Microeconomics I IMB Past Paper Lecture Notes PDF

Microeconomics I IMB Prof. Dr. Harald Simons Professor for Economics Faculty of Business Administration Gustav-Freytag-Str. 42a / Z 312 Email: [email protected] Phone: 0341 / 3076-6529 Simons, Microeconomics I  5. Production Chapter Outline...

Microeconomics I IMB Prof. Dr. Harald Simons Professor for Economics Faculty of Business Administration Gustav-Freytag-Str. 42a / Z 312 Email: [email protected] Phone: 0341 / 3076-6529 Simons, Microeconomics I  5. Production Chapter Outline Technology of Production Production with one variable Input (Labour) Production with two variable Inputs Technical Progress Simons, Microeconomics I, 2  Introduction We now focus on the supply side of the market. The Theory of the Firm deals with the following aspects: – How does a firm make cost-minimising production decisions? – How do the firm’s costs vary with its output? Simons, Microeconomics I, 3  The Technology of Production Production – combination of inputs (or production factors) for the creation of an output. Categories of Inputs (production factors) – Labour – Raw materials – Capital – (but can also be anything else: oil, land, needle and thread, …) Simons, Microeconomics I, 4  The Technology of Production The Production Function: – shows the highest output that a firm can produce for every specified combination of inputs. – describes, what is (currently) technically feasible. The production function for two inputs is: Q = F(K,L) Q = Output, K = Capital, L = Labour at a given technology Simons, Microeconomics I, 5  Production with one variable Input (Labour) Amount Amount Total Average Marginal of Labour of Capital Output Product Product (L) (K) (Q) (APL) (MPL) 0 10 0 --- --- 1 10 10 10 10 2 10 30 15 20 3 10 60 20 30 4 10 80 20 20 5 10 95 19 15 6 10 108 18 13 7 10 112 16 4 8 10 112 14 0 9 10 108 12 -4 10 10 100 10 -8 Simons, Microeconomics I, 6  Production with one variable Input (Labour) APL = slope of the line from the origin to a point on Q MPL= slope of the tangent to a point on Q D Marginal Product (MPL) Output per 100 Total Product (Q) Month C 75 Average Product (DPL) B 50 A: Slope of the Tangent = MPL = 20, APL = 15 B: MPL = 30, APL = 20 C: MPL = APL = 20 25 A D: MPL = 0, APL = 14 0 1 2 3 4 5 6 7 8 9 10 Labour per Month Simons, Microeconomics I, 7  Production with one variable Input (Labour) 1) With additional workers the Total Output (Q) increases at first, reaches a maximum and decreases again. 2) The Average Product of Labour (APL) or the the output of per unit of labour input increases and decreases again. Output Q APL   Labour Input L 3) The Marginal Product of Labour (MPL) or the additional output produced by 1 additional unit of labour increases rapidly at first, decreases later and becomes negative in the end. Output dQ MPL   LabourInput dL Simons, Microeconomics I, 8  Production with one variable Input (Labour) To the left of E: MPL > APL => APL increases. To the right of E: MPL < APL => APL sinks. E: MPL = APL => APL reaches its maximum. Output per 30 Month E 20 10 Average Product Marginal Product 0 1 2 3 4 5 6 7 8 9 10 Labour per Month Simons, Microeconomics I, 9  Production with one variable Input (Labour) The TheLaw Law of of Diminishing DiminishingMarginal Marginal Returns Returns As the use of an input increases, a point will eventually be reached at which the resulting additions to output decrease (i.e. MPL sinks). If labour input is low, MPL increases due to specialisation. If labour input is high, MPL decreases due to inefficiencies. Simons, Microeconomics I, 10  Malthus and the Food Crisis Thomas Malthus (1766-1834, British political economist and social philosopher) predicted mass hunger and starvation His theory: With the world’s limited amount of land both the marginal and average productivity of labour would fall as the world population grew. Malthus was right regarding the diminishing marginal returns of labour – but this is only valid at the given technology! Fortunately, Malthus had forgotten something important. Worth reading: Clark, Gregory; “Farewell to Alms – A Brief Economic History of the World”; Princeton University Press; 2007 Simons, Microeconomics I, 11 Malthus and the Food Crisis Source: IMF Simons, Microeconomics I, 12  Malthus and the Food Crisis The data show that food production has outpaced population growth. Malthus had not considered the effects of technological improvements, that led to the food supply growing faster than the demand. – chemical fertilisers, better harvesting equipment and machines, modified seeds,... – Through this technology surpluses were produced and prices fell (but: increase in price due to bio-fuels and changing nutrition habits in emerging countries in the last years!) Simons, Microeconomics I, 13  The Effect of Technological Improvement Labour productivity cab Output C increase if there are per improvements in time period technology, even though any given production 100 process exhibits B O3 diminishing returns of labour. A 50 O2 O1 Labour per time period 0 1 2 3 4 5 6 7 8 9 10 Simons, Microeocnomics I, 14  Production with two variable Inputs (L,K) Substitution Among Production Factors – Managers need to decide which combination of inputs shall be used. – Necessary decision: determination of trade-off between the inputs. – This flexibility of input allows the producers to react effectively to changes on input markets. Simons, Microeconomics I, 15  Production Function for Food Labour Input Capital Input 1 2 3 4 5 1 20 40 55 65 75 2 40 60 75 85 90 3 55 75 90 100 105 4 65 85 100 110 115 5 75 90 105 115 120 Q: With which variable input combinations can a certain output be achieved? Simons, Microeconomics I, 16  Production with Two Variable Inputs (L,K) Isoquant IsoquantMaps Maps Capital per Year An Isoquant is a curve that shows all the E possible combinations of inputs that yield 5 the same output. 4 The isoquants are based on the production function for each output of 55, 75 and 90. 3 A B C 2 Q3 = 90 D Q2 = 75 1 Q1 = 55 1 2 3 4 5 Labour per Year Simons, Microeconomics I, 17  Production with Two Variable Inputs (L,K) Substitution Among Inputs – The marginal rate of technical substitution (MRTS) is: – Change in Capital Input MRTS = Change in Labour Input – ΔK dK MRTS =  (for a fixed level of Q) ΔL dL Simons, Microeconomics I, 18  Marginal Rate of Technical Substitution Isoquants are downward sloping and convex (like indifference curves). Capital per Year 5 2 The MRTS of labour for capital 4 is diminishing. 1 3 1 2 1 2/3 Q3 = 90 1 1/3 Q2 = 75 1 1 Q1 = 55 1 2 3 4 5 Labour per Month Simons, Microeconomics I, 19  Production with Two Variable Inputs (L,K) Notes: 1) An increase of labour from 1 to 5 in steps of one unit each leads to a decrease of the MRTS from 2 to 1/3. 2) The diminishing MRTS results from diminishing returns and implies that the isoquants are convex. Simons, Microeconomics I, 20  Production with Two Variable Inputs (L,K) Isoquant IsoquantMaps Maps Capital per Year An Isoquant is a curve that shows all the E possible combinations of inputs that yield 5 the same output. 4 The isoquants are based on the production function for each output of 55, 75 and 90. 3 A B C 2 Q3 = 90 D Q2 = 75 1 Q1 = 55 1 2 3 4 5 Labour per Year Simons, Mikroökonomie I, 21  Production with Two Variable Inputs (L,K) Interpretation of the isoquants model 1) Assumed that Capital equals 3 and Labour increases from 0 to 1 to 2 and to 3.  The output increases at a diminishing rate (55, 20, 15), which depicts the short- and long-term diminishing returns of labour. 2) Assumed that Labour equals 3 and Labour increases from 0 to 1 to 2 and to 3.  The output increases again at a diminishing rate (55, 20, 15) due to diminishing returns of capital. Simons, Microeconomics I, 22 Isoquants When Inputs Are Perfect Substitutes Capital per A Month B C Q1 Q2 Q3 Labour per Month Simons, Microeconomics I, 23  Production with Two Variable Inputs Perfect Perfect Substitutes Substitutes Notes on inputs that are perfect substitutes for one another: 1) The MRTS is constant at all points on an isoquant. 2) For a certain output any combination of inputs (A, B or C) can be chosen to reach the same production level. Simons, Microeconomics I, 24 Fixed-Proportions Production Function Capital per Month Q3 C Q2 B K1 Q1 A Labour L1 per Month Simons, Microeconomics I, 25  Production with Two Variable Inputs Fixed-Proportions Fixed-ProportionsProduction ProductionFunction Function Notes, when inputs have to have a fixed proportion: 1) A substitution is not possible. Each level of output requires a specific combination of the inputs (e.g. worker and jackhammer). 2) Additional output cannot be obtained unless more capital and more labour are added in specific proportions (i.e. a change from A to B to C, which is technically efficient). Simons, Microeconomics I, 26