Govt Emerson College, Multan

Name: Iqra Khalil

Roll No: 44

Department: BS Economics

Semester: 4th
 Production Function

Y
Production Function
40

35

30
Output

25

20
Y=F (K’, N)
15

10

0
0 1 2 3 4 5 6
N

Employment

Marginal Product of Labor

MPN

12

10

0
0 1 2 3 4 5 6
-2

-4
Series 2
Employment N
Explanation:

In economics, a production function gives the technological relation between

quantities of physical inputs and quantities of output of goods. The production
function is one of the key concepts of mainstream neoclassical theories, used to
define marginal product and to distinguish allocative efficiency, a key focus of
economics. One important purpose of the production function is to address
allocative efficiency in the use of factor inputs in production and the resulting
distribution of income to those factors, while abstracting away from the
technological problems of achieving technical efficiency, as an engineer or
professional manager might understand it.

For modelling the case of many outputs and many inputs, researchers often use the
so-called Shephard's distance functions or, alternatively, directional distance
functions, which are generalizations of the simple production function in
economics.

In macroeconomics, aggregate production functions are estimated to create a

framework in which to distinguish how much of economic growth to attribute to
changes in factor allocation (e.g. the accumulation of physical capital) and how
much to attribute to advancing technology. Some non-mainstream economists,
however, reject the very concept of an aggregate production function.
 Labor Demand

MPN,W/P
12

10

6
Real wage

0
0 1 2 3 4 5 6
-2

Eployement
-4 N

By the end of this section, you will be able to:

• Predict shifts in the demand and supply curves of the labor market
• Explain the impact of new technology on the demand and supply curves of the labor
market
• Explain price floors in the labor market such as minimum wage or a living wage

Markets for labor have demand and supply curves, just like markets for goods. The law of
demand applies in labor markets this way: A higher salary or wage—that is, a higher price in the
labor market—leads to a decrease in the quantity of labor demanded by employers, while a lower
salary or wage leads to an increase in the quantity of labor demanded. The law of supply
functions in labor markets, too: A higher price for labor leads to a higher quantity of labor
supplied; a lower price leads to a lower quantity supplied.

The demand for labor will be negatively sloped in all types of production for two reasons. First, a
rise in the wage rate increases the costs of firms producing the commodity, forcing them to raise
their selling prices. As the price of the product rises consumers will buy less of it and less output
will be produced and sold. This means that less labor will be used. Second, since a rise in wages
makes labor more expensive relative to capital, firms will substitute capital for labor. This means
that less labor will be used to produce whatever output the firms in the industry sell.
If the wage is free to adjust in response to market forces it will move to, We, where the demand
for labor equals the supply. When the wage is above, We, more labor will be presented for
employment than firms in the industry can profitably hire. It will pay workers to lower their
wages to obtain employment in the industry. And when the wage is below, We, firms will find it
profitable to hire more labor than is presenting itself for employment. They will offer a higher
wage to obtain additional workers.

Unemployment can only result in an industry if the wage is above the market equilibrium and
some institutional force keeps it from being bid down---for example, a union-industry agreement
might fix the wage at Wu, in Figure 2. This will mean that workers who are willing to work in
the industry at a wage above We, but below Wu, will not find employment there. This does not
mean, of course, that there will be unemployment in the economy because the workers who are
displaced from this industry will simply bid wages down and find employment in the non-
unionized sector.

Labor Supply:

Labor Supply Curve

In mainstream economic theories, the labor supply is the total hours (adjusted for intensity of
effort) that workers wish to work at a given real wage rate. It is frequently represented
graphically by a labor supply curve, which shows hypothetical wage rates plotted vertically and
the amount of labor that an individual or group of individuals is willing to supply at that wage
rate plotted horizontally.

Labor supply curves derive from the 'labor-leisure' trade-off. More hours worked earn higher
incomes but necessitate a cut in the amount of leisure that workers enjoy. Consequently, there
are two effects on the amount of labor supplied due to a change in the real wage rate. As, for
example, the real wage rate rises, the opportunity cost of leisure increases. This tends to make
workers supply more labor (the "substitution effect"). However, also as the real wage rate rises,
workers earn a higher income for a given number of hours. If leisure is a normal good—the
demand for it increases as income increases—this increase in income tends to make workers
supply less labor so they can "spend" the higher income on leisure (the "income effect"). If the
substitution effect is stronger than the income effect, then the labor supply slopes upward. If,
beyond a certain wage rate, the income effect is stronger than the substitution effect, then the
labor supply curve bends backward. Individual labor supply curves can be aggregated to derive
the total labor supply of an economy.
Equilibrium output and employment:

We have already briefly discussed how a competitive labor market attains equilibrium. We
now provide a more detailed discussion of the properties of this equilibrium. Figure 4-1
illustrates the familiar graph showing the intersection of labor supply (S) and labor demand
(D) curves in a competitive market. The supply curve gives the total number of employee-
hours that agents in the economy allocate to the market at any given wage level; the demand
curve gives the total number of employee-hours that firms in the market demand at that
wage. Equilibrium occurs when supply equals demand, generating the competitive wage w *
and employment E *. The wage w * is the market-clearing wage because any other wage
level would create either upward or downward pressures on the wage; there would be too
many jobs chasing the few available workers or too many workers competing for the few
available jobs. Once the competitive wage level is determined in this fashion, each firm in
this industry hires workers up to the point where the value of marginal product of labor
equals the com-putative wage. The first firm hires E1 workers; the second firm hires E2
workers; and so on. The total number of workers hired by all the firms in the industry must
equal the market’s equilibrium employment level, E *.
Technology and Wages: Applying Demand and Supply (a) The demand for low-skill labor shifts
to the left when technology can do the job previously done by these workers. (b) New
technologies can also increase the demand for high-skill labor in fields such as information
technology and network administration.

Classical supply curve