BHHT1123

HOSPITALITY ECONOMICS

LECTURE 5

Production and Cost (I)

Learning Objectives

On completion of the chapter, the student will be able to:

❑ Define of production, fixed input and variable input
❑ Differentiate short run production and the long run
production
❑ Determine total product, average product and
marginal physical product/ marginal product of
variable input
❑ Explain law of diminishing marginal returns
DEFINITION OF PRODUCTION

❑ Definition
– Production means the process of using the factor of
production to produce goods and services.
– Production is the process of transforming inputs into
outputs.
INPUTS OUTPUTS

Inputs refers to the Refers to what we

factors of production get at the end of the
Processing
that a firm use in the production process
production process. that is finished
products.
 All natural resources Physical or mental
or gift of nature activities of human beings

CLASSIFICATION
OF FACTORS
OF PRODUCTION

Part of man-made wealth A person who combines the different

used for further production factors of production, and initiates
the process of production and also
bears the risk
PRODUCTION FUNCTION

❑ A production function is a statement of the functional

relationship between inputs and outputs, where it shows
the maximum output that can be produced with given
inputs.
Q = (K, L, M, etc.)

❑ Where: Q = Output
K = Capital
L = Labour
M = Raw Material
SHORT-RUN AND LONG-RUN PRODUCTION
FUNCTION
❑ Two Types of Factor Inputs
– ________________________
• An input which the quantity does not change according to the
amount of output.
• Example:______________,____________, buildings, tools,
equipment, etc.
– ________________________
• An input which the quantity changes according to the amount
of output.
• Example:_____________,_____________, fuel, transportation,
communication, etc.
❑ Short-run and Long-run Periods
– ____________period is the time frame, which at least one of the
inputs (factor of production) is fixed and other inputs can be varied.
– ____________period is the time frame which all inputs are
variable.
SHORT-RUN PRODUCTION FUNCTION

❑ In the short run, we assume that at least one of

the inputs is fixed that is capital.
❑ Therefore, in the short run the production
function can be written as:
Q = ( K , L)
Where: Q = Output
L = Labour
K = Capital (fixed)
SHORT-RUN PRODUCTION FUNCTION
(cont.)
❑ LAW OF DIMINISHING MARGINAL RETURNS
– It states that if the quantities of certain factors are
increased while the quantities of one or more factors
are held constant, beyond a certain level of
production, the rate of increase in output will
decrease.
OR
– “Law of diminishing marginal returns states that as
more of a variable input is used while other input and
technology are fixed, the marginal product of the
variable input will eventually decline”.
SHORT-RUN PRODUCTION FUNCTION
(cont.)
TOTAL PRODUCT (TP)
The amount of output produced when a given amount of
that input is used along with fixed inputs.

AVERAGE PRODUCT (AP)

Divide the total product by the amount of that input
used in the production

Average Product (APL) = Total Product

Total Labour
APL = TP/ L
SHORT-RUN PRODUCTION FUNCTION
(cont.)

MARGINAL PRODUCT (MP)

Change in the total product of that input corresponding to an addition
unit change in its labour assuming other factors that is capital fixed.

Marginal Product (MPL) =

MPL =  TP/  L
SHORT-RUN PRODUCTION FUNCTION
(cont.)
Capital Labour Total Marginal Average Stages of
(Fixed (Variable Product Product Product Production
input) input)
10 0 0 0 0
10 1 8 8 8
10 2 20 12 10 STAGE I
10 3 33 13 11
10 4 44 11 11
10 5 50 6 10
10 6 54 4 9
STAGE II
10 7 56 2 8
10 8 56 0 7
10 9 54 -2 6
STAGE III
10 10 50 -4 5
MP = 54 - 56 AP = 56
9-8 8
= -2 = 7
 SHORT-RUN PRODUCTION FUNCTION

Capital Labour Total Marginal Average Stages of

(Fixed (Variable Product Product Product Production
input) input)
10 0 0 0 0
10 1 8 8 8
10 2 20 12 10 STAGE I
10 3 33 13 11
10 4 44 11 11
10 5 50 6 10
10 6 54 4 9
STAGE II
10 7 56 2 8
10 8 56 0 7
10 9 54 -2 6
STAGE III
10 10 50 -4 5

RELATIONSHIP BETWEEN TP AND MP

When MP is increasing, TP increase at an increasing rate. RELATIONSHIP BETWEEN AP AND MP
When MP is decreasing, TP increase at a decreasing rate. When MP is above AP , AP is increasing
When MP is zero, TP at its maximum. When MP is below AP, AP is decreasing.
When MP is negative, TP declines. When MP equals to AP, AP is at maximum.
SHORT-RUN PRODUCTION FUNCTION
(cont.)
RELATIONSHIP BETWEEN TP AND MP RELATIONSHIP BETWEEN AP AND MP
When MP is increasing, TP increase at an increasing rate. When MP is above AP , AP is increasing
When MP is decreasing, TP increase at a decreasing rate. When MP is below AP, AP is decreasing.
When MP is zero, TP at its maximum. When MP equals to AP, AP is at maximum.
When MP is negative, TP declines.

60 TP MAX
STAGE I STAGE II STAGE III
50

40

30 TP
MP
20
AP MAX;
AP =MP AP
10
MP=0
0
1 2 3 4 5 6 7 8 9 10
-10
SHORT-RUN PRODUCTION FUNCTION
(cont.)

Stage I
▪ Proportion of _______________________
▪Under utilization of fixed factor
▪ Operation involves a waste of resources
Stage II
▪ Called______________________________
▪ The most efficient stage of production
because the combinations of inputs are fully
utilized

STAGES OF PRODUCTION

Stage III
▪ Proportion of______________________________________________
▪ Increase in variable factors decline the TP because of overcrowding
▪ A producer would not like to operate at this stage
Production In the Short Run
❑ Suppose two input (resources), labour (column 1) and
capital (column 2), are used to produce some good
(column 3).
Production In the Short Run
The marginal physical product (MPP) of the variable input:
❑ the change in output that results from changing the
variable input by one unit, holding all other inputs fixed.
❑ In the example, the variable input is labour, this would
mean that the MPP of labour would be defined as:

MPP of Labour = Change in output/Change in labour input

= ∆Q/∆L

❑ From the table, the MPPL rises from 18 to 19 to 20 then

falls from 20 to 19 to 18 and become negative.
❑ As more and more variable inputs, such as labour, were
added to a fixed input, such as capital, the variable inputs
would yield smaller and smaller additions to output.
Production In the Short Run

Law of diminishing marginal returns:

(Law of diminishing marginal product)
❑ As ever larger amounts of a variable input (i.e.
labour) are combined with fixed inputs,
eventually the marginal physical product
(MPP)/ marginal product (MP) of the variable
input will decline.
The Law of Diminishing Marginal Returns

In the short run, as

additional units of a
variable input are
added to a fixed
input, the marginal
physical product
(MPP) of the
variable input may
increase at first.
Eventually, the MPP
of the variable input
decreases. The point
at which MPP
decreases is the point
at which law of
diminishing marginal
returns have set in.
Production In the Short Run
Law of diminishing marginal returns:
Example:
❑ Agricultural workers (variable input) are added to acres
of land (fixed input).
❑ The workers must clear the land, plant the crop and
then harvest the crop.
❑ In the early stages of adding labour to the land, MPP
rises as each worker has abundant units of fixed input
to work with.
❑ But eventually, as we continue to add more workers to
the land, there comes a point where the land is
overcrowded with workers.
❑ Workers are stepping around each other, stepping on
the crops, etc. due to these problems., output growth
begins to slow.
The Law of Diminishing Marginal Returns
❑ If the law of diminishing marginal returns did not hold,
then it would be possible to continue to add
additional units of a variable input to a fixed input,
and the marginal physical product of the variable
input would never decline.
❑ We could increase output indefinitely as long as we
continued to add units of a variable input to a fixed
input.

❑ The law of diminishing marginal returns says that as

more units of the variable input are added, each one
has fewer units of the fixed input to work with;
consequently,______________________________.