Production Economics: Marginality & Production

• Unit 2 covers basic production economics principles.

Theme 1: Marginality and Production Function

• Ecn knowledge provides managers with principles and rules for making decisions.
• Ecn assists with the decision-making process.
• When a problem is identified and defined, data is required.
• Ecn principles give guidelines on how to process raw data into useful information.
• Ecn principles consist of rules ensuring the correct decision is made to maximize profit.
• Economists examine the impact of changing factors under their control, such as increasing fertilizer by 50% and its effect on yield.
• Marginality refers to incremental change, increase, or decrease at the margin.
• "Marginal" can be substituted with "additional" or "extra."
• A marginal change in one thing results from a marginal change in another factor.
• Marginal change calculation involves finding the difference between the initial value and the new value after changing the factor.
• "Δ" refers to "change in."
• An assumption is ceteris paribus.
• Production function (PF) is a basic concept in production economics.
• PF shows the relationship between alternative input levels and their respective output levels in a systematic way.
• PF shows the amount of output that can be produced with different levels of variable input, ceteris paribus.
• The shape of PF is important.
• PF provides basic data to derive other information regarding the relationship between inputs and TPP.
• Average Physical Product (APP) is the output per unit of input. It can be calculated as Output / input level.
• MPP is found in the third column in a table.
• It requires measuring changes in both input and output.
• MPP = output / input level.
• MPP can be positive, negative, or zero, depending on whether a change in input level causes a change in output level.
• Negative MPP indicates too much input is used in the production process.
• Negative MPP is associated with declining output.
• MPP is shown in column 4 in a table.
• Graphs can graphically show PF, APP, and MPP functions.
• Graphs show the relationship between TPP, MPP, and APP.
• TPP increases at an increasing rate up to the input level where MPP is max.
• From there, MPP decreases until it becomes zero (0) at an input level where TPP is max.
• When MPP > APP, APP increases with an increase in input level.
• The Law of diminishing marginal returns states that as additional units of a variable input are used in combination with one or more fixed inputs, Marginal Physical Productivity (MPP) will eventually decline.
• Diminishing marginal returns refers to what happens with MPP as additional units of variable input are added.
• The effect is seen in Stage I.
• In agriculture, as additional units of seed, fertilizer, or water are added to a fixed size of land for a specific crop, the additional units of output (or MPP) will eventually decline.
• MPP decreases more as the crop nears its biological capacity to use the input.

Theme 2: How Much Input to Use

• An important use of PF is determining how much variable input is used
• Farmers must choose the input level to maximize profit.
• Focus is on Stage II.
• Info from TPP, APP, and MPP isn't enough to determine the input level to maximize profit; price info is needed.
• Marginal Value Product (MVP) is additional or marginal income received from using an additional unit of input.
• MVP = TVP / input level.
• (TVP = Output price x Amount of output)
• Marginal Input Costs (MIC) is change in TC caused by using an additional unit of input.
• MIC = Total Input Cost / input level.
• Total Input Cost = quantity of input used x price of input.
• MIC remains constant for all input levels as the additional cost of acquiring and using an additional unit of input equals the price of the input.
• MIC equals input price.
• Both MVP and MIC are monetary values and can be compared to determine the optimum level of input.
• Profit maximizing input level will occur where MVP = MIC.
• If MVP > MIC, additional income exceeds additional costs by using an additional unit of input and additional profit is made by using additional input.
• If MVP < MIC, additional income from using additional input is less than additional costs and profits decrease by using additional unit of input.
• If MVP = MIC, additional income from using additional input equals additional costs and profit is maximised at input level.
• Unless input is free of charge, profit maximisation will not occur at the same input level that maximises TVP.

Theme 3: How Much Output to Produce

• Discussion revolves around how much input is needed.
• How much output is produced is a related question.
• Remember, the goal is to maximise profits.
• Two concepts need to introduced: Marginal Revenue (MR) and Marginal Costs (MC).
• Input and output data is the same.
• Marginal Revenue (MR) is change in income (or additional income) received from selling one more unit of output.
• (Note the difference between MR and MVP)
• MR = ATR / TPP
• (TR = Output price x Amount of output)
• MR remains constant.
• By definition, MR measures change in the total revenue from selling additional unit of output because Change in income should equal price of the product sold, provided that output price remains the same (Assumption).
• Marginal cost (MC) is the change in total cost after producing one additional unit of output.
• MC = Total input cost / TPP
• (Total input cost = Price of input x amount of input used)
• MC tends to decrease before rising because it takes relatively more input produce additional unit of output(Law of diminishing marginal returns???).
• Analyse MR and MC to determine the optimum level of output to produce.
• If MR > MC, additional unit of output increases profit.
• If MR < MC, additional unit of output decreases profit.
• Profit will maximise when MR = MC
• Change in income from selling additional unit of output should be equal to the change in total input cost due to producing additional unit of output
• There is only one optimum level of output and input combination for a given PF and price levels.