Hello! I’m Philippe.

In this video, I will be discussing about the concept of production, and its sub-topics;
theory of production, production function, short-term and long-term analysis in production, and the 3
stages of production.

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What is production?

Production is a process of combining various material inputs and immaterial inputs (plans, know-how)
in order to make something for consumption (output). It is the act of creating an output, a good or
service which has value and contributes to the utility of individuals.

Production is any activity directed to the satisfaction of other peoples’ wants through exchange. This
definition makes it clear that, in economics, we do not treat the mere making of things as production.
What is made must be designed to satisfy wants.

The making or doing of things which are not wanted or are made just for the fun of it does not qualify as
production. On the other hand, all jobs which do aim at satisfying wants are part of production.

Those who provide services Such as hair-dressers, solicitors, bus drivers, postmen, and clerks are as
much a part of the process of satisfying wants as are farmers, miners, factory workers and bakers. The
test of whether or not any activity is productive is whether or not anyone will buy its end-product. If we
will buy something we must want it; if we are not willing to buy it then, in economic terms, we do not
want it.

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There are three types of production; primary production, secondary production, and tertiary production.

Primary production is carried out by ‘extractive’ industries like agriculture, forestry, fishing, mining and
oil extraction. These industries are engaged in such activities as extracting the gifts of Nature from the
earth’s surface, from beneath the earth’s surface and from the oceans.

This includes production in manufacturing industry, turning out semi-finished and finished goods from
raw materials and intermediate goods— conversion of flour into bread or iron ore into finished steel.
They are generally described as manufacturing and construction industries, such as the manufacture of
cars, furnishing, clothing and chemicals, as also engineering and building.

Industries in the tertiary sector produce all those services which enable the finished goods to be put in
the hands of consumers. In fact, these services are supplied to the firms in all types of industry and
directly to consumers. Examples cover distributive traders, banking, insurance, transport and
communications. Government services, such as law, administration, education, health and defense, are
also included.

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Theory of production, in economics, an effort to explain the principles by which a business firm decides
how much of each commodity that it sells (its “outputs” or “products”) it will produce, and how much of
each kind of labor, raw material, fixed capital good, etc., that it employs (its “inputs” or “factors of
production”) it will use. The theory involves some of the most fundamental principles of economics.
These include the relationship between the prices of commodities and the prices (or wages or rents) of
the productive factors used to produce them and also the relationships between the prices of
commodities and productive factors, on the one hand, and the quantities of these commodities and
productive factors that are produced or used, on the other.

However much of a commodity a business firm produces, it endeavors to produce it as cheaply as

possible. Taking the quality of the product and the prices of the productive factors as given, which is the
usual situation, the firm’s task is to determine the cheapest combination of factors of production that
can produce the desired output. This task is best understood in terms of what is called the production
function. Production function means the functional relationship between inputs and outputs in the
process of production. It can also be written as an equation that expresses the relationship between the
quantities of factors employed and the amount of product obtained. It states the amount of product
that can be obtained from each and every combination of factors.

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There are four factors of production; land, labor, capital, and organization.

Land includes natural resources such as the surface, minerals, air, rivers, sea, natural gases or oils, solar
energy, and everything that comes from nature freely.

Labor represents all of the people that are available to transform resources into goods or services that
can be purchased. This factor is somewhat flexible since different people can be allocated to produce
different things. It's also important that a labor force is well educated and well trained to ensure that
they can produce goods at peak efficiency and quality.

Capital is a company's physical equipment and the money it uses to buy resources.

Organization is composed of entrepreneur who combines the other three factors of production to add
to supply and drives these factors to develop an idea into business.

There are also inputs that affect the production process. We can describe inputs as either fixed or
variable.

Fixed inputs are those that can’t easily be decreased or increased in a short period of time. Fixed inputs
define the firm’s maximum output capacity. Fixed inputs also do not change as output changes.

Variable inputs are those that can easily be increased or decreased in a short period of time. Variable
inputs increase or decrease as output changes.

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In the short run one factor of production is fixed, e.g. capital. This means that if a firm wants to increase
output, it could employ more workers, but not increase capital in the short run (it takes time to expand.)

Therefore in the short run, we can get diminishing marginal returns, and marginal costs may start to
increase quickly.

Also, in the short run, we can see prices and wages out of equilibrium, e.g. a sudden rise in demand, may
lead to higher prices, but firms don’t have the capacity to respond and increase supply.

The long run is a situation where all main factors of production are variable. The firm has time to build a
bigger factory and respond to changes in demand. In the long run:

• We have time to build a bigger factory.

• Firms can enter or leave a market.

• Prices have time to adjust. For example, we may get a temporary surge in prices, but in the long-
run, supply will increase to meet it.

• The long run may be a period greater than six months/year

• Price elasticity of demand can vary – e.g. over time, people may become more sensitive to price
changes, in short run, people keep buying a good they are used to.

This shows how a firm’s long-run average costs are influenced by different short-run average costs
(SRAC) curves.

The SRAC is u-shaped because of diminishing returns in the short run.

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There are three stages of production in economics.

Stage one is the period of most growth in a company's production. In this period, each additional
variable input will produce more products. This signifies an increasing marginal return; the investment
on the variable input outweighs the cost of producing an additional product at an increasing rate. As an
example, if one employee produces five cans by him; two employees may produce 15 cans between the
two of them. All three curves are increasing and positive in this stage.

Stage two is the period where marginal returns start to decrease. Each additional variable input will still
produce additional units but at a decreasing rate. This is because of the law of diminishing returns:
Output steadily decreases on each additional unit of variable input, holding all other inputs fixed. For
example, if a previous employee added nine more cans to production, the next employee may only add
eight more cans to production. The total product curve is still rising in this stage, while the average and
marginal curves both start to drop.

In stage three, marginal returns start to turn negative. Adding more variable inputs becomes
counterproductive; an additional source of labor will lessen overall production. For example, hiring an
additional employee to produce cans will actually result in fewer cans produced overall. This may be due
to factors such as labor capacity and efficiency limitations. In this stage, the total product curve starts to
trend down, the average product curve continues its descent and the marginal curve becomes negative.

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That’s it for this lesson! I hope that you learned something watching throughout my video presentation.
Bye!