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THEORY OF PRODUCTION

Production
 Act of manufacturing a product

 Process in which the input are converted


into outputs
Input
 It is the factors of production such as:

Land
Labor
Capital
Entrepreneur
Output
Quantity of goods or services
produced in a given time period, by a
firm, industry, or country.
Production Function
Functional relationship between inputs and
outputs in the process of production.

Technical relation which connects factors inputs


used in the production function and the level
of outputs.
Law of Diminishing Return
 Law stating that if one factor of
production is increased while the others
remain constant, the overall returns will
relatively decrease after a certain point.
Isoquant
 Means “equal quantity”
iso = equal
quant= quantity

 Represents what can be produced

 Combinations of two factors of production which give


the same level of output per unit of time.

 Known as Product Indifference Curve


Marginal Rates of Substitution
 How much of one resource is given up in order
to use an additional unit of the other, given a
fixed capacity.

∆𝑌 𝑎𝑥𝑖𝑠
MRS =
∆𝑋 𝑎𝑥𝑖𝑠

∆𝐾
MRS =
∆𝐿
Where: K - Capital
L - Labor
Hierarchy of Isoquants

 An array of isoquants which corresponds


to different levels of resource inputs.
Isocost Curve and it’s Hierarchy

 Illustrates all the possible combinations of two


factors that can be used at given costs and for a
given producer's budget.

 Isocost line represents a combination of inputs


which all cost the same amount.
Isoquant-Isocost Combination

 Isoquant Curve - what can be produce

 Isocost Curve - cost and budgetary limits of


production
Productivity
 Measures how efficiently production inputs,
such as labor and capital, are being used in an
economy to produce a given level of output.

 Efficiency and therefore the power of inputs


to produce.
Average Productivity
The efficiency of inputs taken as a whole and is
measured as their average output.

𝑄
Productivity =
𝐼

where: Q – output
I - input
Marginal Productivity
Refers to the extra output gained by adding
one unit of labor; all other inputs are held
constant

∆𝑄
MP =
∆𝐼
Relative Resource Efficiency
Production resources are complementary not
only in function but also in efficiency.

Resources do not become more internally


efficient at the same time, but every
improvement contributes to the overall
productivity picture.
Basic Ways to Improve Resource
Efficiency
Change the nature of the resource through
innovation

Change the external condition of resources

More balanced resource combination

Using resource-saving technology


Return to Scale
 Measures how output changes relatively to resource
inputs in the long run and indicate how overall
resource efficiency changes with plant size.

 the variation or change in productivity that is the


outcome from a proportionate increase of all the
input.
Formula:
% (∆𝑄)
R=
% (∆𝐼)

Where:
R = Returns to Scale
Q = Output
I = Resource Input
∆ = Change
% = Percentage
Returns to Scale
Returns to Scale Returns Marginal Productivity Average Productivity
R = % (∆𝑄) / % (∆𝐼) ∆Output / ∆Input Output / Input

Greater than 1 Increasing Increases Increases

Equal to 1 Constant Constant Constant

Less than 1 Decreasing Decreases Decreases

Less than 0 or Decreasing and Negative Decreases


Negative Negative