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

wpp.png

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

wpp

  • 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.

wpp.png

 

 

 

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