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MANAGERIAL ECONOMICS
PRODUCTION ●​ Example:
Theory of the Firm ○​ If our electronics firm operates
●​ Describes how a firm makes in a country with low wage
cost-minimizing production decisions rates, it may decide to produce
and how the firm’s resulting cost televisions by using a large
varies with its outputs. amount of labor, thereby using
very little capital.
The Production Decision of a Firm
Production Technology The Production Function
●​ A firm can produce a particular level of ●​ Describes the relationship between
output by using different combinations the inputs into the production process
of inputs and the resulting output by a
●​ Example: production function.
○​ An electronic firm might ●​ A production function indicates the
produce 10,000 televisions per highest output (q) that a firm can
month by using a substantial produce for every specified
amount of labor and very little combination of inputs.
capital ●​ q= F(L,K)
○​ Building a highly automated
capital-intensive factory and Short-Run
using very little labor ●​ Refers to a period of time in which the
Cost Constraints quantities of one or more factors of
●​ Firms must take into account the production cannot be changed
prices of labor, capital, and other ●​ There is at least one factor that cannot
inputs. Just as a consumer is be varied; such a factor is called a
constrained by a limited budget, the fixed input
firm will be concerned about its cost of ●​ Firms vary the intensity with which
production. they utilize a given plant and
●​ Example: machinery
○​ The firm that produces 10,000 ●​ All fixed inputs in the short-run
televisions per month will want represent the outcomes of previous
to do so in a way that long-run decisions based on estimates
minimizes its total production of what a firm could profitably produce
cost, which is determined in and sell.
part by the prices of the inputs ●​ Short enough that the quantity used of
it uses. at least one input cannot be
Input Choices immediately changes in response to a
●​ Given its production technology and desired change in output
the prices of labor, capital, and other ●​ Short enough that the shape of the
inputs, the firm must choose how product fxn is not altered through
much of each input to use in technological progress
producing its output. ●​ Sufficiently long enough that you can
●​ The firm must take into account the produce something
prices of different inputs when Long-Run
deciding how much of each input to ●​ The amount of time needed to make
use. all inputs variable.
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MANAGERIAL ECONOMICS
●​ There is no specific time period, such ●​ The law of diminishing marginal
as one year returns usually applies to the short run
when at least one input is fixed
Production with One Variable Input (Labor)
Labor Productivity
●​ When capital is fixed but labor is ●​ The average product of labor for an
variable, the only way the firm can entire industry or for the economy as a
produce more output is by increasing whole
its labor input. ●​ Provide useful comparisons across
Average Product of Labor industries and for one industry over a
●​ The average product is calculated by long period.
dividing the total output q by the total ●​ Especially important because it
input of labor L. determines the real standard of living
●​ APL that a country can achieve for its
●​ =Output/labor input = q/L citizens
Marginal Product of Labor Causes of productivity growth
●​ MPL ●​ Stock of capital
●​ The additional output produced as the ○​ Total amount of capital
labor input is increased by 1 unit. available for use in production
●​ =Change in output/change in labor ●​ Technological change
input ○​ The development of new
●​ Positive as long as output is technologies allowing factors
increasing, but becomes negative of production to be used more
when output is decreasing. effectively
●​ The marginal product is above the
average product when the average Production with Two Variable Inputs
product is increasing and below the Isoquants
average product when the average ●​ Curve showing all possible
product is decreasing. combinations of inputs that yield the
●​ The marginal product must equal the same output
average product when the average Isoquant Map
product reaches its maximum ●​ Graph combining a number of
isoquants, used to describe a
The Average Product of Labor Curve production function.
●​ The average product of labor is given Input Flexibility
by the slope of the line drawn from the ●​ Isoquants show the flexibility that firms
origin to the corresponding point on have when making production
the total product curve decisions: They can usually obtain a
●​ The marginal product of labor at a particular output by substituting one
point is given by the slope of the total input for another. It is important for
product at that point. managers to understand the nature of
this flexibility.
The Law of Diminishing Marginal Returns ●​ For example, fast-food restaurants
●​ States that as the use of an input have recently faced shortages of
increases in equal increments (with young, low-wage employees.
other inputs fixed), a point will Companies have responded by
eventually be reached at which the automating—adding selfservice salad
resulting additions to output decrease. bars and introducing more
●​ Principle that as the use of an input sophisticated cooking equipment.
increases with other inputs fixed, the They have also recruited older people
resulting additions to output will to fill positions.
eventually decrease
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MANAGERIAL ECONOMICS
Diminishing Marginal Returns
●​ Even though both labor and capital
are variable in the long run, it is useful
for a firm that is choosing the optimal
mix of inputs to ask what happens to
output as each input is increased, with
the other input held fixed.

Marginal rate of technical substitution