# 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. 