producer decision making chapter 4. production - a process by which resources are transformed into...

Producer Decision Making

Chapter 4

Production - a process by which resources aretransformed into products or services thatare usable by consumers.

Producer Decision Making

Decisions a Producer Must Make

What to Produce?

How Much to Produce?

How to Produce?

How Big to Be?

Producer Decision Making

Resource (input) - A factor that can beused to produce a product that cansatisfy a human want or desire.

Producer Decision Making

Physical Relationships

Land - everything you see in viewing the earth’s surface.

Labor - physical act of performing a task.

Management - the sole responsibility of decision making.

Capital - every manufactured thing that can be used to aid or enhance production.

Producer Decision Making

Different quantities and combinations of these four things will produce different amounts of the product.

Producer Decision Making

Production Function

Y = Output

X = inputs (land, labor, capital, management)

Function Y = f ( x1, x2, x3, ..., xn )

This function is used to determine the level of output given the units of inputs.

Producer Decision Making

Mapping a Production Function

III

III IV

Producer Decision Making

Constant Returns - if all inputs were increased in a constant ratio, the output will increase by the same percentage as the inputs.

Producer Decision Making

Total Physical Product CurveTPP

X

Y

TPP = Total Physical Product

Producer Decision Making

X = 1 acre of land , $1000 of capital, 1 weekof management time.

2 X = 2 acres of land , $2000 of capital, 2weeks of management time.

X produces 5 units of output

2 X produces 10 units of output

Producer Decision Making

Law of diminishing returns - as successiveamounts of a variable input are combined witha fixed input in a production process, thetotal product will rise, reach a maximum,then eventually decline.

Changing the Level of One Input

Producer Decision Making

Changing the Level of One Input

Y

TPP

X1 X2, X3,...,Xn

Producer Decision Making

Marginal Physical Product - the amount addedto total physical product when another unitof the variable input is used.

Changing the Level of One Input

Producer Decision Making

Y

TPP

X1 X2, X3,...,Xn

Change in Y

Change in one unit of X

Marginal Physical Product

Producer Decision Making

Y

TPP

X1 X2, X3,...,Xn

Or it could be measured at a point of Tangency.

.

Marginal Physical Product

Producer Decision Making

Y

TPP

X1 X2, X3,...,Xn

What is MPP Here?

Marginal Physical Product

Producer Decision Making

Y

TPP

X1 X2, X3,...,Xn

What is MPP Here?

Marginal Physical Product

Producer Decision Making

MPP =Change in output TPP Y

Change in input X1 X1= =

Marginal Physical Product

Producer Decision Making

Average Physical Product

Y

TPP

X1 X2, X3,...,Xn

APP

Producer Decision Making

Change in Y

Change in X

Y

TPP

X1 X2, X3,...,Xn

Average Physical Product

APP

Producer Decision Making

Y

TPP

X1 X2, X3,...,Xn

Average Physical Product

APP

Producer Decision Making

Average Physical Product

APPOutput Y

Input X1= =

Producer Decision Making

Y

X1 X2, X3,...,Xn

Marginal and Average Product Curves

Stage I Stage II Stage III

APP

MPP

Producer Decision Making

Stage I Irrational

As long as MPP > APP it will always be profitable to usemore of that particular input. So because in Stage IMPP > APP everywhere, we will not produce in this region.

Producer Decision Making

Y

X1 X2, X3,...,Xn

Marginal and Average Product Curves

Stage I Stage II Stage III

APP

MPP

Producer Decision Making

Stage II Rational

In Stage II profit maximization will occur. APP > MPP everywhere, and production is stillincreasing with increases in inputs.

Producer Decision Making

Y

X1 X2, X3,...,Xn

Marginal and Average Product Curves

Stage I Stage II Stage III

APP

MPP

Producer Decision Making

Stage IIIIrrational

Stage III is irrational because as we increase theuse of the input X1 output actually falls as aresult. This cannot possibly be a profitableregion of production.

Producer Decision Making

Y

X1 X2, X3,...,XnMarginal and Average Product Curves

Stage I Stage II Stage III

APP

MPP

Y

TPP

X1 X2, X3,...,Xn

Stage I Stage II Stage III

Total Physical Product Curve

To determine the optimum level of an input, weneed information about the value of the productand the cost of the input.

Value of Product

TVP = Price of Product * Amount of Product

AVP = TVP / Quantity of Input (X1)

MVP = Change in TVP / Change in Quantity of Input (X1)

Producer Decision Making

$Y

X1 X2, X3,...,Xn

Marginal and Average Value Curves

AVP

MVP

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Cost of the input

Marginal Factor Cost - is the amount added to totalcost when an additional unit of the variable input isused.

MFCX 1 = PriceX 1

Producer Decision Making

$Y

X1 X2, X3,...,Xn

Marginal and Average Value Curves

AVP

MVPMFC= PX 1

Optimal Input Usage

.

Producer Decision Making

Total Factor Cost

TFC = Price X1 * Units of X1 used

Producer Decision Making

$Y

X1 X2, X3,...,Xn

AVP

MVPMFC= PX 1

Optimal Input Usage

.

Total Factor Cost

TFC

Producer Decision Making

Adjusting to Price Changes

PRODUCT PRICE CAN CHANGE AND WILL

INPUT PRICES CAN ALSO CHANGE

Producer Decision Making

Changing the level of Product Price

$Y

X1 X2, X3,...,Xn

AVP

MVPMFC= PX 1

Optimal Input Usage

TFC

Increasing Output Price

Producer Decision Making

Changing the level of Product Price

$Y

X1 X2, X3,...,Xn

AVP

MVPMFC= PX 1

Optimal Input Usage

.TFC

Increasing Output Price

Producer Decision Making

$Y

X1 X2, X3,...,Xn

AVP

MVP

MFC= PX 1

Optimal Input Usage

.TFC

Changing the level of an input priceAn increase in MFC

Producer Decision Making

$Y

X1 X2, X3,...,Xn

AVP

MVP

MFC= PX 1

Optimal Input Usage

.TFC

Changing the level of an input price

An increase in MFC

Producer Decision Making

Deriving the demand for an input

Producer Decision Making

Price of Input Quantity of Input

15 30

10 40

5 60

2 80

Product Price $

Quantity of Input

Demand

30 40 80

2

10

15

Producer Decision Making

$Y

X1 X2, X3,...,Xn

AVPMVP or Demand forX1

0 120

$

Demand for input from MVP

Producer Decision Making

$Y

X1 X2, X3,...,Xn

AVP

MVP or Demand forX1

0 120

$

Demand for input from MVP

MFC = Px1

60

Producer Decision Making

$Y

X1 X2, X3,...,Xn

AVP

MVP or Demand forX1

0 120

$

Demand for input from MVP

MFC = Px1

60

Producer Decision Making

$Y

X1 X2, X3,...,Xn

AVP

MVP or Demand forX1

0 120

$

Demand for input from MVP

MFC = Px1

60

Producer Decision Making