Production

–Basic Production Concept

–Production with one Variable Input
–Production in the Long Run
 BASIC PRODUCTION
CONCEPT
Production is a process of combining various inputs to produce an
output in order to make something for consumption. It is an act of
creating an output in the form of commodity or service which
contributes to the utility of individuals.

It is an organized activity of transforming resources into finished

products in the form of goods and services and its objective is to
satisfy the demand for such transformed resources.

Therefore, it makes clear that, in economics, we do not treat the mere

making of things as production. What is made must be designed to
satisfy wants. Therefore, it is comprising all activities which provide the
goods and services which people want and for which they are
prepared to pay the price.
 FUNCTION

Production function signifies the technical relationship between the

physical inputs and physical output of the firm. It is a tool that
analyze the qualitative input-output relationship that represents the
firm. It also indicates the maximum level of output the firm can
produce for any combination of inputs.
 INPUT-OUTPUT
RELATIONSHIP
Input are the factors of production that are used to obtain a target
output. This includes the land and its natural resources, labor and
capital. Output is the end result of the input or the saleable goods for
which the consumers are willing to buy.

Raw materials are purchased and being transformed into different

goods or services which it sells to its customers and other business
firms. Production is basically concerned with changing the form of
things, changing raw materials into finished articles. Production
means creation of new utility. Man takes the things given by nature
(input) and simply gives it a new form (output) so that it becomes
more useful to the consumer.
 BASIC FACTORS OF
PRODUCTION
Land – in the economic sense is the natural resources of this planet. It is not only land itself but
also what lies under the land (like coal and gold), what grows naturally on top of the land (forest,
animals) and what is around the land in the seas and oceans (fish and oil).
Labor – is the human input to the production process. It includes physical and mental abilities
that covers clerical, managerial and administrative functions as well as skilled and unskilled
manual work. Labor is perishable and is quantifiable. Not all labor is of the same quality because
of human capital. Some workers are more productive than others because of the education,
training and experience they have received. The greater the human capital of the worker the
more he or she is productive. And the bigger the organization then usually the wider is the variety
of human work required.
Capital – is any product of land and labor which is reserved for use in future production. It is
that part which is not used for the purpose of consumption but is utilized in the process of
production. Capital last a long time but eventually needs replacing. When its value declines with
age, it is said to be depreciating.
 Examples of Factors of
Production
FACTOR OF ENGINEERING
FARMER DENTIST
PRODUCTION COMPANY

Factory Site Dental Clinic

Land Rice field Crops
Warehouse Medicines
Skilled workers
Labor Farm Laborer Managerial Receptionist
workers

Machinery and Dental Chair and

Capital Tractor
Equipment other equipment
 CLASSIFACATIONS OF
OUTPUT
 Fixed – are the inputs whose quantity is constant for some
period of time or constant for short run production function.

 Variable – are inputs whose quantity can vary, even in the

short run or for short period of time. It will change
depending upon how much we choose to produce.
PRODUCTION
WITH ONE
VARIABLE
INPUT
 Short run production
•Period of time in which quantities of one or more production factors
cannot be change. The inputs are called fixed inputs.

•When discussing production in the short run, three definitions are

important:

 Total product
 Marginal Product
 Average product
 TOTAL PRODUCT
•It gives maximum of output that can be produced at different levels of one input, assuming that the other input is fixed
at a particular level.

MARGINAL PRODUCT

TP = Q = f(L)

• Change in the output resulting from a very small change in one

factor input, keeping the other factor inputs constant
• MP tells us how output changes the level of the input by one unit
• The marginal product of input L is defined as holding input K
constant.
TP
MPL =
L
AVERAGE PRODUCT
• The average product (AP) of an input is the total product
divided by the level of the input.

• AP tells us on average, how many units of output are

produced per unit of input used.

• The average product of input L is defined as holding input

K constant.

TP
APL =
L
Law of diminishing marginal
returns
• The declining marginal product of an input (like labor)
represents one of the best know-and most important
empirical laws of production.

• As units of one input are added (with all other input held
constant)resulting additions to output with eventually begin
to decrease; that is marginal product will decline.
PRODUCTION WITH ONE
VARIABLE INPUT
PRODUCTION
IN THE LONG RUN
 Production in the Long-run

• Firm must choose the proportion of inputs to use.

• When both labor and capital are variable.
• Substituting capital (K) for labor (L).
• Determine the scale of it’s operation.
(the movement and out flow of K nd L.)
 Returns to Scale
 The scale of a firm’s operations denotes the level of all the firms
input.
 A change in scale refers to a given percentage change in all inputs.

Returns to Scale- measure the percentage change in output resulting

from a percentage change in input.

Important cases:
1. Constant returns to scale
2. Increase returns to scale
3. Decrease returns to scale
 Constant Returns to Scale
% change output = % change in input

• Occur if a given percentage change in all

inputs result in an equal percentage
change in output
 Increase Returns to Scale

% change output > % change in input

• when an increase in inputs leads to bigger proportional increase

in output.
• Better to used large production facilities to supply output.

How firm do better than return to scale?

Increasing its scale, firm use new production methods that
were infeasible at the smaller scale.
 Decrease Returns to Scale

% change output < % change in input

• These include Organizational Factors

• Difficulties in coordinating and monitoring the many
management function.
 Output Elasticity
% change output = 1% change in input

Increasing return (>1)

Output Elasticity is 1
Decreasing return (<1)
 Least-cost Production

• In the long-run, the firm can vary all of it’s inputs, because inputs
are costly.
Q = F (L, K)

Labor
Capital
Ff. formula using:
A. Total Cost using L & K
B. Two inputs
A.Total Cost using L and K
TC = PL + PK
B. Two Inputs
MPL = MPK
PL PK
 ISOQUANT
• Producing a greater output, requires larger amount of input.
• Isoquant negative slope, embodies the basic trade-off between inputs.
• Shows all possible combinations of input.

Marginal Rate of technical substitution (MRTS)

- Rate of one input substitutes to other.
- The MRTS is equal to the slope of isoquant.

MPL
MRTS = MPK
Given:
PL = 40/ hr.
PK = 60/ unit
MPL = 80
MPK = 90
Q = 500
Labor (L) Capital (K)

6 12

10 8

12 6
 ISOCOST LINE

• is a line that represents all combinations of a firm’s factors

of production that have the same total cost.

Capital Labor

Capital substitute in labor

firm’s total cost is constant