CHAPTER III

THEORY OF
PRODUCTION

Diane L. Antonio
TOPIC OUTLINE:
3.1 Theory of Production
3.2 Inputs in Production
3.3 Stages of Production
3.4 Law of Diminishing Returns
 3.1 THEORY OF PRODUCTION
Production is a process that create/adds value or utility.
It is the process in which the inputs are converted into outputs.
PRODUCTION FUNCTION
• Production Function means the functional relationship between inputs
and outputs in the process of production.

Q=f (K,L,etc.)
3.2 INPUTS IN PRODUCTION

LAND CAPITAL

LABOR ENTREPRENEUR
 INPUTS: FIXED vs VARIABLE
FIXED INPUTS VARIABLE INPUTS

Remain the same in the short period In the long run all factors of production
varies according to the volume of outputs.

The cost of these inputs are called: Fixed The cost of these inputs are called: Variable
Costs Costs

Examples: Building & Land Examples: Raw Materials & Labor

 SHORT RUN: PRODUCTION STAGES
Three stages of short-run production are readily seen with the three
product curves--total product, average product, and marginal product.

Total Product Average Product Marginal Product

- total amount of output - It is output
that a firm produces The rate change of output as a
per unit of
within a given period, result changes in one variable
inputs of
utilizing given inputs. input.
variable
factors. 
MP=CHANGED OUTPUT/CHANGE
TP=AP*L AP=TP/L INPUT
 Marginal Product Average
Labor (L) Capital (K) Total Product (TP)
(MP) Product (AP)

0 10 -
Short run production function with Labor as Variable

1 10 10 10 10
2 10 30 20 15
3 10 60 30 20
4 10 80 20 20
5 10 95 15 19
6 10 108 13 18
7 10 112 4 16
input

8 10 112 0 14
9 10 108 -4 12
10 10 106 -2 10
 Marginal Product Average
Labor (L) Capital (K) Total Product (TP)
(MP) Product (AP)

0 10 -
Short run production function with Labor as Variable

1 10 10 10 10
2 10 30 20 15 1st
Stage
3 10 60 30 20
4 10 80 20 20
5 10 95 15 19
6 10 108 13 18
2nd
7 10 112 4 16 Stage
input

8 10 112 0 14
9 10 108 -4 12 3rd
Stage
10 10 106 -2 10
3.3 STAGES OF PRODUCTION
First stage: Increasing return
● TP increase at increasing rate till the end of the stage
● AP also increase and reaches at highest point at the end of
the stage.
● MP also increase as it become equal to AP at the end of the
stage.
● MP > AP

Second stage: Diminishing return

● TP increases, but at diminishing rate and it reach at highest
at the end of the stage.
● AP and MP are decreasing both both are positive.
● MP become zero when TP is at maximum, at the end of the
stage.
● MP < AP

Third stage: Negative return

● TP decreases and TP curve slopes downward.
● As TP decreases, MP is negative. AP is decreasing but
positive.
 WHERE SHOULD RATIONAL FIRM PRODUCE?

Stage I: MP is above AP implies an increase in input increases output in greater proportion.

MEANING: The firm is not making the best possible use of the fixed factor

Stage III: MP is negative implies contribution of additional labor is negative so the total output decreases.

MEANING: In this case, it will be unwise to employ an additional labor.

Stage II: MP is below AP implies increase in input increases output in lesser proportion.

THIS IS WHERE A RATIONAL PRODUCER/FIRM SHOULD PRODUCE.

But where exactly the firm will operate within stage II cannot be determined only on the basis of the product curves.
 LAW OF RETURNS TO SCALES :LONG RUN PRODUCTION FUNCTION

The long run is a period of time in which all factors of production and costs are variable.

Law of Returns to Scale

describes the relationship between variable inputs and output when all the inputs, or factors are increased
in the same proportion. It has been observed that when there is a proportionate change in the amounts of
inputs, the behavior of output varies.
• Increasing returns to scale
• Inputs 10% increase- Outputs 15% increase > Increasing returns to
scale
• Constant returns to scale
• Inputs 10% increase- Outputs 10% increase > Constant returns to scale
• Decreasing returns to scale
• Inputs 10% increase- Outputs 5% increase > Decreasing returns to
scale
 3.4 LAW OF DIMINISHING RETURNS
- economic law stating that if one input in the production of a commodity is increased while all
other inputs are held fixed, a point will eventually be reached at which additions of the input
yield progressively smaller, or diminishing, increases in output.

UNITS OF FERTILIZER TOTAL EARS OF CORN MARGINAL EARS OF CORNS

1 100 100
2 250 150
3 425 175
4 550 125
5 600 50
6 525 -75
 THANK YOU FOR LISTENING!
REFERENCES:
● https://www.economicsdiscussion.net/production-function/the-theory-of-production-function-concept-and-importance/16834

● https://www.britannica.com/topic/diminishing-returns

● https://www.investopedia.com/terms/l/lawofdiminishingmarginalreturn.asp

● http://uir.unisa.ac.za/bitstream/handle/10500/19514/Van_Reenen__MJ__0869815806__Section2.pdf?sequence=3&isAllowed=y

● https://www.vedantu.com/commerce/total-product-average-product-and-marginal-product#:~:text=Average%20Product%20(AP)%
3D%20Total,TP
)%2F%20Labour%20(L).&text=It%20denotes%20the%20addition%20of,of%20additional%20worker%20or%20input.

● Theory of Production (slideshare.net)

● Microeconomics: Production Theory (slideshare.net)