1

THEORY OF
PRODUCTION
Chapter 6-Part 1
 Subtopic? 2

Short run vs long run Law of diminishing Stages of production

production returns
 Production? 3

Process of transforming
inputs into outputs
 Inputs VS Outputs 4

Inputs Output
Factors of production/economic What we get at the end of the

Processing
resources (land, labour, capital, production process (finished good)
entrepreneur) that a firm use in such as car, fried mee, crispy fried
order to produce goods/services banana
 Fixed Inputs VS Variable Inputs 5

Fixed Inputs (F.I)

✓ input which cannot be
altered in term of quantity in
the short run (the quantity
does not change according
to the amount of output
produce)
✓ No. of computer in the ✓ input which the
factory will be the same quantity changes
even though when there is according to the
no production Types of amount of output.
✓ Amount of flour needed will
Example: Input change as the amount of
Machinery, land, office output produce change
building, Size of
factory, etc. Example:
Raw materials, electricity,
fuel, transportation,
communication, etc.

Variable Inputs (V.I)

 Time Range 6

Different between short-run and long-run

Short run Long run

A period in which there is A time period in which

a combination of at least there is no F.I (all inputs
one F.I and one/more V.I in the production process
in the production process are V.I)

Input use Input use

Fixed inputs + Variable inputs

Variable Inputs only

Short run Long run

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 Production Concept 7

Total Product • Max. output that can be produced with a given qty of input
• Formula = Average Product x Total Labour
(TP) • TP = Output = Quantity

Average Product
(AP)
Marginal
Product (MP)
 Relationship between TP & MP and AP & MP 8

TP MAX
60 RELATIONSHIP BETWEEN TP AND MP
STAGE I STAGE III
STAGE II ✓ When MP is increasing, TP increase at an
50 increasing rate.
✓ When MP is decreasing, TP increase at a
40 decreasing rate.
✓ When MP is zero, TP at its maximum.
✓ When MP is negative, TP declines.
30 TP

MP
AP MAX;
20
AP =MP AP RELATIONSHIP BETWEEN AP AND MP
10
MP=0
✓ When MP is above AP , AP is increasing
✓ When MP is below AP, AP is decreasing.
0 ✓ When MP equals to AP, AP is at maximum.
1 2 3 4 7 8 9 10
5 6
-10
Stages of Production 9

AP = MP

4
8
 Stages of Production 10

Stage I
➢ begins from TP=0 until AP=MP
➢ TP increase at an increasing rate, known as increasing returns
Stage II
➢ Begins from AP=MP until MP=0
➢ AP Continues to rise if MP > AP
➢ TP increase at a decreasing rate, known as diminishing returns
➢ Not an efficient stage because number of variable input
➢ The most efficient stage of production
are small relative to its fixed input because the combinations of inputs are fully utilized
➢ A rational producer will continue its production as he can still A rational producer will choose to produce at this stage
increase output by increasing the quantity of variable inputs used

Stage III
➢ Begins from MP=0
➢ not an efficient stage because proportion of fixed factors is lower than variable factors
➢ Increase in variable factors decline the TP because of overcrowding of variable inputs
➢ A producer would not like to operate at this stage
 Example 11

Capital (F.I) Labour (V.I) Total Product Marginal Product Average product

10 0 0
10 1 8
10 2 20
10 3 33
10 4 44
10 5 50
10 6 54
10 7 56
10 8 56
10 9 54
10 10 50
 Answer 12

Capital (F.I) Labour (V.I) Total Product Marginal Average Using graph
Product product paper plot the TP,
10 0 0 - - AP and MP curve.
10 1 8 8 8
10 2 20 12 10
10 3 33 13 11
10 4 44 11 11
10 5 50 6 10
10 6 54 4 9
10 7 56 2 8
10 8 56 0 7
10 9 54 -2 6
10 10 50 -4 5
 LAW OF DIMINISHING MARGINAL RETURNS (LDMR) 13

states that as more Capital (F.I) Labour (V.I) Total Marginal Average
units of a variable Product Product product
factor are combined 10 0 0 - -
with a fixed factor, 10 1 8 8 8
marginal product will 10 2 20 12 10
fall after a certain 10 3 33 13 11
point 10 4 44 11 11
For example after 10 5 50 6 10
three number of 10 6 54 4 9
labour value of MP 10 7 56 2 8
decrease, therefore 10 8 56 0 7
the LDMR set in after 10 9 54 -2 6
3 number of labour
10 10 50 -4 5
TUTORIAL QUESTION1
Answer

Land Worker TP AP MP
100 0 0 - -
100 1 40 40 40
100 2 90 45 50
100 3 126 42 36
100 4 150 37.5 24
100 5 165 33 15
100 6 174 29 9
100 7 168 24 -6

c) TP Maximum at 6 Number of labour

d) Diminishing return sets in with the addition of 3 number of labour
e) Stage 2