THEORY OF PRODUCTION

Production
is the transformation of inputs into
outputs
factors of production (capital and
labor) are called the inputs of
production
Output
is the result that has been created
by the inputs (when labor and
capital are combined)
two types of output: goods and
services
the quality and quantity of labor and other
capital and all other inputs have a direct
impact on the quality and quantity of
output
the technology of a firm is the process by
w/c inputs are turned into outputs
the ultimate objective of production is to
create goods and services that will yield
utility to consumers
factor of production are classified into:
fixed factor and variable factor
fixed factor remains constant regardless
of the volume of production while variable
factor changes in accordance w/ the
volume of production
The production function
it
shows
the
relationship
between
quantities of various inputs used and the
maximum (technically feasible) output that
can be produced with those inputs used
per unit of time expressed in a table,
graph, or an equation
is a mathematical equation to find out the
different variables in computing or solving
production. In production function, Q = F
(K,L); where Q stands for output, K stands
for capital , and L stands for labor.
The Short-run vs. Long-run Analysis of
Production
the difference is not based on time but on
the production inputs
in short-run, the use of at least one factor
of production cannot be changed, or there
are fixed inputs
in long-run, all factors can be changed
the time factor is dependent across firms
and industries
EXAMPLE: A laundry business can be
adjusted in a moths or two, but for Isuzu
Motors Philippines capital adjustment
could take two or three years
PRODUCTION W/ ONE VARIABLE INPUT
Law of Diminishing Marginal Returns
Describes a pattern in most production
portion in the short-run

It says that output will decrease even if

there is an increase in one of the inputs

Three stages of production

It is important to describe the three stages
of production because it will help us define
the quantity of labor ( or any other input)
that a profit maximizing form will employ
STAGE I of production starts at the origin
until the highest portion of the APL.
STAGE II goes from the highest portion of
the APL until MPL is zero.
STAGE III of production begins where MP L
is zero until its negative range

Return to Scale
If doubling all inputs causes output to
increase more than double, the firm is
operating under increasing returns to
scale.
If doubling all inputs causes doubling of
output, there are constant returns to
scale.
If doubling all inputs results to less than
double output, the firm is experiencing
decreasing returns to scale.
PRODUCTION W/ TWO VARIABLE INPUTS
Isocost
Shows the different combinations of capital
(K) and labor (L) that a producer can
purchase or hire given his total outlay and
the factor prices.
Isoquant
Is a curve w/c shows the different
combinations of capital (K) and labor (L)
w/c yield the same level of output.
Isoquant have three characteristics:
1. Negatively sloped
2. Convex to the origin
3. Do no intersect
The negatively sloped isoquant can be
explained
through
the
diminishing
marginal rate of technical substitution
(MRTS). MRTS is the amount of capital that
a producer is willing to give up in
exchange for labor and still lie on the same
isoquant
An isoquant is convex to the origin
because of the diminishing MRTS, meaning
a producer is willing to give up0 less and
less of capital to gain additional amount of
labor. The less of the remaining capital
makes it more valuable than additional
labor.