Chapter 6-7

• Production function


  Indicates the highest output q that a firm can produce for every specified combination of inputs
• Inputs


  Labor (L), capital (K), and materials
• Firms can turn inputs into outputs in a variety of ways, using various combinations of labor, materials, and capital
• The production function relates the quantity of output to the quantities of the two inputs, capital and labor
• Inputs and outputs are flows, referring to amounts used or produced per year
• The production function applies to a given technology - as the technology improves, the firm can obtain more output for a given set of inputs
• Fixed input


  Production factor that cannot be varied
• Short run


  Period of time in which quantities of one or more production factors cannot be changed
• Long run


  Amount of time needed to make all production inputs variable
• In the short run, firms vary the intensity with which they utilize a given plant and machinery; in the long run, they vary the size of the plant
• All fixed inputs in the short run represent the outcomes of previous long-run decisions based on estimates of what a firm could profitably produce and sell
• There is no specific time period, such as one year, that separates the short run from the long run. Rather, one must distinguish them on a case-by-case basis
• In the long run firms can vary the amounts of all their inputs to minimize the cost of production
• When capital is fixed but labor is variable, the only way the firm can produce more output is by increasing its labor input
• Average product of labor (APL)


  Output per unit of labor input
• Marginal product of labor (MPL)


  Additional output produced as the labor input is increased by 1 unit
• When the marginal product is greater than the average product


  The average product is increasing
• When the marginal product is less than the average product


  The average product is decreasing
• The marginal product must equal the average product when the average product reaches its maximum
• The average product of labor is given by the slope of the line drawn from the origin to the corresponding point on the total product curve
• The marginal product of labor at a point is given by the slope of the total product at that point
• Marginal product


  The additional output produced by adding one more unit of an input, with other inputs held constant
• As the use of an input increases in equal increments (with other inputs fixed)


  A point will eventually be reached at which the resulting additions to output decrease
• Law of diminishing marginal returns

  Principle that as the use of an input increases with other inputs fixed, the resulting additions to output will eventually decrease
• The law of diminishing marginal returns usually applies to the short run when at least one input is fixed
• The law of diminishing marginal returns can also apply to the long run, even though inputs are variable
• The law of diminishing marginal returns describes a declining marginal product but not necessarily a negative one
• Technological improvements


  Allow the total product curve to shift upward, so that more output can be produced with the same inputs
• Malthus wrongly predicted dire consequences from continued population growth due to failing to account for long-run improvements in technology
• Over the past century, technological improvements have dramatically altered food production, resulting in the average product of labor and total food output increasing
• Labor productivity determines the real standard of living that a country can achieve for its citizens
• One of the most important sources of growth in labor productivity is growth in the stock of capital
• Labor productivity


  Average product of labor for an entire industry or for the economy as a whole
• Stock of capital


  Total amount of capital available for use in production
• Technological change


  Development of new technologies allowing factors of production to be used more effectively
• There is a simple link between labor productivity and the standard of living
• In any particular year, the aggregate value of goods and services produced by an economy is equal to the payments made to all factors of production, including wages, rental payments to capital, and profit to firms
• Consumers in the aggregate can increase their rate of consumption in the long run only by increasing the total amount they produce
• Causes of productivity growth

  • Growth in the stock of capital - more and better machinery allows each worker to produce more output
  • Technological change - development of new technologies that allow labor (and other factors of production) to be used more effectively and to produce new and higher-quality goods
• Levels of labor productivity have differed considerably across countries, as have rates of growth of productivity