INTRODUCTORY ECONOMICS

THEORY OF PRODUCTION AND COST

Jamila Allana B. Valdez

NATURE OF PRODUCTION

• Firm is an entity concerned with the purchase and employment of

resources in the production of various goods and services

• Production is a process of using factor of production (land, labor,

capital and entrepreneurship) to produce goods and services.

• Production function shows the relationship between the quantity

of inputs used and the quantity of output produced.

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NATURE OF PRODUCTION
Production function refers to the physical relationships between the
inputs or resources of a firm and their output of goods and services at a
given period of time.

ALTERNATIVE INPUT INPUTS PRODUCTION OUTPUTS DIFFERENT

COMBINATION FUNCTION QUANTITIES OF
• Land OUTPUT
• Labor • Goods
• Capital • Services
e.g Textiles, Bags,
Electric Fan, Ballpen
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Example: A Farmer’s Production Function

INPUTS INPUTS PRODUCTION OUTPUTS OUTPUT

• Land FUNCTION • Rice
• Labor
• Seeds
• Fertilizers

Example: A Garment Manufacturer’s Production Function

INPUTS INPUTS PRODUCTION OUTPUTS OUTPUT

• Land FUNCTION • RTWs
• Labor
• Machinery ECON 122 – INTRODUCTORY ECONOMICS
TYPES OF INPUTS

• Fixed Inputs – are resources used at a constant amount in the

production of commodity
Example: Land, Buildings, Machinery

• Variable Inputs – refer to the resources that can be change in

quantity depending on the level of output being produced.
Example: No. of workers; raw materials

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TIME FRAME OF PRODUCTION: SHORT RUN VS. LONG RUN
SHORT RUN LONG RUN
• The short run is a time frame The long run is a time frame in
in which the quantity for one or which the quantities of all
more resources used in resources—including the plant
production is fixed. size—can be varied
• For most firms, the capital,
called the firm’s plant, is fixed
in the short run
• Other resources used by the
firm (such as labor, raw
materials, and energy) can be
changed in the short run

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PRODUCTION ANALYSIS WITH
ONE VARIABLE INPUT
ONE VARIABLE INPUT
Total Product of Labor – It plots total product as a function of the variable
input, labor.

Average Product of Labor – It is the average amount of output each worker

can produce.

Marginal Product of Labor – The change in output generated from adding

one more unit of the variable input, labor.

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PRODUCTION IN ONE VARIABLE
Production Function of a Rice Farmer in a One-Hectare Land

Labor (L) CAPITAL

0 10 0
1 10 9
2 10 19
3 10 26
4 10 30
5 10 30
6 10 26
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PRODUCTION IN ONE VARIABLE
35
Labor (L) CAPITAL
30
0 10 0 - -
25 𝑻𝑷 𝑳
1 10 9 9 9 20

2 10 19 9.5 10 15

,
10
3 10 26 8.67 7
5 𝑨𝑷 𝑳
4 10 30 7.5 4 0
0 1 2 3 4 5 6 7

5 10 30 6 0 -5 𝑴𝑷 𝑳
-10
6 10 26 4.33 -4
𝐿𝑎𝑏𝑜𝑟
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ONE VARIABLE INPUT
Law of diminishing marginal product states that as the use of input
increases (with other inputs fixed), a point will eventually be reached at which
the resulting additions to output decreases

Example: As more and more workers are hired at a firm, each additional
worker contributes less and less to production because the firm has a limited
amount of equipment.

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 PRODUCTION IN ONE VARIABLE
35 Stages of Production

30
Stage
Increasing at an
25 𝑻𝑷 𝑳 I
increasing rate
Increasing 𝑻𝑷 𝑳
20 Increasing at a
𝐼 𝐼𝐼 𝐼𝐼𝐼 II decreasing rate Decreasing but is
15
positive
,

10
III decreasing Decreasing is negative
𝑨𝑷 𝑳
5 𝑨𝑷 𝑳
0
0 1 2 3 4 5 6 7 Stage I and II boundary 𝑴𝑷 𝑳
• APL = MPL
-5 𝑴𝑷 𝑳 • APL is at it’s HIGHEST point
-10 Stage II and III boundary
• MPL = 0 TPL is at it’s HIGHEST point
𝐿𝑎𝑏𝑜𝑟 ECON 122– INTRODUCTORY ECONOMICS
3 TYPES OF MARGINAL RETURNS

• Increasing Returns
• Diminishing Returns
• Negative Returns

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INCREASING RETURNS

• When the number of labor are added, the marginal product

increases.
• When the marginal product is increasing, the total product
increases at an increasing rate.
• Business would not want to produce when marginal product is
increasing, since by adding an additional laborer the cost per unit
of output would be declining.

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DIMINISHING RETURNS

• The law of diminishing marginal returns: as more of a variable

resource are added to a fixed amount of other resources, the
marginal product of the additional variable resource will
eventually decline.
• As the marginal product begins to fall but remains positive, total
product continues to increase but at a decreasing rate.
• As long as the marginal product of a laborer is greater than the
average product, the average product will rise.
• The marginal product will always intersect the average product at
the maximum average product.
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NEGATIVE RETURNS

• There may even come a point where adding an additional worker

makes things so crowded that total product begins to fall.
• In this case the marginal product is negative.
• We would not produce in the region where marginal product is
negative

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THANK YOU.