BASICS OF

MICROECONOMICS
STT05104
PRODUCTION THEORY
TOPIC 4
OUTLINE
 Definition of terms
 Factors of production
 Objectives of firm
 Types of business units
 Advantages and Disadvantages of each

business unit
 Growth of firm
 Definition of Production
 Production is an activity that results in the
creation of goods and services for the
satisfaction of human wants
 Production results in the creation of

utilities/satisfaction
 Production theory
 Production means a process by which inputs
of factors of production (land, labour, capital
etc.) are converted or transformed into an
output (Dwivedi, 2005).
 Input is a good or services that is used

process of production
 Production theory
 The process of production is not until a
commodity has reached a person who wishes
to make use of it (i.e. final consumer)
 For that case it includes services of

distribution and direct services

 Examples of distribution services are

transport, wholesale traders and retailers,

banking and insurance and direct services
 Examples of direct services are lawyers,

doctors, teachers and the like

 Production theory
 But it excludes services which are not
exchanged for money like services of
housewife or free social services
 Direct production

 Direct production means the production of

goods and services by an individual for its
own use or consumption
 It is also known as subsistence production
 Examples :- farmer plants its own maize for

food or a person building his own house for

residence purposes
 Indirect production
 Indirect production means the production of
goods and services which are produced by a
person in order to sell these goods or
services to somebody else
 Examples ; in textile factory cloth is produced

but this cloth is sold in the market

 Those who use this cloth are not the ones

who produced it
 Indirect production
 A farmer produces maize and sell this in
market this can also be called indirect
production
 This type of production is also called

production for the market

 Indirect production
 Sometimes it can become difficult to
distinguish between direct and indirect
production e.g. a farmer who produce maize
and he may be undecided for sometime
whether to sell the maize to the market or to
use the maize himself
 Levels of production
 Levels of production means different stages
of production
 They can also be called as types of

production
 They can be classified as follows :

i. Primary production
ii. Secondary production
iii. Tertiary production
 Primary production
 it is the first stage of production
 It includes hunting, fishing, farming, mining

and forestry etc

 These are known as extractive industries
 Output or production at this stage is raw

material which is used as input for the

production of finished goods
 Examples: minerals extracted like coal, iron,

petroleum are used in the manufacturing

industries
 Primary production
 Agricultural products like cotton and
sugarcane are used to produce cloth and
sugar
 Output of primary production can be used for

secondary production
 In some cases it can be sold to final

consumer e.g. a fruit grower can sell oranges

to the consumer directly
 Secondary production
 It is the second stage of production
 The output of primary production is used as

input of secondary production

 It includes manufacturing and constructive

industries
 E.g. cotton produced in primary production is

used in the textile factories to produce cloth

 Another e.g. of secondary production is the

construction of roads, buildings, bridges

e.t.c.
 Tertiary production
 It is the third stage of production
 The process of production may still be

incomplete after the second stage of

production
 This stage starts after completion of goods
 In this stage the goods are transferred from

the factory to the final consumer

 Tertiary production
 The movement of transferring the goods from
the factory to final consumer involves
different services
 That is why Tertiary production means to

provide services after secondary production

 These services may be further classified as

commercial services and personal services

 Commercial services refer to the services of

wholesalers, retailers, banks, insurance,

transport etc.
 Tertiary production
 Personal or direct services refer to the
services of doctors, advocates, teachers etc.
 Factors of production
 In order to produce any commodity some
factors are needed and these are known as
factors of production.
 These includes :

i. Land
ii. Labour
iii. Capital
iv. Organization
 Land
 Land means all those factors which are given
free by nature i.e. free of cost to human
beings
 These includes soil, sunshine, rainfall ,

rivers , seas etc

 The price of land is rent or royalty
 Main features of land
i. It is basic factor of production
ii. Its supply is limited. Human beings cannot
create more
iii. Land lacks mobility. It cannot be moved from
one place to another but it can be used for
alternative purpose
iv. Fertility of different pieces of land is different
v. Human beings can increase productivity of
land by using greater units of labour and
capital
 Labour
 Labour means any mental or physical efforts
of human beings made for any material
benefit i.e. monetary reward
 Mental labour (a lot of brain work and

minimum physical effort)e.g. work of doctor

or accountant
 Physical labour (more physical effort less

mental work) e.g. work of a farm worker or a

carpenter
 Labour
 Any mental or physical work which is not
undertaken for getting income but simply to
attain pleasure or happiness is not labour
 Examples i.e. work of gardener for pay or

home garden, doctor treating his own wife

 Labour includes human efforts of body or

mind which are undertaken in expectation of
reward
 Labour
 Any human effort which is not made for any
material benefit cannot be regarded as
labour e.g. mother looking after her children
without any reward
 Labour is an important factor of production
 Without labour land and capital cannot

produce anything
 Price of labour is wages and salaries
 Main features labour
i. Labour cannot be stored i.e. it is perishable
labour can neither be postponed nor
accumulated for the next day. It will perish.
Once time is lost, it is lost forever e.g.
labour of unemployed worker.
ii. Labour cannot be separated from labourer
i.e Land and capital can be separated from
their owner, but Labour cannot be separated
from a labourer
 Main features labour
 iii. Supply of labour cannot be increased or
decreased immediately if demanded since it
depends upon different factors like
population , education and training facilities
and social conditions

 Assignment 2 : what are other features of

labour apart from the one’s discussed ?
 Efficiency of labour
 Efficiency of labour means quality and
quantity of any commodity which is produced
by a labourer
 Factors affecting efficiency of labour

i. Mental abilities and physical strength

ii. Social services
iii. Working conditions
iv. Wage level
 Efficiency of labour
v. Educational and training
vi. Supply of proper equipments and tools
 Mobility of labour
Mobility of labour means movement of
labourers from one place to another place or
from one profession to another profession
 Various kinds of mobility of labour

i. Geographical e.g. one place to another place

ii. Occupational e.g. agriculture to industry
iii. Horizontal e.g. one employment to another
employment (same grade)
iv. Vertical e.g. low grade to senior grade
Advantages of mobility of labour
i. Higher employment level
ii. Higher wage level
iii. Greater production
iv. International community
 Division of labour
Division of labour means to divide one
particular job into smaller parts and to give
each part to separate labourers e.g. car
production (one worker is responsible for one
part only)
 Division of labour may be of different kinds

such as:
i. Complicated division of labour
ii. Occupational division of labour
iii. Geographical division of labour
 Advantages of division of labour
i. Greater production
ii. Greater efficiency
iii. Economy of tools
iv. Saving of time
v. Personal liking
 Disadvantages of division of labour
i. Monotony of the work- a labourer specializes
in one small part of work only so it tends to
restrict his further progress
ii. Lack of responsibility- since one job is
completed by different workers , so nobody is
responsible for better quality of the product
directly
iii. Greater risk of unemployment – since a
worker can do one type of work only incase of
depression in one industry the worker become
unemployed as they cannot do any other work
 Capital
 Capital means all goods which are man made
and are helpful for further production e.g.
machines, tools , roads, buildings
 Capital is an important factor of production

since it increases the productivity of land and

labour
 The owners of capital are paid interest
 Forms of capital
i. Private and Public capital
ii. Fixed and Circulating capital
iii. Sunk and Floating capital

Assignment 3 : differentiate the different forms

of capital mentioned above
Organization or Entrepreneurship
 Organization means to combine other
factors of production i.e. land , labour and
capital
 The person who organizes the business is

known as organizer or entrepreneur

 The reward for the services of an organiser or

entrepreneur is known as profit

Functions of the entrepreneur
 To start the business
 To employ land, labour and capital
 To look after the production
 To sell the product in the market
 To pay the reward of land ,labour and capital
 To take responsibility of profit and loss
 Sometimes from entrepreneurs are
distinguished from organisers
 Entrepreneur – responsible for the profit or

loss
 Organiser – supervises the whole production

process
 Examples : in small scale business organiser

and entrepreneur are the same e.g. retail shop

but in large scale business entrepreneur
employ managers who organise their business
 Firm
 Firm by definition refers to one unit of
business organization which is in the
production of any commodity e.g.
 Firm vs. Industry
 Firm is only one unit of business organization

while an industry consists of all those firms

which are producing the same product
 Objectives of firm
 Main objective of firm is to earn maximum
profits
 This can be achieved by adopting the
following methods:
i. Raising the price of the commodity
ii. Decreasing cost of production
iii. In some cases, lowering the price of the
commodity
 Business organization
 Business organization / unit is one unit of
control which is busy in the production or
distribution of any commodity
 A business organization may be owned by

one person or a group of persons

 It may be classified as small, medium or large
 The business organisations may be controlled

by the owners themselves or by the managers

on behalf of the owners
Forms of business organisation
i. Private sector
ii. Public sector

Private sector comprises of business

organisations owned by the private
individuals

Public sector comprises of business

organisations owned by the government
 Private Sector
i. Sole proprietorship
ii. Companies
iii. Partnerships
iv. Co-operatives
 Public Sector
i. Public corporations
ii. Parastatal bodies
iii. Local government authorities
 SOLE PROPRIETORSHIP
 This is the type of business organisation
when one person is responsible for profit and
loss and he is the sole owner of the business
 Main characteristics of Sole
proprietor
i. Capital is contributed by the owner – a sole
trader cannot appeal to the public at large to
subscribe
ii. The owner takes all the profit and shares the
losses with nobody
iii. The liability of sole trader is unlimited i.e.
there is no distinction between his business
and personal property incase of failure the
creditors of the business can claim payment
from personal property
 Liability - the state of being legally responsible
for something
 Liabilities – legally binding obligations/ debts

that companies/individuals take on as they

conduct business
 Limited liability -owner don't face much

personal financial risk for debts of your

business.
 Unlimited liability -The owners can be held

personally liable for all debts incurred by the

business.
 Advantages of Sole Proprietor
i. Direct contact with customers – which helps
the owner to understand their needs better
ii. Quick decisions and independence – make
decision in time without consulting anyone
iii. Close supervision – a sole trader has direct
contact with clients and employees
iv. Need for small capital-little or no cost of
organization involved
 Disadvantages of Sole Proprietor
i. Unlimited liability or debts- the owner is
liable for all the debts of the business up to
the extent of selling off some of his
properties
ii. Insufficient capital for expansion –financial
banking is limited and he cannot appeal to
the public for funds
iii. Over-worked – he performs wide range of
activities some with no experience
 Disadvantages of Sole Proprietor
iv. Uncertainty of business- the continuity of
the business is uncertain incase the owner is
sick or died
v. Unable to carry out Research-because of
smallness of capital and fear of risk, this
limits the owner to do market research and
make large investments
 Partnership
 Partnership may be defined as “ a
relationship between persons carrying on a
business in common with a view of profit”
 In a partnership business, two or more

people share the ownership of single

business and jointly run a business
 The liability of the individual partner is

unlimited unless the partnership agreement

provides for any limitation
 Features of Partnership
i. Capital is contributed by the partners no
appeal is made to the public to subscribe
ii. Partnership has a limited life i.e. it may be
ended by death , withdrawal , bankruptcy or
incapacity of any member of the firm
iii. Each partner is personally responsible for all
debts of the firm so, liability of the individual
partner is unlimited unless partnership
agreement provides for any limitation
iv. Profits and losses are shared on agreed basis
 Types of Partnerships
i. Ordinary Partnership - It is the one in which
all the members have unlimited liability i.e.
they are answerable to all the debts of the
firm to the extent of selling off their
personal properties
ii. Limited Partnerships – it is the one in which
the liability of the members/partners is
restricted to the amount of capital they have
put in the business
 In such a partnership however, there must be
at least one partner whose liability is
unlimited
 Forming a limited partnership is more

complex and formal than that of ordinary

partnership since it must register with
register of companies.
 During registration partnership deed or

articles of partnership must be drawn up

 Partnership deed – it is an important
document which govern the members in their
partnership firm. It covers the following:-
i. Name , location and nature of business
ii. Names of the partners and their duties
iii. Amount to be invested by each
iv. Duties, power and liabilities of each partner
v. Means of settling the accounts in case of
dissolution ,death , retirement ,insolvency
of one or more partners
 Advantages of Partnership
i. Easy to form or establish, less costly to
form however time should be invested in
developing partnership agreement
ii. Ability to raise funds/capital may be
increased since there is more than one
owner
iii. Specialization and even distribution of work
i.e. each partner take up those affairs for
which he is best suited
 Disadvantages of Partnership
i. Limited life of business i.e.
death ,retirement , bankruptcy or withdrawal
of one partner suddenly brings that
partnership to an end
ii. Joint involvements – partners are jointly and
individual liable for the actions of other
partners
iii. Less freedom of action – each partner must
be consulted every time decision is made
iv. Unlimited liability- except for limited partners