Overview
Purpose:
To explain the concept of the production function, and to describe how firms can minimize their costs of production by utilizing an optimal combination of inputs and scale of operation.
Objectives:
1. The relationship between the rate of output of a commodity and the rate at which inputs are used is called the production function.
a) an "input" is a factor, such as labor, machinery, or land, that contributes to production.
b) a production function "embodies" a given technology; a change in technology changes the relationship between inputs and output.
c) if a percentage increase in all inputs results in an increase in output greater than the percentage increase in inputs, the production process has economies of scale.
2. Some inputs can be changed more easily than others in response to a change in demand. Those inputs (such as labor, raw materials, or energy) are called variable inputs, and inputs which can only change in the long-run (such as a factory) are called fixed inputs.
3. If the successive additions to output lessen as more and more of an input is added (while technology and the quantity of other inputs are held constant), the input is subject to diminishing marginal returns.
4. To minimize its costs, a firm must choose a combination of inputs to meet the following condition: the marginal product of a dollar’s worth of any one input must equal the marginal product of a dollar’s worth of any other input used.
| Key Economic Concepts production function, specialization, fixed input, variable input, average product, marginal product, technological change, cost minimization, law of diminishing marginal returns. |
| Contemporary Issues The collapse of Enron, in the wake of the 2001 recession, sent a shock wave through financial markets, pushing down stock prices and creating a crisis about U.S. corporate governance. Enron had been one the superstars of the 1990s boom. However, creative accounting had hidden serious financial problems in the company even before the end of the boom. Why is good corporate governance and confidence in companies’ financial statements so important for a capitalist system? Does profit maximization ever conflict with high ethical standards? Are high ethical standards more likely to be rewarded in the short-run or the long-run? |
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