THEORY OF PRODUCTION

MEM
BAPS III

Production
is the transformation of inputs into outputs
factors of production (capital and labor) are called

the inputs of production

Output
is the result that has been created by the inputs (when labor and capital

are combined)
two types of output: goods and services
the quality and quantity of labor and other capital and all other inputs
have a direct impact on the quality and quantity of output
the technology of a firm is the process by w/c inputs are turned into
outputs
the ultimate objective of production is to create goods and services that
will yield utility to consumers
factor of production are classified into: fixed factor and variable
factor
fixed factor remains constant regardless of the volume of production
while variable factor changes in accordance w/ the volume of
production

The production function

it shows the relationship between quantities of

various inputs used and the maximum (technically

feasible) output that can be produced with those
inputs used per unit of time expressed in a table,
graph, or an equation
is a mathematical equation to find out the different
variables in computing or solving production. In
production function, Q = F (K,L); where Q stands for
output, K stands for capital , and L stands for labor.

The Short-run vs. Long-run Analysis of Production

the difference is not based on time but on the

production inputs
in short-run, the use of at least one factor of
production cannot be changed, or there are fixed inputs
in long-run, all factors can be changed
the time factor is dependent across firms and industries
EXAMPLE: A laundry business can be adjusted in a
moths or two, but for Isuzu Motors Philippines capital
adjustment could take two or three years

PRODUCTION W/ ONE
VARIABLE INPUT

Law of Diminishing Marginal Returns

Describes a pattern in most production portion in

the short-run
It says that output will decrease even if there is an
increase in one of the inputs

Three stages of production

It is important to describe the three stages of

production because it will help us define the quantity

of labor ( or any other input) that a profit
maximizing form will employ
STAGE I of production starts at the origin until the
highest portion of the APL.
STAGE II goes from the highest portion of the APL
until MPL is zero.

STAGE III of production begins where MPL is zero

until its negative range

Return to Scale
If doubling all inputs causes output to increase more

than double, the firm is operating under increasing

returns to scale.
If doubling all inputs causes doubling of output,
there are constant returns to scale.
If doubling all inputs results to less than double
output, the firm is experiencing decreasing
returns to scale.

PRODUCTION W/ TWO
VARIABLE INPUTS

Isocost
Shows the different combinations of capital (K) and

labor (L) that a producer can purchase or hire given

his total outlay and the factor prices.

Isoquant
Is a curve w/c shows the different combinations of

capital (K) and labor (L) w/c yield the same level of
output.

Isoquant have three characteristics:

Negatively sloped
2. Convex to the origin
3. Do no intersect
1.

The negatively sloped isoquant can be explained

through the diminishing marginal rate of technical

substitution (MRTS). MRTS is the amount of capital
that a producer is willing to give up in exchange for
labor and still lie on the same isoquant
An isoquant is convex to the origin because of the
diminishing MRTS, meaning a producer is willing to
give up0 less and less of capital to gain additional
amount of labor. The less of the remaining capital
makes it more valuable than additional labor.

 END