Short Run and Long Run Theory - Economics Video Lecture | SSC CGL Tier 2 - Study Material, Online Tests, Previous Year

I'd like to welcome you to the next
lesson which is on production functions
and more specifically long run
production functions it's a very
important part of microeconomics and
we're gonna go from this on the kind of
journey looking at how firms produce the
costs of production based upon their
methods of production and then looking
at revenue functions and finally looking
at coffee maximization but before we get
down that that journey down the road
there we have to look at some basics to
do with what firms produce and how they
produce it okay I'm going to take an
example of some nice cookies so
hopefully you're not too hungry before
we start this this lesson if you are
then sort yourselves out quickly these
are the learning outcomes it's quite a
short presentation here but some are
very key concepts of microeconomics
looking at production functions where
output of for example cookies is related
or a function of capital and labor and
land the resources that firms have we
can look at the difference between the
long run and the short run and this term
called isochron which I'm going to leave
for a few minutes
likewise the next one and then of course
how firms can produce using different
production methods they can use for
example relatively capital intensive
methods of production or relatively
labor intensive methods of production
depending upon the costs of factors of
production and availability in markets
and finally with a couple of MC cues for
you to look at
okay let's get cracking production
functions the output we're going to take
as being a nice plate of delicious
home-baked cookies which you can see
them there and we're going to look at a
bit of theory here we're going to have
two axes with two factors of production
capital and labor don't forget capital
of course is physical capital used to
make other goods and services so in the
case of the cookie we're talking about
we're talking about Hubbins the fixed
assets for example and also the raw
materials are going to make in the
cookie that chocolate chips the sugar
the flour eggs and whatever else goes
into making them they're all part of
capital and of course labor we're going
to have in this case probably the other
master chef so we have capital and labor
we have these curves here these are
called ISO quads but I'm not going to
discuss them for a few minutes this
particular curve here looks at an output
okay and we're going to assume that
anywhere on this curve okay we are
producing 500 cookies per day that's the
output level now it's called an ISO
quant because there's an equal quantity
the word ISO is a Greek word meaning
equal I'm sure you remember isosceles
triangles triangles with equal angles
and here we have an equal quantity so
wherever you are on this one particular
curve this one particular i so quant you
are producing 500 cookies per day okay
whereas if you move on to the next ISO
quant over here okay you are producing
at a higher output level 1000 cookies
per day so if you're producing for
example at that point there you're
producing a thousand cookie today using
relatively capital into
means of production you do have some
labor but you have relatively more
capital than labor if you're down here
okay at that point there you are
producing 500 cookies per day and you
are using a relatively high amount of
labor and relatively less capital so an
ISO quant represents a quantity of
production per time period if we move on
to a different ISO quant we have a
different production level and all
points on the same iso quant represents
an equal quantity of goods for whatever
time period we are talking about and
then you can trace out the path which a
firm follows as it increases production
so for example at this particular output
level here it might be 100 cookies per
day the firm's just started out they're
using a certain amount of capital labor
and and capital this pointing in order
for them to produce 500 cookies per day
they have decided based on factor cost
the cost of labour the cost of capital
they have decided to use a certain
amount of labour over here and a certain
amount of of capital and then as they
produce even more they've made some
other decision to produce using a
certain amount of labour and a certain
amount of capital and so on so this
black line here it's a bit kind of
squiggly as I drawn it represents the
the production function in other words
the output of cookies will be a function
of the amount of capital that a firm has
and the amount of labour that the firm
has and I'm gonna represent that now by
k1 in the initial I so quant and l1 for
labour on the initial isoquant they had
decided to use k1 of capital and l1 of
labour but in producing a higher
quantity of cookies they had decided to
use k2 of capital and l2
of Labor and those are firms decisions
based upon availability of factors of
production in local or international
markets and of course therefore the
resultant factor cost in other words the
relative price of factors of production
which we could represent as being
something like this the relative price
of labor would be the price of labor
divided by the price of capital we tend
to use K for capital in economics
because C is used for a macroeconomic
variable called consumption okay
so there we have the relative price of
factors of production and this will
determine to a large extent where the
firm's use relatively more labor or
relatively more capital so now we write
out some of that text it's an important
part of exam technique to be able to
draw diagrams and to be able to refer to
those diagrams in your discussion and of
course to be able to write out the
relationships not just in terms of
letters like K 1 and L 1 but to write
them out in in in prose in effectively
good you know good English that's an
important skill you have to develop so
we're going to have a mixture of
analysis of graphs in our lessons but
also we are going to try to write out of
14 presentations it's rather more
difficult it's a skill you can develop
often by writing out essays and having
feedback on them from your tutors so
production consists of inputs and
outputs inputs are the factors of
production in other words the resources
we have to hear capital and labour I'm
not ignoring land or enterprise but I
can't show them on a two-dimensional
graph output is whatever the firm
produces per time period for Ford so
many cars per per month or per year for
us so many cookies day so a firm who
produces 500 cookies per day with one
oven and let's say two chefs that's the
amount of labour they have that's the
amount of capital they have
now imagine we have an equation 500
cookies Q equals to L and 1k so in other
words two chefs two units of labour and
one other one is of capital here we'll
be able to help us produce 500 cookies
per day this is a kind of you know
production function ignoring enterprise
and land and of course we can switch
that around if we want to and make it Q
equals 2l divided by 500 plus 1k over
over 500 and then we have a production
function of Q expressed as a function of
L and K so we can write our production
function as something like this in more
mathematical terms q is a function of K
and L so Q is a function of K and L
if you were to double the inputs so now
you have four units of labour and two
units of capital what would you expect
to happen well you're gonna get more
cookies I expect but it may not be a
thousand it could be more than a
thousand and it could be less than a
thousand and that's a topic we'd come
back to later where we look at the
returns to scale okay if we double the
input and the output also doubles we
have constant returns to scale and if
not nation we just talked about ISO
quads and the ISO Quan that we drew was
roughly convex to the origin my drawings
not too good here but you can see it's
pretty much convex to the origin and
that that implies a certain relationship
that you know as you have less of one
factor of production okay as you have
less for example labour you're gonna
have to substitute with less capital
here sorry you're gonna have more labour
so you can have less ovens for example
let's say half an oven but you need to
have three chefs or you can have less
labour let's say you have one chef and
then you have to have for example three
ovens so here capital and labor are to
some extent substitutable because we can
still produce our 500 cookies by having
less capital less ovens but we must
substitute for the loss of the ovens by
having extra labor and vice versa so
labor and capital are to some extent
substitutable in the production of
cookies and we say here that when the
curve is convex to the origin then the
relationship is one where they the
resources are not perfect substitutes
but for example as we lose a certain
amount of capital here we have to
substitute with a certain amount of
labour but down here when we substitute
when we lose the same amount of capital
we have to substitute with
more labor and that's because of what we
call diminishing marginal returns to
labor or to any factor of production we
still need capital and right down here
we've lost a lot of capital and it's
more difficult for labor to substitute
so you need even more labor than before
to substitute for the same loss of
capital so when you have a convex to the
origin ISO quant it implies that the
factors of production are imperfectly
substitutable now that is not always the
case there are different scenarios and
these ISO cons can actually have
different shapes and the examiners do
like to ask about that in multiple
choice questions so I have two different
scenarios coming up here the first one
is where capital and labor are gay can
be perfect substitutes not imperfect so
cookies can be cooked with extra ovens
and less labor or more labor and less
capital and even we can have a situation
where we use only capital or only labor
and we show this and wonder if you can
actually guess before I demonstrate
before I show it I'll give you a few
seconds to think about it
what shape do you think the isoquant
will be when capital and labor are
perfect substitutes
okay I'm gonna click in about and what
do you think five seconds okay one two
three four five there you go okay so
here capital and labor are perfect
substitutes you can produce cookies with
only capital or only labor and as you
lose a certain amount of capital the
amount of labor you require per unit of
capital loss will always be the same
because in this scenario labor and
capital are perfect substitutes may not
be too realistic but we do learn these
theoretical paradigms often to contrast
with more realistic situations maybe a
more realistic one in certain situations
is the one coming up now here we have
capital and labor which must be employed
in fixed proportions and one factor of
production cannot substitute for the
other one at all so here production is
according to fixed proportions of
capital and labor now I wonder if you
can guess what it looks like here I'm
gonna give you up to 10 seconds to
working out okay I'm going to count to
myself ten seconds that's three eight
nine ten here we go it's actually
l-shaped
and the reason is that the firm needs to
have this much capital it could be a
certain amount of oven space for a tray
of cookies and a certain amount of labor
in terms of minutes required to to get
the to do the food preparation and put
the the tray of uncooked
mixture into the oven for baking and if
you want to produce more cookies that's
frankly no point having an extra oven or
there's no point in having extra labor
there's simply no point you need to have
a fixed amount of capital and labor if
you want to produce more cookies then
you move on to a new isoquant which will
also be kind of l-shaped like that and
again you're going to produce here so
your production function will just be a
line that draws together and and go
through all of these different points
where the right angle is formed okay
there's no point employing more capital
than you need because you're inking it
you can increase your costs and there's
no point similarly of using more labor
because again you're going to have
higher cost right so there we have two
different scenarios do learn them and
understand them for multiple Church
questions in particular
okay now in the long term we are
focusing in this presentation only on
the long term and I have a separate
presentation just for the short term for
you to separate out the thought
processes that you have completely on
these two topics okay it's very
important to distinguish between the
long term and the short term in
economics there's actually no time
period specified in economics for that
the long term is is a time period in
which all factors of production are
variable there are no fixed factors you
can have more ovens or more chefs and
more land and more enterprise as much as
you want and in any combination that you
want you can double them all you can
triple them all you can have them all or
make them one third you have that
flexibility the short term is defined as
a period when at least one of those
factors is fixed in supply and that's
the topic of a whole different
presentation right here we're going to
just clarify graphically a bit more on
isoquants and on different production
functions that reflect different
production methods so here we have an
ISO quant which represents a production
of 500 cookies per day and we have two
different production methods so the
convex to the origin curve here
containing a see there's a and there C
represents different ways of producing
500 cookies per day so it's called an
ISO quant equal quantity high so quant
point a over here is a relatively
capital intensive method of production
tp1 that we're going to see in a minute
traces out a long-run production
function using capital intensive means
of production there we have a new ISO
quant with a higher level of production
and there you have the production
function which is tp1 using relatively
high amounts of capital and
relatively low amounts of labour so it
could be for example that you have two
ovens and one chef let's call that the
relatively capital intensive means of
production of our 500 cookies per day
now it may be that in the particular
country you live in
the price of capital happens to be
relatively high it could be a country
where capital is relatively scarce not
abundant and therefore for a firm
maximizing profits it might make more
sense rationally for profit maximization
to use a different method of production
so where labor costs are relatively
lower than capital costs in other words
the relative price of labour is lower
then it makes sense to use a different
production method which is tp2 going
through Point C and D we're still
producing 500 and 1000 but we're using a
different production method we're going
to use more labour we have another chef
over here and we're going to get rid of
one oven so we're now going to have two
units of labour and one unit of capital
for the same output so Point C there
represents a relatively labor-intensive
method of production and tp2 here traces
out a long-run production function using
labor-intensive means of production and
which one the firm chooses will depend
upon the relative price of factors of
production okay understand and learn the
method of discussion terms like relative
price are factors of production I so
quant production functions all these
terms are critical because in almost
every single assessment you're going to
be asked for some kind of discussion as
well even of course with advanced
placement you're gonna have more weight
given to multiple choice questions but
you still have 30% given to
structured