ECO200Y5 Chapter Notes - Chapter 6: Diminishing Returns, Isoquant, Substitute Good

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11 Feb 2016
School
Department
Course
Professor
Natalie Ianniello
ECO200
Barber
June 6, 2015
Chapter #6 – Producer Behaviour
Basics of Production:
Production – process by which a person, company, government, etc.
creates a good or service that others are willing to pay for
For a good to be consumed, it must be produced *rst
Final goods – good that is bought by a consumer
Intermediate goods – a good that is used to produce another good
Production function – mathematical relationship between how much
output can be made from di+erent combinations of inputs
Assumptions about *rms’ production behavior:
-The *rm produces a single good
-The *rm has already chosen which product to produce
-The *rms’ goal is to minimize cost of production
-The *rm uses only two inputs in making product (capital and
labour)
-In short run, a *rm can choose to employ as much or as little
labor but cannot rapidly change capital
-In the long run, *rm can freely choose the amounts of labour
and capital
-The more inputs the *rm uses, the more output it makes
-A *rms production exhibits diminishing marginal returns to
labour and capital
-Firm can buy as many capital or labour as it wants at *xed prices
-If there is a well-functioning capital market (i.e. banks) the *rm
does not have a budget constraint
Production function – Q = f(K,L)
Production in the Short Run:
In short run capital is *xed so we use K with a line over it
And usually that K has a numerical value
To see why there are diminishing marginal returns, we need to under-
stand just what happens when one input increases while the other
input remains *xed
This is what is meant by an input’s
marginal product
Marginal product – additional output that a *rm can produce by using
an additional unit of an input
MPL = change in Q/ change in L
Diminishing marginal product – feature of the production function, as a
*rm hires additional units of a given input, the marginal product of that
input falls
Each extra person hired has less capital to work with
They do not occur all the time, they just eventually will occur
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APl = Q/L
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