Production function in long run.

 

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Decisions about production require individual agents to make decisions about the allocation and use of physical inputs. Objectives of agents, technology,availability and quality of inputs determine the nature of these decisions. Sincethe objectives are often pecuniary, it is often necessary to relate the decisionsabout the physical units of inputs and outputs to the costs of production.

If the prices of the inputs and the production relationships are known (orunderstood), it is possible to calculate or estimate all the cost relationshipsfor each level of output. In practice however, the decision maker will probablyhave partial information about some of the costs and will need to estimateproduction relationships in order to make decisions about the relative amountsof the different inputs to be used.

Production is the process of altering resources or inputs so they satisfy morewants. Before goods can be distributed or sold, they must be produced.Production, more specifically, the technology used in the production of a good(or service) and the prices of the inputs determine the cost of production.Within the market model, production and costs of production are reflected inthe supply function.

Production processes increase the ability of inputs (or resources) to satisfy

wants by:

• a change in physical characteristics

• a change in location

• a change in time

• a change in ownership

It its most simplistic level, the economy is a social process that allocates relatively scarce resources to satisfy relatively unlimited wants. To achieve this objective, inputs or resources must be allocated to those uses that have the greatest value. In a market setting, this is achieved by buyers (consumers) and sellers (producers) interacting.

Consumers or buyers wish to maximize their utility or satisfaction given (or constrained by) their incomes, preferences and the prices of the goods they may buy. The behavior of the buyers or consumers is expressed in the demand function.

The producers and/or sellers have other objectives. Profits may be either an objective or constraint. As an objective, a producer may seek to maximize profits or minimize cost per unit. As a constraint the agent may desire to maximize "efficiency," market share, rate of growth or some other objective constrained by some "acceptable level of profits. In the long run, a private producer will probably find it necessary to produce an output that can be sold for more than it costs to produce. The costs of production (Total Cost, TC) must be less than the revenues (Total Revenue, TR).

 

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Given a production relationship (Q = f (labour, land, capital, technology, …)) and the prices of the inputs, all the cost relationships can be calculated.

Often, in the decision making process, information embedded in cost data must be interpreted to answer questions such as;

• "How many units of a good should be produced (to achieve the objective)?"

• "How big should may plant be?' or How many acres of land should I plant in potatoes?"

Once the question of plant size is answered, there are questions,

• "How many units of each variable input should be used (to best achieve the objective)?"

• "To what degree can one input be substituted for another in the production process?"

The question about plant size involves long run analysis. The questions about the use of variable inputs relate to short-run analysis. In both cases, the production relationships and prices of the inputs determine the cost functions and the answers to the questions.

Often decision-makers rely on cost data to choose among production alternatives. In order to use cost data as a "map" or guide to achieve production and/or financial objectives, the data must be interpreted. The ability to make decisions about the allocation and use of physical inputs to produce physical units of output (Q or TP) requires an understanding of the production and cost relationships.

The production relationships and prices of inputs determine costs. Here the production relationships will be used to construct the cost functions. In the decision making process, incomplete cost data is often used to make production decisions.

The theory of production and costs provides the road map to the achievement of the objectives.