Producer Behaviour
Producer Behaviour
This domain examines how a firm converts inputs into output. The exam tests the short-run production function, total, average and marginal product, the law of variable proportions, returns to scale, isoquants and the least-cost combination.
Core rules
- In the short run at least one input is fixed; in the long run all inputs are variable.
- TP is total output; AP = TP ÷ units of variable input; MP = change in TP ÷ change in variable input.
- The law of variable proportions has three stages: increasing returns (MP rises, then AP rises), diminishing returns (MP falls but remains positive, AP falls), and negative returns (MP becomes negative, TP falls). A rational producer operates in stage II.
- MP intersects AP at AP maximum. When MP is above AP, AP rises; when MP is below AP, AP falls.
- Returns to scale describe output response when all inputs change proportionately: increasing, constant or decreasing.
- An isoquant shows input combinations yielding the same output; MRTS is its slope. Producer equilibrium is where the isoquant is tangent to the isocost line, or MP of labour divided by wage equals MP of capital divided by rental.
Worked example
With one fixed input, employing 1, 2, 3 and 4 workers gives TP 10, 24, 33 and 36. AP is 10, 12, 11 and 9. MP is 10, 14, 9 and 3. AP rises while MP exceeds AP and falls once MP falls below AP; AP peaks at 12 with two workers, where MP is still above AP. Diminishing returns begin after the second worker because MP falls from 14 to 9.
Traps
Do not say MP is always falling; it rises initially. Do not confuse diminishing returns to a variable factor with decreasing returns to scale. AP can rise even when MP is falling, as long as MP is above AP. Remember that stage II begins where AP is maximum, not where MP is maximum.