THEORY OF

PRODUCTION
 PRODUCTION
Creation of goods and
services to satisfy the needs
and wants.
 TERMS TO REMEMBER :
ECONOMIC EFFICIENCY – profitable
improvement in overall resource
efficiency.
ISOCOST CURVE– defines the cost and
budgetary limits of production.
ISOQUANT – represents what can be
produced; also known as product
indifference curve.
 TERMS TO REMEMBER :
ISOQUANT – ISOCOST MODEL –
illustrates more dynamically how
different plant sizes and resource
combinations determine different levels
of resource efficiency and plant capacity.
MARGINAL PRODUCT – product due to
the additional or last unit of the variable
resource input.
 TERMS TO REMEMBER :
MARGINAL RATE OF SUBSTITUTION
– defined as how much of one
resource is given up in order to use
an additional unit of the other, given
a fixed capacity.
PRODUCTION – basically means act
of manufacturing a product.
 TERMS TO REMEMBER :
PRODUCTIVITY – the efficiency and
therefore the power of inputs to
produce.
RESOURCE MIX OR COMBINATION –
defined as how much of one
resource is used per unit of the
other.
 THEORY OF
PRODUCTION
 THEORY OF PRODUCTION
It is an analysis of OUTPUT – INPUT
relationship.
We will discuss the relation of
output to the size, combination, and
efficiency of resources.
Output Function serves as a tool in
analyzing cost – output relationship.
 PRODUCTION FUNCTION

Plant size and the

efficiency of its resources
determine plant capacity
(maximum output).
 MARGINAL PRODUCT

- It is the product due to the

additional or last unit of the
variable resource input.
 AVERAGE PRODUCT

- It is the output per unit of the

variable resource input
OUTPUT

RESOURCE INPUT
 LAW OF DIMINISHING RETURNS

The production function shows that

stretching the use of variable
resources against the limits of fixed
resources decreases additional
product.
“Too many cooks spoil the broth”.
 LESSONS OF
DIMINISHING RETURNS
 LESSON # 1
The size of a resource, given the
rest as fixed, should not go
beyond its product – maximizing
point.
 LESSON # 2
Plant capacity can only increase
with more of all resources unless
technology changes.
 LESSON # 3
Resources are basically
complementary.
THE ISOQUANT
 THE ISOQUANT

Theoretically, there are infinite

combinations of resource inputs which
determine the same plant capacity
(maximum output).
In a two – variable resource system,
these combinations form the product
indifference curve or isoquant.
MARGINAL RATE OF SUBSTITUTION

It is defined as how much of

one resource is given up in
order to use an additional unit
of the other, given a fixed
capacity.