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On the whole, the income elasticity of demand for most commodities varies as income changes

depending on the nature of the commodity. If the income elasticity of demand (E I) is negative,
the commodity is inferior. If the income elasticity of demand (EI) is positive, the commodity is
normal (either luxury or necessity). A normal good is usually a luxury if E I > 1, and a necessity if
0<EI<1.
Depending on the level of income, the income elasticity of demand (E I) for a commodity is likely
to vary considerably. Thus, a commodity may be a luxury at low level of income; a necessity at
intermediate level of income; and inferior at high level of income.

2.3. Theory of production

Technically defined, production is the process of transforming factors of production (inputs)


into output. Inputs are the physical, human, material, financial, and information resources
that enter the transformation process. Transformation process comprises the technologies
used to convert inputs into output.
If we take a university as a production process, transformation process includes technologies
such as lectures, reading assignments, laboratory experiments, term papers and tests/
examinations. Inputs at the university comprise students, faculty, building, etc. Graduating
students from universities are regarded as output.
Inputs are classified into fixed inputs, the supply (quantity) of which cannot be changed over
a short period of time and variable inputs, the quantity of which can be varied in the short-
run. The most important fixed inputs in the short-run are land and capital whereas labour and
raw materials are instances of variable inputs in the short-run. Output is defined as any final
good or service that comes out of the production process.
Thus, the description of the technical relationship between inputs and output is called
production function. Stated differently, production function describes the combination of
inputs and the maximum attainable output that can be produced using that combination of
inputs. Production function is defined for a given technology because as technology
improves the maximum attainable output for a given cost increases and a new production
function is formed.
The distinction between the momentary-run, short-run and the long-run period is based on
the difference between fixed inputs and variable inputs. The momentary - run is the period
of time so short that no change in production an take place. The short-run is the period of
time in which the quantity of some factors of production cannot be varied. The long run is the
period of time in which it would be possible to increase the quantity of all factors.
Consequently, therefore, all inputs are variable in the long-run.
The time period varies from firm to firm and from industry to industry. The short-run may be
a matter of eight or ten months for some firms while for others it may extend to years.
Production in the short-run
The short-run is the period of time in which variable inputs such as labour and raw materials
can be adjusted while fixed factors such as plant and equipment cannot be fully modified or
adjusted.
At any point in time, for instance, the production of teff requires inputs of labour, land,
fertilizer and available technical knowledge, which can be portrayed in the form of the
production function as follows:
Qt = f (L, Ld, F, T,) Where:
QT = Quantity of teff produced
L = labour input
Ld = land input
F = fertilizer
T = technical knowledge
The above production function states that the output of teff depends on the inputs listed in the
parenthesis. A real production function is very complex. However, economists have
simplified it by reducing the number of variable inputs used in the production function to a
manageable number.
Thus, given land input, fertilizer and available technical knowledge, the output of teff in the
above production function depends on the labour input (L) in the short-run. Hence, the
production function boils down to:
QT = f (L, Ld*, F*, T)
QT = f (L)
Note that all other inputs in the bracket with the asterisk are assumed to be constant in the short-
run.