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CHAPTER FIVE
PRODUCTION
OBJECTIVES
1. To introduce the concept of production and to lay the groundwork for the
later discussion about cost. (Basic Production Concepts)
2. To explain short-run concepts including fixed inputs, marginal product,
and diminishing marginal returns. (Production in the Short Run)
3. To explain, long-run concepts, including returns to scale, output elasticity,
and least-cost production. (Production in the Long Run)
4. To examine different types of production functions and their graphical
representations. (Measuring Production Functions)
4. To explore optimization in the context of production using marginal
analysis. (Other Production Decisions)
TEACHING SUGGESTIONS
I. Introduction and Motivation
There seems to be a renaissance these days in the area of production. It has
gotten renewed interest in the press, in business schools, in engineering
departments and in industry. A lot of talk about "competitiveness" and
"industrial policy" turns on issues of production. We feel it is very useful to
motivate students as to the importance of production. It is the core of what
businesses do.
This chapter gives an introduction to the economics of production and, even
so, just scratches the surface. The main purpose is to lay the groundwork
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for a discussion of cost. In addition, this chapter provides another
opportunity to discuss optimization and marginal analysis.
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II. Teaching the "Nuts and Bolts"
Students often confuse short-run and long-run concepts (for example, the
law of diminishing marginal returns and returns to scale). We find it is
useful to highlight the differences by asking for concepts associated with
each and putting these on the chalkboard. Here is an example:
Short-run Long-run
Some inputs are fixed All inputs are variable
Law of diminishing marginal returns Returns to scale: constant, increasing
or decreasing
Marginal product Input elasticity
Total product curve Isoquants
Inputs and Outputs. Students sometimes get confused between inputs and
outputs when dealing with marginal concepts. That is they get confused
between marginal revenue and marginal revenue product. They also
confuse marginal cost (per unit output) and marginal cost per unit input.
We suggest emphasizing this distinction over and over again. Here is one
possible approach:
What we say What we mean
Marginal revenue Marginal revenue per unit of output
Marginal cost Marginal cost per unit of output
Marginal revenue product Marginal revenue per unit of input
Marginal cost per unit of input,
for instance, the wage
Marginal cost per unit of input
It is also important to emphasize the following:
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1. MRP is just MR times MP. If the firm is perfectly competitive in the
output market then MRP = (P)(MP).
2. Marginal cost per unit of input is usually just the price of the input.
(That is, if the firm is too small to affect input price.)
3. When optimizing by equating marginal revenue and marginal cost it is
important that both be per unit output or both be per unit input.
Isoquants. Some students have problems with the notion of isoquants. One
way to approach this is to ask how a production function with output as a
function of two inputs might be represented graphically. One way is with a
family of total product curves. For example, each curve could graph Q as a
function of L with a distinct K held constant. With this family of curves we
could determine output for any given combination of K and L. (Of course, if
there was not a curve for the chosen value of K we would have to
interpolate.)
The other way to represent the production function is through isoquants. It
is sometimes useful to get the students to view isoquants as they would a
topographic map. Pretend that quantity values are elevations. Now consider
the problem of maximizing output for a given level of cost. The cost
constraint can be thought of as a fence with the goal to get to the highest
elevation while constrained by the fence.
ADDITIONAL MATERIALS
I. Short Readings
J. Trop, “ Steel Industry feeling Stress as Automakers Turn to Aluminum,”
The New York Times, February 24, 2014, p. B1.
M. Ramsey, “Fuel Goal Tests Ford’s Mettle,” The Wall Street Journal,
January 13, 2014, p. B1.
J. Markoff, “Skilled Work without the Worker,” The New York Times, August
19, 2012, p. A1.
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C. Woodyard, “Ford Focuses on Flexibility,” USA Today, February 28, 2011,
p. 1B.
T. Schlesinger, “On the World’s Largest Cruise Ship, the Sea is an
Afterthought,” The New York Times, February 13, 2011, pp. TR8, TR9.
K. Linebaugh, “Honda’s Flexible Plants Provide Edge,” The Wall Street
Journal, September 23, 2008, p. B1.
“Calling across the Divide,” The Economist, March 12, 2005, p. 74.
(The link between cell phones and economic growth in the developing
world.)
H. R. Varian, “IT May or May Not Matter; it Depends How You Use it,” The
New York Times, May 6, 2004, p. C2.
L. Zinser, “Path to the Super Bowl No Longer Lined with Stars,” The New
York Times, February 1, 2004, p. A12. (Building a winner under the salary
cap.)
V. Postrel, “Lessons in Keeping Business Humming, Courtesy of Wal-Mart
U,” The New York Times, February 28, 2002, p. C2.
“Incredible Shrinking Plants,” The Economist, February 23, 2002, pp. 71-73.
“A Long March,” The Economist, July 14, 2001, p. 63.
(This article surveys the progress of mass customization.)
II. Longer Readings
J. Romley and N. Sood, “Identifying the Health Production Function: The
Case of Hospitals, NBER Working Paper W19490, 2013.
R. Mosheim and C. Lovell, “Scale Economies and Inefficiency of US Dairy
Farms,” American Journal of Agricultural Economics 91(3), August 2009,
777–794.
Cookenboo, L., “Production Functions and Cost Functions: A Case Study,”
in Managerial Economics and Operations Research, edited by Edwin
Mansfield, W.W. Norton & Co., 1993.
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III. Quips and Quotes
Knowledge is the only instrument of production that is not subject to
diminishing returns. (J.M. Clarke)
Advice from the coach to his star player who has made four Fs and one D:
“Son, look's to me like you're spending too much time on one subject."
Production not being the sole end of human existence, the term unproductive
does not necessarily imply any stigma. (John Stuart Mill)
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