CHAPTER 6：INPUTS AND PRODUCTION FUNCTIONS

1. Production function – maximum quantity of output a firm can produce given the quantities
of inputs that it uses.
 Q = f(L,K)

2. Average product of labour – Average amount of output per unit of labour

• APL = Q / L

3. Marginal product of labour – Rate at which total output changes as the quantity of labour
the firm uses is changed
• MPL = ∆Q / ∆L

4. Law of diminishing marginal returns – Marginal products decline as the quantity used of
a single input increases

5. Isoquant – Curve that shows all the combinations of labour and capital that can produce a
given level of output

6. Marginal rate of technical substitution (MRTS) – Rate at which the quantity of capital can
be reduced for every unit increase in quantity of labour, so that output remain constant.
 Slope of the isoquant is negative
7. Special Production Functions

 Linear production function– One type of input is perfectly substituted for another
type.
– MRTSLK is constant
– Q = aL + bK
 Fixed-proportions production function– A production function where the inputs
must be combined in a constant ratio to one another (perfect complements).
– Leontief production function
– Q = min (2L,2K)
 Cobb-Douglas Production Function – Intermediate between a linear production
function and a fixed-proportions production.
– Q = ALαKβ
 Constant elasticity of substitution production function – A type of production
function that includes linear production functions, fixed-proportions production
functions, and Cobb-Douglas production function as special cases.
– Q = [aLσ-1/σ + bKσ-1/σ] σ/σ-1

8. Returns to scale – The concept that tells us the percentage by which output will increase
when all inputs are increased by a given percentage.

%  (quantity of inputs)
Returns to Scale 
%  (quantity of all inputs)
 • Increasing returns to scale – If a 1% increase in all inputs results in a greater than
1% increase in output
• Constant returns to scale – If a 1% increase in all inputs results in exactly a 1%
increase in output
• Decreasing returns to scale – If a 1% increase in all inputs results in a less than 1%
increase in output

9. Return to Scale vs Marginal Returns

• Returns to scale – All inputs are increased simultaneously
• Marginal returns – Increase in the quantity of a single input holding all others constant
• Marginal product of a single factor may diminish while the returns to scale may not
– Slope of MRTSLK is diminishing along the isoquant

10. Technological Progress

• Neutral technological progress – Increase both MPL and MPK
 Isoquant shifts inward and remains the same shape
• Labour-saving technological progress – Increase MPK only → MRTSLK↓
 Isoquant shifts inward and becomes flatter
• Capital-saving technological progress – Increase MPL only → MRTSLK↑
 Isoquant shifts inward and becomes steeper