pcecon.com Class Notes


When dealing with production, we use
inputs or factors of production or resources,
(these are just different names for the same things)
to produce
output or product or quantity (Q) or an amount of production or goods and services
(these are also just different names for the same thing).

Why so many names? Just to keep repetition to a minimum. Plus sometimes one name sounds better than others. For example, canola oil is really short for "Canadian oil, low acid," but it is really just rapeseed oil, which sounds sort of violent for cooking stuff in. Cilantro is the same stuff as coriander. It's also called "Chinese parsley," even though it originates from Europe (and I bet you thought it came from Mexico).

Production involves a few main catagories of inputs:
capital- consists of machines, buildings, tools and such
generally, if you can use it without using it up, it's capital
labor- the time of workers; when this is used, it's gone
materials- the stuff that gets turned into the product; again, when they are used, they are used up (they become the product, and are no longer inputs)
land- we can consider this as a form of capital, although purists would count it as different
power and fuel- electricity, gas, oil, etc.
entrepreneurship- knowledge of how to put things together and make them work

To keep things simple, we generally focus on
capital, labor and materials, and put the other inputs in one of those catagories (afterall, an entrepreneur is a special kind of worker, for example).

Production Decisions

In using inputs to produce products, we make decisions in two time frames, the
short run and the long run.

In the long run, a decision maker can change any of the inputs as he or she sees fit. Everything is

In the short run, capital is
fixed (is not changing). Labor and materials can still be altered and thus are considered variable. This is because it is hard to change big expensive stuff like buildings overnight. Plus, once you have some capital, such as a tool, you can just use it over and over without necessarily acquiring more of it if you want to make more product in the short run. So, it is fixed.

With the other inputs (like labor and materials), you will need more of them to make more product, since they get used up right as you use them once. Thus, such inputs are variable in the short run.

Production in the Short Run

Total product is the name given to the relationship between labor (variable input) and output in the short run. It looks like this

Notice that the curve starts out flat, then gets steeper, then flattens again, and then falls. These changes in slope actually mean something. The slope of the curve at various points tells us about the additions to total product that can be achieved by adding additional amounts of the variable input.

The additional product that is produced by adding one more unit of variable input is called...

Marginal Product

The marginal product is really the slope of the total product curve. Marginal product starts out small and grows. Then, it starts to fall, and eventually even becomes negative.

The increasing of marginal product when a few units of variable input are being used is called
increasing returns. Increasing returns occur because additional units of the input add onto the existing units in a special way. One name for this is synergy. Also, there are some tasks that two or more workers (for example) can accomplish that would be impossible for only one to do, such as moving heavy equipment or furniture. The ability to accomplish such things might be attributed to team work. Further, if several individual jobs are required to make a product, having each worker specialize in one of the jobs might increase production, and the more workers there are, the better these jobs can be divided up. This is called division of labor.
Despite these, it appears that as more units of a variable input are used in the short run (with a fixed amount of capital resources), the additional product that is produced by adding more variable input (the marginal product) eventually gets smaller and smaller.
This is called the
law of diminshing returns, and can be seen in the decline of marginal product as inputs are further increased.
When output falls as more inputs are used, we say there are
negative returns.

Copyright 2006-7 by Ray Bromley. Permission to copy for educational use is granted, provided this notice is retained. All other rights reserved.

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