The Theory of Production

The Theory of Production Chapter 5, Lesson Four

The Theory of Production • The theory of production deals with the relationship between the factors of production and the output of goods and services. • We will focus on the short run, a period of production that allows producers to change only the amount of the variable - input labor

The Theory of Production • This contrasts with the long run, which is a period of production long enough for producers to adjust the quantities of all their resources, including capital.

Law of Variable Proportions • The law of variable proportions states that, in the short run, output will change as one input is varied while the others are held constant. • How is the output of the final product affected as more units of one variable or resource are added to a fixed amount of other resources • Adding salt to a meal will make the meal better, to a point, but will eventually ruin the meal.

Production Function • The production function is the concept that describes the relationship between changes in output to different amounts of a single input, ceteris paribus (all others things held constant) • As you add one more resource (like labor) and you keep everything else the same, how will the final production change?

Production Function Schedule number total marginal of workers product product 0 0 0 1 7 7 2 20 13 3 38 18 4 62 24 5 90 28 6 110 20 7 129 19 8 138 9 9 144 6 10 148 4 11 145 -3 12 135 -10

Production Function • The first column of the production function is the variable input (usually number of workers or hours of labor) • The second column is the total product or total output—the total amount of finished product that is made.

Production Function • The next column is the marginal product—the extra output or change in total product caused by the addition of one or more units of input • In other words, how much the amount of final product changes as you add one unit of input (a worker)

Remember: • Everything else stays the same, the number of factories, the amount of raw materials, equipment, etc. • Only number of workers is changing.

Think about it • As we add workers, at first it will help our production. • Jobs will be split, we’ll see division of labor and specialization. • Production should increase. • But at a point, adding another worker in a full factory will start slowing down production.

Stages of Production • Stage 1 is increasing returns (returns being what you get back from putting something in)—as the number of workers increases they make better use of their time, machinery and resources and become increasingly more efficient in their work • There is increasing marginal product with every worker added because that worker can add efficiency and help increase production

Production Function with Stages number total marginal of workers product product 0 0 0 stage 1 1 7 7 increasing 2 20 13 marginal 3 38 18 product 4 62 24 5 90 28 stage 2 6 110 20 diminishing 7 129 19 returns 8 138 9 9 144 6 10 148 4 stage 3 11 145 -3 negative ret. 12 135 -10

Stages of Production • Stage 2 is diminishing returns—total production keeps growing, but by smaller and smaller amounts. • The rate in increase in total production is starting to slow down. • Each additional worker is making a diminishing, but still positive, contribution to total output • Diminishing returns—output increases at a diminishing (smaller and smaller) rate

Stages of Production • Stage 3 is when there is too much input. • Total output decreases as input increases. • Marginal product is negative—as input increases, total plant output decreases. • There’s too much salt in the meal and the meal is now ruined.

Now Graph These Points It will look like this, increasing, then starting to even out, then decreasing

The Theory of Production