Chapter 5.

Theory of Production

Key words

• Total product (TP) : the amount of output produced when a given amount of input is used
together with fixed input.

• Average product (AP) : is total product divided by the number of input used.

• Marginal product (MP) : is the change in total product as a result of a change in input

Definiton of Production

• Production : the transformation of inputs and outputs.

• Inputs : factors of production used in production.
• Output : goods and services produced (finished product)

Classification of Factors of Production

Land Capital
All natural resources are available for Man-made wealth which is used to produce
free. more wealth.
e.g : land surfaces, air, water, lake, seas, E.g : building, factories, machinery, tools,
minerals, forests, mountains, and so on equipments, inventories of goods, trucks,
railroads, raw materials and money.
Labour Entreprenuership
All physical or mental activities by man Human ability to combine the factors of
for monetary reward. production, and initiate the process of
e.g : lecturers, doctors, electricians, production.
designres, engineers and so on e.g : an entrepreneur bears the risks involved

Production Functions

Q = f (K, L, M, etc)
Where :
Q – The amount of output per unit of time (depends on the quantity of inputs)
K, L, M, etc = the various factors of production, like capital, labour, raw materials, etc.

The more inputs used in production, the more the amount of output produced.

Both sort run and long run actually depends on the inputs (factors of production) which can vary in
production. There are two types of inputs :

1. Fixed input is an input where the quantity doesn’t change according to the output
e.g : machinery, land, buldings, tools, equipment.
2. A variable input is an input where the quantity changes according to output.
e.g : raw mterials, electricity, fuel, transportation, communication, etc.

The short run has at least one input which is fixed, but other inputs vary.

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The long run has inputs which are all variable.
Fixed factor Its employment remais constant when output increases.
Variable factor Its employment increases as output increases.

Short-run Production Function-One Fixed Input and One Variable

• Supposed that only two inputs are used in production : capital and labour.
Q = f(L,K) K = Quantity of capital is fixed
Or
Q = f (K, L) L = quantity of labour is fixed
Law of Diminishing Marginal Returns
“as more of variable input is used while other inputs and technology are fixed, the marginal product
of the variable input will eventually decline.”

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Short-Run Production Relationships
In the short run, rational firms should be operating only in Stage II
Q: Why not Stage III?  firm uses more variable inputs to produce less output
Q: Why not Stage I?  underutilizing fixed capacity, so can increase output per unit by increasing
the amount of the variable input

Isoquant Analysis and Isoquant Curves

• An isoquant or isoproduct represents all the possible combinations of variable input that are
used to generate the same level of output (total product).
• Isoquant MAP is a number of isoquants that are combined in a single graph.
• An isoquant MAP can be used to estimate the maximum attainable output from difference
combination of inputs.
• A higher isoquant curve represent a higher level of output.

Tabel 5.5. Isoquant Curve

Illustration : The isoquant for 800 cans of soymilk. The isoquant curve labelled as Q= 800
cans. Points on the isoquant curve shows various combinations of labour and capital inputs
that produce the maximum of 800 canned soymilkin a month, with the available technology
and other inputs.
There are a few combination if a firm wants to produce 800 cans :
1 unit of capital and 5 units of labour or
2 unit of capital and 3 units of labour or
3 unit of capital and 2 units of labour or
5 unit of capital and 1 units of labour

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 Points on the isoquant
curve represent
different combinations
of labour and capital
to produce 800 cans of
soymilk

Properties of an Isoquant Curve :

1. The isoquant curve slopes downwards from left to right. If we increase the input of labour,
we will have to decrease the input of capital to produce the same level of output.
2. The isoquant curve is convex to the origin, due to diminshing marginal rate of technical
substitution (MRTS). Fewer inputs of capital are substituted for one more unit of labour.
3. The isoquant curve that is far from the origin represents a larger output.

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 4. The isoquant curves never intersect with each other because two different levels of output
(Q1 & Q2) cannot be produced using the same units of input.

Long-Run Production-All Inputs Are Variable

• A firm can expand its scale of production by increasing all inputs, such as more labour,
equipment, buildings, plants, machinery, etc.
• The law returns to scale
“responsiveness of output to a given proportionate change in the quantities of all inputs”.
• There are three possibilities : increasing return to scale, constant return to scale and
decreasing return to scale.

Long-Run Production Function

• If all inputs into the production process are doubled, three possibilities/things can happen:
– output can more than double or output will increase by greater proportion
 ‘increasing returns to scale’ (IRTS)
– output can exactly double or output will increase in the same proportion
 ‘constant returns to scale’ (CRTS)
– output can less than double or will increase in smaller proportion
 ‘decreasing returns to scale’ (DRTS)

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‘increasing returns to scale’ (IRTS) when labour and capital are doubled (from 300 to 500) or
output increases more than double (500 to 800 units)
‘constant returns to scale’ (CRTS) when output can exactly double or output will increase in the
same proportion (100 to 200 units or 200 to 300 units)
‘decreasing returns to scale’ (DRTS) when output can less than double (800 to 900 units) or will
increase in smaller proportion (900 to 950 units)

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Assessment:
1) The scissors that were used to cut out the cup origami pattern would be an
example of…
A. labor
B. land
C. capital
D. entrepreneurship
2) If 1 worker produces a total of 4 unitsof output, 2 workersproduce a total of 10
units of output, 3 workers produce a total of 18 units of output, 4 workers produce a
total of 25 units of output, 5 workers produce a total of 30 unit sof output, and 6
workers produce a total of 28 units of output, with the addition of what worker do
diminishing returns first occur?
A. worker 6
B. worker 3
C. worker 4
D.worker 5
3) Briefly explain what the entrepreneur could do to improve the productivity of the
additional workers hired. Use complete sentences for your answer.

Assessment:
1) The scissors that were used to cut out the cup origami pattern would be an
example of…
A. labor
B. land
C. capital
D. entrepreneurship
2) If 1 worker produces a total of 4 unitsof output, 2 workers produce a total of 10
units of output, 3 workers produce a total of 18 units of output, 4 workers produce a
total of 25 units of output, 5 workers produce a total of 30 units of output, and 6
workers produce a total of 28 units of output, with the addition of what worker do
diminishing returns first occur?
A. worker 6
B. worker 3
C. worker 4
D.worker 5
3) Briefly explain what the entrepreneur could do to improve the productivity of the
additional workers hired. Use complete sentences for your answer.