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THEORY OF PRODUCTIONTHEORY OF PRODUCTION(With One Variable Input)(With One Variable Input)

Marcelo SP. Mendoza

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consists of a formal framework to assist themanager in deciding how to combinemost efficiently the various inputs neededto produce the desired output (product of

service), given the existing technology. this theory is centered around the concept

of a production function.

ECONOMIC THEORY OFECONOMIC THEORY OFPRODUCTIONPRODUCTION

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Transformation of I/Ps or resources into O/P of goods andservices.

The creation of any good or service that has economicvalue to either consumers or other producers.

PRODUCTIONPRODUCTION

and so forth)

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Relates to the maximum quantity of output thatcan be produced from given amounts of variousinputs for a given technology. This can beexpressed in the form of a mathematical model,Schedule (table) , or graph

Mathematical model: Q = f(X,Y) The function fincorporates the existing state of

technology in producing Q from X and Y. The general function fcan take may different

forms. e.g. Q = L

1K2,

where L is the amount of labor and K is the amountof capital used in the production process (,1, and2 are constants).

Production FunctionProduction Function

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Classification of inputs (X and Y): 1. Fixed input one required in the

production process but whose quantityemployed in the process is constant overa given period of time regardless of thequantity of output produced.

2. Variable input one whose quantityemployed in the process changes,depending on the desired quantity ofoutput to be produced.

Production FunctionProduction Function

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Short run the period of time inwhich one (or more) of the inputs isfixed or incapable of being varied;

Long run period of time in which allinputs or resources employed in aproduction process are variable or

can be varied

Production FunctionProduction Function

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Total Product Function

identifies what outputs are possibleusing various levels of the variable input

total volume of outputs resulting fromuse of different quantities of inputs

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Total ProductCurve: Ore-

MiningExample

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Marginal product the incremental changein total output that can be produced bythe use of one or more unit of the variableinput in the production process

MPx= Q X

Average product the ratio of the totaloutput to the amount of the variable input

used in producing the output. APx= Q X

Marginal and Average ProductMarginal and Average ProductFunctionsFunctions

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MarginalandAverage

ProductCurves:Ore-MiningExample

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The percentage change in output Q resultingfrom a given percentage change in theamount of the variable input X employed inthe production process with Y remainingconstant

Indicates the responsiveness of output tochanges in the given input

Ex= %Q = Q/Q = Q/X %X X/X Q/X

Since MPx= Q/X and APx = Q/X: Ex= MPx APx

Production ElasticityProduction Elasticity

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Also known as the diminishing marginalproductivity law or law of variableoptions;

Given that the amount of all otherproductive factors remains unchanged,the use of increasing amounts of avariable factor in the production processbeyond some point will eventually resultin diminishing marginal increases in totaloutput.

Law of Diminishing MarginalLaw of Diminishing MarginalReturnsReturns

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Relationship among Total, Average,Relationship among Total, Average,and Marginal Product Curvesand Marginal Product Curves

Q3

Stage IEp>1

Stage II0

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Stage I the range of X over which theaverage product is increasing.

Stage II rage of X from the point at whichthe average product is a maximum (X2) to

the point where the marginal product(MP) declines to zero (X3).

Stage III the range of X over which the

total product is declining or, equivalently,the marginal product is negative.

Three Stages of ProductionThree Stages of Production

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The amount that an additional unit of thevariable input adds to total revenue:

MRPx= TR X where TR is the change in total revenue

associated with the given change (X) in thevariable input.

MRPx is equal to the marginal product ofX(MP

x) times the marginal revenue (MR

Q)

resulting from the increase in outputobtained:

MRPx= MPxMRQ

Marginal Revenue ProductMarginal Revenue Product(MRP(MRPxx))

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The amount that an additional unit of thevariable input adds to total cost:

MFCx= TC

X where TC is the change in cost associated

with the given change (X) in the variableinput

Marginal Factor CostMarginal Factor Cost

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The optimal level occurs at the point wherethe marginal benefits are equal to themarginal costs

For the short-run production decision, the

optimal level of the variable input occurswhere:

MRPx= MFCx

Optimal Input LevelOptimal Input Level

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Thank

You!