope of the isoquant The Concept of Returns to Scale (Long-run) multiple in → multiple out; constant/increasing/decreasing returns to scale Output expansion lines are lines representing the path of increasing output levels that begin from the origin, with a shape that depends on the technology itself. All isoquants have the same slope (MRTS) at the intersection of the OE line. An OE line with constant MRTS is called an isocline. Lecture 10: RETURNS TO SCALE Non-homogenous production functions mean other factors besides K and L are in play. IRS/DRS depends on direction the curve needs to move towards point. Returns to scale are increasing at first and then eventually decrease. Technical indivisibility: mismatched input capacities wasting some productive capacity Larger firms benefit more from geometric relations (length/width vs area), labour time (different chopping diameters), and spare equipment inventories (% of spare to used). Cobb-Douglas Production Function: Y = K L α + β = 1 → CRS, α + β < 1 → DRS, α + β > 1 → IRS π = Total Revenue - Total Cost π = P Y – (rK + wL) ; r*K = cost of capital, w*L = cost of labour Y Isocost line (solve TC for K) → K = (TC - wL) / r Lecture 11: PROFIT
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