Basic Production Concepts 191a single input. Then we consider production in the long run, when the firm
has the flexibility to vary the amounts of all inputs. Next, we turn to the vari-
ous types of production functions and discuss the means by which they are
estimated. Finally, we consider a number of constrained production decisions
involving the allocation of inputs (in fixed supply) to multiple plants or prod-
ucts, or both.BASIC PRODUCTION CONCEPTS
Productiontransforms inputs into outputs. For instance, producing automo-
biles requires a variety of inputs (also called factors of production): raw mate-
rials (steel, plastic, rubber, and so on), factories, machines, land, and many
different categories of workers. For analysis, it is convenient to refer to two
main categories of inputs—labor and materials on the one hand and long-term
capital on the other—with each category broadly defined. Labor and materi-
als includes production workers, marketers, and managers at all levels as well
as raw materials and intermediate goods, including parts, water, and electric-
ity. Capital includes buildings, equipment, and inventories.
The firm’s production functionindicates the maximum level of output the
firm can produce for any combination of inputs. We will start by considering a
production function with two inputs, labor and capital.^1 A shorthand descrip-
tion of such a production function is[5.1]This states that the firm’s quantity of output depends on the respective quan-
tities of labor (L) and capital (K). For instance, a major domestic automobile
manufacturer might plan to produce 3 million passenger cars per year, using
materials (of all kinds) that cost $24 billion, a total nationwide labor force of
80,000 workers, and a total capital stock valued at $100 billion. Note that the
firm’s production function specifies the maximum output for a given combina-
tion of inputs. It assumes that managers use inputs efficiently. Obviously, pro-
duction technologies improve over time, and efficient firms vigorously pursue
these improvements.QF(L, K).
(^1) As we have said, production also requires material inputs. For now, we assume that the firm has
little or no flexibility with respect to this input. Each part requires a fixed amount of raw materi-
als; producing twice as many parts requires twice as much raw materials and so on. Accordingly, the
production function focuses on labor and capital and does not list the implicit amount of raw mate-
rials associated with each level of output. A more detailed production function might disaggre-
gate materials into scores of categories, separate labor into numerous job descriptions, and
disaggregate capital expenditures.
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