THEORY OF

PRODUCTION
& PRICING

WHAT IS PRODUCTION?
THE PROCESS OF USING THE
SERVICE OF LABOR AND
EQUIPMENT TOGETHER WITH THE
OTHER INPUTS TO MAKE GOODS
AND SERVICES AVAILABLE.

PERIOD OF PRODUCTION
SHORT RUN
REFERS TO A PERIOD OF TIME IN WHICH THE SUPPLY OF
CERTAIN INPUTS ARE FIXED OR INELASTIC.
LONG RUN
REFERS TO A PERIOD OF TIME IN WHICH SUPPLY OFF ALL
INPUT IS ELASTIC.

PRODUCTION FUNCTION
PHYSICAL RELATIONSHIP BETWEEN
THE FIRMS INPUT AND ITS OUTPUT OF
GOODS AND SERVICES PER UNIT OF
TIME USING A GIVEN PRODUCTION
PROCESS.

FACTORS OF PRODUCTION
1.LAND
.THE ECONOMIC RESOURCE ENCOMPASSING NATURAL
RESOURCES FOUND WITHIN A NATION.
2.LABOR
. REPRESENTS THE HUMAN CAPITAL AVAILABLE TO
TRANSFORM RAW OR NATURAL RESOURCES INTO
GOODS.

3. CAPITAL
.REPRESENT THE MONETARY RESOURCES COMPANIES USE
TO PURCHASE NATURAL RESOURCES, LAND & OTHER
CAPITAL GOODS.
. IT ALSO INCLUDES PHYSICAL ASSETS SUCH AS BUILDING ,
FACILITIES , EQUIPMENT & VEHICLES.
4. ENTREPRENEURSHIP
.ALSO CONSIDERED A FACTOR OF PRODUCTION SINCE
SOMEONE MUST COMPELETE THE MANAGERIAL FUNCTIONS
OF GATHERING, ALLOCATING AND DISTRIBUTING
ECONOMIC RESOURCES OR CONSUMER PRODUCTS TO

LAW OF DIMINISHING MARGINAL

RETURNS
CORRESPOND TO THE USE OF VARIABLE INPUT.
ALSO IMPLIES THAT THE AVERAGE PRODUCT
OF A VARIABLE INPUT WILL EVENTUALLY
DECLINE AS SOME OF THAT INPUT IS USED
TOGETHER WITH FIXED INPUTS.

EXAMPLE:
BOX A SHOWS HOW THE TOTAL PRODUCT
OF A VARIABLE INPUT IS LIKELY TO
INCREASE AND THEN DECREASE IN THE
SHORT RUN.
BOX B SHOWS THE PATTERN OF VARIATION
IN MARGINAL AND AVERAGE PRODUCT IN
THE SHORT RUN.

NUMBER OF
WORKERS
EMPLOYED PER
WEEK

TOTAL PRODUCT OF
MPL ( PAIRS OF
LABOR ( PAIR OF
SANDUGO SANDALS
SANDUGO SANDALS PER PER WEEK)
WEEK)

ARL

18

11

33

15

11

46

13

11.5

55

11

60

10

63

65

8.13

66

7.33

10

66

6.6

11

64

-2

5.82

12

60

-4

Cost
the expenses incurred in the production of
goods.
includes all expenses from the time the raw
material are brought till the finished products
reach the wholesaler.

TYPE OF COSTS
1.FIXED COST
.COSTS WHICH DO NOT VARY WITH THE VOLUME OF
PRODUCTION.
EXAMPLE: RENT, INTEREST, DEPRECIATION, INSURANCE
,SALARIES.
2. VARIABLE COST
.COSTS WHICH CHANGE WITH THE QUANTITY OF PRODUCTION.
ALSO KNOWN AS PRIME OR DIRECT COSTS

3.

BUSINESS COST

INCLUDE ALL THE EXPENSES WHICH ARE INCURRED

TO CARRY OUT A BUSINESS.
4.TOTAL COST
.THE SUM OF TOTAL FIXED COST AND TOTAL
VARIABLE COST.
FORMULA: TC = FC + VC

5. AVERAGE COST

THE COST PER UNIT OF OUTPUT.

THE TOTAL COST DIVIDED BY NUMBER OF
UNITS PRODUCED.
6. MARGINAL COST
THE ADDITIONAL COST TO TOTAL COST
WHEN AN ADDITIONAL UNIT IS PRODUCED.