Transcript production theory

Production Function
Production Function
 States the relationship between inputs and outputs
 Inputs – the factors of production classified as:
 Land – all natural resources of the earth – not just ‘terra firma’!

Price paid to acquire land = Rent
 Labour – all physical and mental human effort involved in
production

Price paid to labour = Wages
 Capital – buildings, machinery and equipment
not used for its own sake but for the contribution
it makes to production

Price paid for capital = Interest
Production Function
Inputs
Process
Land
Labour
Capital
Product or
service
generated
– value added
Output
Production Function
Production function is the technical relationship
between the output of a commodity and the input
factors required to produce that commodity
 Production involves transformation
of inputs such as capital, equipment,
labor, and land into output - goods
and services
 In this production process, the
manager is concerned with
efficiency in the use of the inputs
- technical vs. economical efficiency
Production Theory
Production is the process through
which one can change a given good
or commodity from its current
status of non-final consumable
good to a finished product or good,
using technology and other input
factors
Analysis of Production Function:
Short Run
 In the short run at least one factor fixed in supply but all
other factors capable of being changed
 Reflects ways in which firms respond to changes
in output (demand)
 Can increase or decrease output using more or less of some
factors but some likely to be easier
to change than others
 Increase in total capacity only possible
in the long run
Relationship Between Total, Average, and
Marginal Product: Short-Run Analysis
 Total Product (TP) = total quantity of
output
 Average Product (AP) = total product per
total input
 Marginal Product (MP) = change in
quantity when one additional unit of input
used
Total, marginal and Average Product
Short-Run Analysis of Total,
Average, and Marginal Product
 If MP > AP then AP
is rising
 If MP < AP then AP
is falling
 MP = AP when AP is
maximized
 TP maximized when
MP = 0
Law of Diminishing Returns
(Diminishing Marginal Product)
Holding all factors constant except one, the law
of diminishing returns says that:
 As additional units of a variable input are
combined with a fixed input, at some point the
additional output (i.e., marginal product) starts
to diminish

e.g. trying to increase labor input without also
increasing capital will bring diminishing returns
 Nothing says when diminishing returns will
start to take effect, only that it will happen at
some point
 All inputs added to the production process
are exactly the same in individual
productivity
Three Stages of Production in Short Run
AP,MP
Stage I
Stage II
Stage III
APX
Fixed input grossly
underutilized; specialization
and teamwork cause AP to
increase when additional X
is used
MPX
Specialization and teamwork
continue to result in greater
output when additional X is used;
fixed input being properly utilized
Fixed input capacity is
reached; additional X causes
output to fall
X
Production Intensity
The production intensity is measured by the
ratio of labor parameter α to capital parameter β
or (α/ β). The lower the ratio, the more capital
intensive is the output and vice versa