Theory of Production

Learning Objectives
 Explain the production function.
 Explain the principle of diminishing
marginal returns.
 Discuss the stages of production in
relation to the product curves.
 Differentiate production isoquants and
isocosts .
What is Production?
Production
Factors of Production
 Fixed and Variable Inputs
Fixed resource is an input for the production of
goods and services that does not change in the
short run like factory, building, equipment, or other
capital used in production.

Variable Resource an input whose quantity can

be changed in the time period under consideration
like labor and raw materials.
Short Run and Long Run in Production

Short –run is a period of time during which at

least one input is fixed while the others are
variable. It is short enough that not all factors of
production can be adjusted.

Long–run is a period of time long enough that

all factors of production can be adjusted.
 Production
function: Q = f (x)
The established Q = Output
physical f= is an function of
relationship among X = Inputs
inputs, process,
and outputs in a MP= Marginal Product
production MP= ∆TP
situation and can ∆X
be expressed in AP= Average Product
mathematical AP= TP
form: X
Schedule of Total Product
INPUTS TP MP AP
0 0 ***** ****
1 5 5 5
2 12 7 6
3 20 8 6.7
4 27 7 6.8
5 33 6 6.6
6 38 5 6.3
7 42 4 7
8 45 3 5.7
9 42 -3 4.8
10 38 -4 3.8
 PRODUCT CURVES
50
40
30
20 TP
10
0
0 1 2 3 4 5 6 7 8 9 10
 Diminishing Marginal Product
INPUTS TP
0 0 50
1 5 40
2 12
3 20 30
4 27 20 TP
5 33
10
6 38
7 42 0
8 45 0 1 2 3 4 5 6 7 8 9 10
9 42
10 38

The principle that as successive increments of a variable

resource are added to a fixed resource, the marginal
product of the variable resource will eventually decrease.
 STAGES OF PRODUCTION
50
STAGE 2 STAGE 3
40
STAGE 1
30
20 TP
10
0
0 1 2 3 4 5 6 7 8 9 10
Stages of Diminishing Productivity
STAGE 1 STAGE 2 STAGE 3
Increasing Returns Decreasing Increase in Negative Returns
Returns

TP increases Increases and reaches Decreases

maximum

AP Increases and Reaches Begins to decline Decreases

maximum

MP MP > AP Decreases and Negative

becomes zero
 Production Isoquant
• Isoquant is also called as
equal product curve or
production indifference
curve or constant product
curve.
• Isoquant indicates
various combinations of
two factors of production
which give the same level
of output per unit of
time.
Characteristics of Isoquant
Isoquants do not intersect
A higher IQ implies a higher level of output
 IQs are convex to the origin:
Isoquants possess continuous substitutability of
K and L over a stretch. Beyond this stretch, K and
L are not substitutable for each other.
 Isocost
Isocost curve is the locus traced out by various
combinations of L and K, each of which costs the
producer the same amount of money .
 Optimal Combination of Inputs
The point of tangency between the isocost and an
isoquant is an important but not a necessary
condition for producer’s equilibrium.
 Reference
Mankiw, G.N., (2012). Essentials of Economics 6th Edition. Harvard
University: South-Western, Cengage Learning
Mastrianna F.V.(2013).Basic Economics 16th Edition. South-Western
Cengage Learning
McConnel, C. et.al (2012). Economics: Principles, Problems, and Policies
(Global Edition). McGraw Hill Co., Inc.
Paraiso O.C. et.al (2011). Introduction to Microeconomics, Mutya
Publishing House, Inc.
Stock W.A., (2013) Introduction to Economics: Social Issues and
Economic Thinking

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