MANAGERIAL ECONOMICS

PRODUCTION THEORY
DR. JUDY ANN O. FERRATER-
GIMENA

S
Meaning of production
 PRODUCTION THEORY

S  Production- refers to the transformation of inputs or

resources into outputs of goods and services.
S  - refers to the conversion of raw materials to
human satisfying goods
S  Inputs- are the resources used in the production of goods
and services
S  1. Variable Inputs- varies with outputs (e.g. raw materials
& direct labor)
S  2. Fixed Inputs- does not vary with output (e.g. rental/
building, machines, tools, equipment, payment for support
employees, etc.)
Production System
Meaning of System
Meaning of production system
 Production Time Period

1.  Short-Run Production Time Period- at one least

on input is fixed while the others are variables
(customized production) which leads to
diseconomies of scale.
-the cost per unit of output is relatively high
2.  Long-Run Production Time Period-when all
inputs are variables (mass production/long range
production) which leads to economies of scale.
- the cost per unit of output is lesser
 Production Function

S  -is an equation, table, or graph showing the maximum output of a

commodity that a firm can produce per period of time with each set
of inputs. Both inputs and outputs are measured in physical rather
than in monetary units.
S  -technology assumes to remain constant during the period of the
analysis
For simplicity, we assume here that a firm here produces only one
type of output (commodity or service) with two inputs, labor (L) and
capital (K). Thus, the general equation of this simple production
function is
Q= f (L, K)
Cobb Douglas Standard Production Function
K for capital is taken from Karl Marx’s The Das Capital)
 Discrete Production Surface

The height of the bar refers to the maximum output (q) that can be produced with
each combination of labor (L) and capital (K) shown on the axis. Thus, the tops of all
the bars form the production surface of the firm.
 Total, Average & Marginal
Product of Variable Input
S  Total Product-the firm uses a number of inputs to
produce its output. If the firm varies the quantity of only
one input, keeping the other inputs quantities unchanged,
then the quantity of its output obtained at any quantity
of the variable input is called the total product of the
input.

S  For example, if the said variable input is labour and it

is obtained that the firm produces 42 units of output
when it uses 6 units of labor along with the fixed inputs,
then we say that the total product is 42 units of labour.
Total, Average & Marginal
Product of a Variable Input
Total, Average & Marginal
Product of Labor Curves
 Total, Average & Marginal
Product of a Variable Input
S  By holding the quantity of one input constant and changing the quantity
used of the other input, we can derive the total product (TP) of the
variable input

S  From the total product schedule we can derive the marginal and average
product schedules of the variable input.
S  The marginal product (MP) of labor (MPL) is the change in the total
product or extra output per unit change in the labor/input used, while the
average product (AP) of labor (APL) equals total product divided by the
quantity labor used. That is:
S  MPL= ΔTP/ΔL or MP= ΔTP/ΔI (Input)

S  APL= TP/L or AP= TP/I (Inputs)

 Production or Output Elasticity

S  Production or output elasticity of labor (EL). This measures the

percentage change in output divided by the percentage change in the
quantity of labor used.

S  EL= %ΔQ/%ΔL or
S  EL= ΔQ/Q = ΔQ/ΔL = MPL
ΔL/L = Q/L APL
Law of Diminishing Returns and
Stages of Production
 Returns to Scale

S  Describe what happens to long-run returns/ output as the scale of production

increases, when all input levels including physical capital are variable
S  Explains what will happen to the outputs if inputs are increased
S  It explains the long-run linkage of the rate if increase in output (production)
relative to associated increase in the inputs (factors of production)
S  R=%ΔQ/%ΔI=(Q2-Q1) *100 / (I2-I1)*100
S  Q1 I1
S  When the input of Company Z increased from 120 to 240 man hours of labor, the
output increases from 300 to 600 units. How much is the value of returns?
S  R=(240-120)/120*100)/(600-300)/300)*100
S  R= 1 (constant returns to scale
 Returns to Scale

S  Increasing Returns to Scale- when inputs are doubled/

increased, the outputs also increased more than double
(R>1)

S  Constant Returns to Scale- when inputs are doubled/

increased, the outputs will also increase in doubled quantity
(R=1)

S  Decreasing Returns to Scale- when inputs are doubled/

increased, the outputs also decreased (R<1)
Increasing Returns to Scale
Constant Returns to Scale
Decreasing Returns to Scale