Managerial Economics - Production - Essay Example

Inputs are the resources used in the production of goods and services. Inputs are classified into labour, capital and land or natural resources. Inputs are also classified as fixed or variable. Fixed inputs are those that cannot be readily changed during the time period under consideration, except perhaps at very great expense. Variable inputs are those that can be varied easily and on very short notice. The time period through which at least one input is set is called the short run, while the time period when all inputs are variable is called the long run.

The length of the long run depends on the industry. In the short run, a firm can increase output only by using more of the variable inputs together with the fixed inputs. In the long run, the same increase in output could likely be obtained more efficiently by also expanding the firm's production facilities. In the long run, technology usually improves. A production function is an equation, table, or graph showing the maximum output of a commodity that a firm can produce per period of time with each set of inputs.

Both inputs and outputs are measured in physical rather than in monetary units. For simplicity we assume hear that a firm produces only one type of output (commodity or service) with two inputs, labour (L) and capital (K). Thus the general equation of this simple production function is Q = f (L, K). The quantity of output is a function of, or depends on, the quantity of labour and capital used in production. "Output" refers to the number of units of the commodity produced, "labour" refers to the number of workers employed, and "capital" refers to the amount of the equipment used in production.

An explicit production function would indicate precisely the quantity of output that the firm would produce with each particular set of inputs of labour and capital.Optimal Use of Variable InputThe firm should employ an additional unit of labour as long as the extra revenue generated from the sale of the output produced exceeds the extra cost of hiring the unit of labour (i.e., until the extra revenue equals the extra cost). The extra revenue generated by the use of an additional unit of labour is called the marginal revenue product of labour (MRPL).

This equals the marginal product of labour (MPL) times the marginal revenue (MR) from the sale of the extra output produced. This is MRPL = (MPL) (MR). The extra cost of hiring an additional unit of labour or marginal resource cost of labour (MRCL) is equal to the increase in the total cost to the firm resulting from hiring the additional unit of labour. That is, MRCL = TC/L A firm should continue to hire labour as long as MRPL > MRCL and until MRPL = MRCL. Optimization AnalysisOptimization analysis can best be explained by examining the process by which a firm determines the output level at which it maximizes total profits.

While the process the firm maximized total profit was determined above by looking at the total-revenue and total-cost, it is more useful to use marginal analysis. Indeed, marginal analysis is one of the most important concepts in managerial economics in general and in optimization analys