Production Theory

Objectives:

• To understand how producer behave in a market
• To explain the Production Theory and the Law of Diminishing Marginal Returns

Production and Production Theory

• Production – is the transformation of resources into goods and services that have a considerable value to the consumers. In the process of production, the resources are called inputs while the products and services produced in the process of production is called outputs

 

• There are two kinds of Inputs:
  • Fixed Inputs – These resources do not change as the outputs increases or decreases.
    • Land
  • Variable Inputs – These resources changes as the volume of output changes.

 

• Producer’s Objective – is to seek for profit maximization in the market by maximizing revenue while minimizing costs of production.

The Production Function and the Law of Diminishing Marginal Returns

• Production Function – Refers to the greatest output that can be created given an exact number of inputs. Production function is expressed as:
• Output (Q) is a function of:    Q=f(Land,Labor,Capital)
  • Land – are resources which may also refer to raw materials;
  • Labor – are resources came from the efforts exerted by Men to product the output; also refered to as manpower resource;
  • Capital – are resources invested by the man to produce the outputs such as equipments, machinery, and other capital goods.
• The law of diminishing marginal returns states that, at some point, adding an additional factor of production results in smaller increases in output.

 

L	TP	MP	AP
1	10	0	10
2	19	9	9.5
3	26	7	8.7
4	30	4	7.5
5	30	0	6
6	26	-4	4.3
7	19	-7	2.7

Where;

L = Labor Units

TP = Total Product Units

MP = Marginal Product Units = TPn+1 -TPn

AP = Average Product Units = TP/L

Phase	TP	MP	AP
I	Increasing	diminishing	Decreasing
II	maximum	Zero	Decreasing
III	diminishing	Negative	Decreasing

 

Long Run and Short Run Adjustments – In production analysis, two time frames are used.

• Short Run is where a firm adjust only its variable inputs
• Long Run is where all inputs are variable

 

Analysis of Isocosts and Isoquants

• Isocost is a line represents all the possible combinations of two variable inputs that are of equal total cost.
• Isoquant traces out the different combinations of variable inputs that a firm can use to produce the given amounts of output.