03-LECTURE NOTES - Production Function - MANAGERIAL ECONOMICS

LECTURE NOTES
ON
MANAGERIAL
ECONOMICS
Production Function
LEARNING OBJECTIVES
Define the production function
KEY TAKEAWAYS
Key Points
• The production function describes a boundary or frontier representing the limit

of output obtainable from each feasible combination of inputs.
• Firms use the production function to determine how much output they should
produce given the price of a good, and what combination of inputs they should
use to produce given the price of capital and labor.
• The production function also gives information about increasing or decreasing
returns to scale and the marginal products of labor and capital.
Key Terms
• Production function: Relates physical output of a production process to

physical inputs or factors of production.
• marginal cost: The increase in cost that accompanies a unit increase in
output; the partial derivative of the cost function with respect to output.
Additional cost associated with producing one more unit of output.
• output: Production; quantity produced, created, or completed.
In economics, a production function relates physical output of a production process to

physical inputs or factors of production. It is a mathematical function that relates the
maximum amount of output that can be obtained from a given number of inputs –
generally capital and labor. The production function, therefore, describes a boundary
or frontier representing the limit of output obtainable from each feasible combination
of inputs.
Firms use the production function to determine how much output they should produce
given the price of a good, and what combination of inputs they should use to produce
given the price of capital and labor. When firms are deciding how much to produce
they typically find that at high levels of production, their marginal costs begin
increasing. This is also known as diminishing returns to scale – increasing the quantity
of inputs creates a less-than-proportional increase in the quantity of output. If it weren’t
for diminishing returns to scale, supply could expand without limits without increasing
the price of a good.
Factory Production: Manufacturing companies use their production function to determine the optimal
combination of labor and capital to produce a certain amount of output.
Increasing marginal costs can be identified using the production function. If a firm has
a production function Q=F(K,L) (that is, the quantity of output (Q) is some function of
capital (K) and labor (L)), then if 2Q<F(2K,2L), the production function has increasing
marginal costs and diminishing returns to scale. Similarly, if 2Q>F(2K,2L), there are
increasing returns to scale, and if 2Q=F(2K,2L), there are constant returns to scale.
Examples of Common Production Functions
One very simple example of a production function might be Q=K+L, where Q is the
quantity of output, K is the amount of capital, and L is the amount of labor used in
production. This production function says that a firm can produce one unit of output
for every unit of capital or labor it employs. From this production function we can see
that this industry has constant returns to scale – that is, the amount of output will
increase proportionally to any increase in the amount of inputs.
Another common production function is the Cobb-Douglas production function. One

example of this type of function is Q=K0.5L0.5. This describes a firm that requires the
least total number of inputs when the combination of inputs is relatively equal. For
example, the firm could produce 25 units of output by using 25 units of capital and 25
of labor, or it could produce the same 25 units of output with 125 units of labor and
only one unit of capital.
Finally, the Leontief production function applies to situations in which inputs must be
used in fixed proportions; starting from those proportions, if usage of one input is
increased without another being increased, output will not change. This production
function is given by Q=Min(K,L). For example, a firm with five employees will
produce five units of output as long as it has at least five units of capital.

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LECTURE NOTES

Define the production function

• The production function describes a boundary or frontier representing the limit

• Production function: Relates physical output of a production process to

In economics, a production function relates physical output of a production process to

Examples of Common Production Functions

Another common production function is the Cobb-Douglas production function. One

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