Producer Equilibrium

A firm or an organization is an economic unit that converts inputs (labor, materials, and capital) into outputs (goods and services) by employing various factors of production.

It carries out the following functions:1.Employment of FOP2.Production of goods and services3.Profit maximisation

Also called as Inputs, refers to the resources consisting of land, labour, capital, technology, information, organization etc… which are collectively employed in the process of manufacturing a specific product or delivering a defined service.

Products 1. Tangible 2. Durable3. Homogeneous4. Consumption can

be postponed

Services 1. Intangible 2. Non durable3. Heterogeneous 4. Simultaneous

production & consumption

Once the product decision is taken, producer has to look at main major areas pertaining to production. They are:

1.Quantity of output2.Optimal combination of inputs for a

specified level of output. In order to do the above mentioned, a

producer has to define the production function & optimal input employment rate.

production process: transform inputs or factors of production into outputs

common types of inputs:• capital (K): buildings and equipment• labor services (L)• materials (M): raw goods• Orgnisiation: organising various fop in one place for the purpose of producing products .

It explains the functional relationship between quantities of inputs used and maximum quantity of output that can be produced, given current knowledge about technology and organization.

Note: We assume in our discussion that the

producer employs only two factors of production, usually labor or capital.

In simple words, firm’s production function for a particular good (q) shows the maximum amount of the good that can be produced using alternative combinations of capital (k) and labor (l)

a production function that uses only labor and capital:

q = f (L, K, A, M, T…) to produce the maximum amount of

output given efficient production.Here, q is quantity of output f denotes the functional relationship

L denotes unit of Labor K denotes unit of capital A denotes unit of land M denotes management or organising T denotes Technology

Shows max level of output that can be produced by employing one and all input combinations.

It defines max level of output for all or any combination of inputs.

It does not tell about the least cost combination.

It does not trace out the profit max output levels.

5 500 1000 1500 2000 2500

4 400 800 1200 1600 2000

3 300 600 900 1200 1500

2 200 400 600 800 1000

1 100 200 300 400 500

0 1 2 3 4 5

CAPITAL

RATE OF LABOR

one of the most widely estimated production functions is the Cobb-Douglas:

q = AL K

A, , are positive constants Q is the quantity of output K & L are units of Capital & LaborEg: Q = 100L K

The relationship between the factors of production (land, labor, capital, entrepreneurs) and output of goods and services.

Short run – change in one input due to less time

Long run – change in more variables or inputs i:e land & capital

Stage I – Increasing returns*output rises at an increasingly faster rate (each new worker makes more than the previous worker did)

Stage II – Diminishing returns*output rises at a diminishing rate (each new worker increases output, but not as much as the previous worker did)

Stage III – Negative returns *output decreases as each new worker is added

Measures the change in output for a proportionate change in both inputs.

Returns to scale can be:1.Increasing 2.Constant 3.Decreasing

explains how output changes if all inputs are increased by equal proportions

how much does output change if a firm increases all its inputs proportionately?

answer to this question helps a firm to determine its scale or size in LR

when all inputs are doubled, output doubles

f(2L, 2K) = 2f(L, K) potato-salad production function is

CRS

when all inputs are doubled, output more than doubles

f(2L, 2K) > 2f(L, K) increasing the size of a cubic storage

tank: outside surface (two-dimensional) rises less than in proportion to the inside capacity (three-dimensional)

when all inputs are doubled, output rises less than proportionally

f(2L, 2K) < 2f(L, K) decreasing returns to scale because

• difficulty organizing, coordinating, and integrating activities rises with firm size

• large teams of workers may not function as well as small teams

as a firm increases an input, holding all other inputs and technology constant, • the corresponding increases in output will

become smaller eventually• that is, the marginal product of that input

will diminish eventuall

both capital and labor are variable firm can substitute freely between L

and K many combinations of L and K

produce a given level of output: q = f (L, K)

curve that shows efficient combinations of labor and capital that can produce a single (iso) level of output (quantity):

examples:• 10-unit isoquant for a Norwegian printing firm

10 = 1.52 L0.6 K0.4

• Table 6.2 shows four (L, K) pairs that produce q = 24

( , )q f L K

have most of the same properties biggest difference:

• isoquant holds something measurable, quantity, constant

• indifference curve holds something that is unmeasurable, utility, constant

follow from the assumption that production is efficient:

1. further an isoquant is from the origin, the greater is the level of output

2. isoquants do not cross 3. isoquants slope down

slope of an isoquant shows the ability of a firm to substitute one input for another while holding output constant