Production Theory

Production refers to the transformation of resources into outputs of goods and services
The output may be final output or intermediate output.
Production is a flow concept. It is applicable to the output produced over a period of time, or
expressed in terms of per unit a time period.
A Firm is an organization that seeks to bring together various resources to produce output. The
widely acceptable objective of the firm is to be able to maximize its profits in carrying out the
activity of production.
In calculation of “economic profits”, the firm needs to consider
(i) Accounting costs (costs borne out of payments to labour and any rental cost capital employed)
(ii) Opportunity costs. These costs include the cost of foregoing revenue due to self owned
resources (such as time, land and capital of the entrepreneur)
 Classification of Inputs
Inputs, resources or factors of production are the means of producing the goods and services
demanded by society. Inputs can be classified as labour or human resources (including
entrepreneurial talent), capital or investment goods, and land or natural resources.

Inputs can further be classified into Fixed and Variable:

Fixed inputs are those that cannot be varied or can be varied only with excessive cost during the
time period under consideration. Examples of fixed inputs include firms plant and specialized
equipment.
Variable inputs are those that can be varied easily on short notice. Examples are raw materials
and many types of labour.

The time period during which at least one input is fixed is known as the Short Run.
Time period where all inputs are variable is called the Long Run.
 Production with one variable input (Short Run)

Labour (Workers Output or Total Average Product of Marginal Product of

per year) Product (TP) Labour (APL) Labour (MPL)

0 0
1 3
2 8
3 12
4 14
5 14
6 12
- -
3 3
4 5
4 4
3.5 2
2.8 0
2 -2

 𝐴𝑃 = 𝑇𝑃
Average Product of Labour 𝐿
𝐿

Marginal Product of Labour   Δ 𝑇𝑃

𝑀𝑃 𝐿=
Δ𝐿
 TP TP

G H
F
I

C
B
A
O L L
APL APL

F’
G’
H’
E’
D’ I’
C’
B’
A’

L L
 TP

X APL,
W U’
MPL V’
Y
V
T’
W’

U F’ G’

H’
T APL
S’
S
444444
E’
D’
L
B’ C’
MPL A’ X’
U’ V’
O L
T’ Y’
W’ I II MPL
Falling III
Production Rising
MPL>0 Falling
Stages MPL>0
MPL<0

S’
Law of Diminishing Returns
(Law of Variable
X’
L Proportions)
Y’