Rosey Jazz V. Era BSBA 1B CLASS NO.

14

Chapter 5: The Theory of Production

Contents:

1. The production function

2. The law of diminishing returns

3. Total product, marginal product and average product

4. Stages of production

The Theory of Production

The theory of production examines the relationship between the factors of production (land,

 The theory of production deals with the relationship between the factors of production
and the output of goods and services.
 The law of variable proportions can explain how increasing units of a single input will
cause the output to vary.

1|Page
1. Production Function

Production function refers to the functional relationship between the quantity of a good produced
(output) and factors of production (inputs).“The production function is purely a technical relation
which connects factor inputs and output.” Prof. Koutsoyiannis Defined production function as
“the relation between a firm’s physical production (output) and the material factors of production
(inputs).” Prof. Watson In this way, production function reflects how much output we can expect
if we have so much of labour and so much of capital as well as of labour etc. In other words, we
can say that production function is an indicator of the physical relationship between the inputs
and output of a firm.The reason behind physical relationship is that money prices do not appear
in it. However, here one thing that becomes most important to quote is that like demand function
a production function is for a definite period. It shows the flow of inputs resulting into a flow of
output during some time. The production function of a firm depends on the state of technology.
With every development in technology the production function of the firm undergoes a change.

Mathematically, such a basic relationship between inputs and outputs may be expressed as: Q =
f( L, C, N )

Where Q = Quantity of output

L = Labour

C = Capital

N = Land.

2|Page
Hence, the level of output (Q), depends on the quantities of different inputs (L, C, N) available to
the firm. In the simplest case, where there are only two inputs, labour (L) and capital (C) and one
output (Q), the production function becomes.

Features of Production Function:

1. Substitutability: The factors of production or inputs are substitutes of one another which make
it possible to vary the total output by changing the quantity of one or a few inputs, while the
quantities of all other inputs are held constant. It is the substitutability of the factors of
production that gives rise to the laws of variable proportions.

2. Complementarity: The factors of production are also complementary to one another, that is,
the two or more inputs are to be used together as nothing will be produced if the quantity of
either of the inputs used in the production process is zero.The principles of returns to scale is
another manifestation of complementarity of inputs as it reveals that the quantity of all inputs are
to be increased simultaneously in order to attain a higher scale of total output.

3. Specificity : It reveals that the inputs are specific to the production of a particular product.
Machines and equipment’s, specialized workers and raw materials are a few examples of the
specificity of factors of production. The specificity may not be complete as factors may be used
for production of other commodities too. This reveals that in the production process none of the
factors can be ignored and in some cases ignorance to even slightest extent is not possible if the
factors are perfectly specific. Production involves time; hence, the way the inputs are combined
is determined to a large extent by the time period under consideration. The greater the time
period, the greater the freedom the producer has to vary the quantities of various inputs used in
the production process.

2. The Law of Diminishing Returns

3|Page
The law of diminishing marginal returns states that adding an additional factor of production
results in smaller increases in output. After some optimal level of capacity utilization, the
addition of any larger amounts of a factor of production will inevitably yield decreased per-unit
incremental returns. For example, a worker may produce 100 units per hour for 40 hours. In the
41st hour, the output of the worker may drop to 90 units per hour. This is known as Diminishing
Returns because the output has started to decrease or diminish

3. Total product, marginal product and average product

Total product is the total amount produced per a set of resources, average product is the average
cost per unit produced per set of resources, and marginal product is the cost for the very next unit
to be produced in resources. The marginal product curve crosses the average product curve at the
maximum of the average product curve. Marginal product focuses on the changes between
production totals and the quantity of resources. Average product shows output at a specific
level of input.

4|Page
Total Product- In simple terms, we can define Total Product as the total volume or amount of
final output produced by a firm using given inputs in a given period of time.

Marginal Product- The additional output produced as a result of employing an additional unit of
the variable factor input is called the Marginal Product. Thus, we can say that marginal product
is the addition to Total Product when an extra factor input is used.

Marginal Product = Change in Output/ Change in Input

Thus, it can also be said that Total Product is the summation of Marginal products at different
input levels. Total Product = Ʃ Marginal Product

Average Product- It is defined as the output per unit of factor inputs or the average of the total
product per unit of input and can be calculated by dividing the Total Product by the inputs
(variable factors).

Average Product = Total Product/ Units of Variable Factor Input

5|Page
4. Stages of production

Stage 1– this stage extended with zero input of variable factor to the level of input where it has
been analyzed the average product is maximum. As said by economic assignment writer, the
fixed factor under this stage is excessive. Similarly, the output can be increased via increasing
variable input relative to a fixed input. For instance, in a company, if one worker can produce 5
crafts, then together two employees can produce 15 crafts. At this stage, the elasticity curve also
found to be greater than unity as marginal productivity is greater than average productivity.
Hence it can be deduced, one per cent change in inputs leads to more than one per cent changes
in output.

Stage 2- At the beginning of stage 2, the marginal returns start to decrease and the total product
is maximum. In other words, it can be said, an average and marginal physical product start
declining (Layson,2015). For instance, in the previous example, if a worker is added 10 more
crafts to the products and another one is producing 8 crafts, then the total product curve of the
company is still rising while average and marginal curve found to be in dropping situation.
Although the firm is facing downwards slope, the total productivity will be still higher than stage
1. At this stage average productivity is also equal to marginal productivity; hence elasticity

6|Page
coefficient is equal to 1. That means change lead by one per cent in input causes one per cent
change in the output. It can be denoted as 0<_Ep <_1 (Tsukamoto, 2017)

Stage 3– In this stage, the marginal product is found to be negative and total production is found
to be declining at the same time. That means adding more values to the variable inputs seems to
be counterproductive (Bjork, 2020). This is completely irrational. The output per unit for both
variable input and fixed said to be negative. As the marginal product is negative, so it depicts the
elasticity is also negative with respect to any change in the input that implies no profit incurred
even if factors is added. To illustrate this, let’s take the previous example, hiring more employees
to product crafts will leads to less number of total production.

7|Page