Name:- Rahul Subhash Suraiya

Topic:- Three stages of Short Run Production Function

Subject:- Economics for Business Decisions

Roll no:- FPAC016A

Submitted to Professor Mr.Rajesh Gupta

 INDEX

Serial No. Particular Page No.

1 Introduction 1

2 Elements of 2
production

3 Factors of production 4

4 Short run Production 7

Analysis

5 References 14
Introduction : -
In terms of Economics, Production is the process of combining various material
inputs and immaterial inputs (plans, know-how) in order to make something for
consumption (output). It is the act of creating an output, a good or service which
has value and contributes to the utility of individuals. The area of economics that
focuses on production is referred to as production theory, which is intertwined
with the consumption (or consumer) theory of economics.

The production process and output directly result from productively utilising the
original inputs (or factors of production). Known as primary producer goods or
services, land, labour, and capital are deemed the three fundamental production
factors. These primary inputs are not significantly altered in the output process,
nor do they become a whole component in the product. Under classical
economics, materials and energy are categorised as secondary factors as they are
bi-products of land, labour and capital.

Delving further, primary factors encompass all of the resourcing involves, such
as land, which includes the natural resources above and below the soil. However,
there is a difference in human capital and labour. It is common practice that
several forms of controllable inputs are used to achieve the output of a product.
The production function assesses the relationship between the inputs and the
quantity of output.
Elements of Production :-
The underlying assumption of production is that maximisation of profit is the key
objective of the producer. The difference in the value of the production values
(the output value) and costs (associated with the factors of production) is the
calculated profit. Efficiency, technological, pricing, behavioural, consumption
and productivity changes are a few of the critical elements that significantly
influence production economics.

• Efficiency
Within production, efficiency plays a tremendous role in achieving and
maintaining full capacity, rather than producing an inefficient (not optimal)
level. Changes in efficiency relate to the positive shift in current inputs,
such as technological advancements, relative to the producer's
position. Efficiency is calculated by the maximum potential output divided
by the actual input. An example of the efficiency calculation is that if the
applied inputs have the potential to produce 100 units but are producing 60
units, the efficiency of the output is 0.6, or 60%. Furthermore, economies
of scale identify the point at which production efficiency (returns) can be
increased, decrease or remain constant.

• Technological Changes
This element sees the ongoing adaption of technology at the frontier of
the production function.

• Behaviour, Consumption and Productivity

There is a strong correlation between the producer's behaviour and the
underlying assumption of production – both assume profit maximising
behaviour. Production can be either increased, decreased or remain
constant as a result of consumption, amongst various other factors. The
 relationship between production and consumption is mirror against the
economic theory of supply and demand. Accordingly, when production
decreases more than factor consumption, this results in reduced
productivity. Contrarily, a production increase over consumption is seen
as increased productivity.

• Pricing
In an economic market, production input and output prices are assumed
to be set from external factors as the producer is the price taker. Hence,
pricing is an important element in the real-world application of production
economics. Should the pricing be too high, the production of the product
is simply unviable. There is also a strong link between pricing and
consumption, with this influencing the overall production scale.
Factors of Production :-

Land

Land is a broad term that includes all the natural resources that can be found on
land, such as oil, gold, wood, water, and vegetation. Natural resources can be
divided into renewable and non-renewable resources.

• Renewable resources are resources that can be replenished, such as water,

vegetation, wind energy, and solar energy.
• Non-renewable resources consist of resources that can be depleted in
supply, such as oil, coal, and natural gas.

Labour as a Factor of Production

Labour as a factor of production refers to the effort that individuals exert when
they produce a good or service. For example, an artist producing a painting or
an author writing a book. Labour itself includes all types of labour performed
for an economic reward, such as mental and physical exertion. The value of
labour also depends on human capital, which is determined by the individual’s
skills, training, education, and productivity.
Productivity is measured by the amount of output someone can produce in each
hour of work. The income that comes from labour is referred to as wages. Note
that work performed by an individual purely for his/her personal interest is not
considered to be labour in an economic context.

The following are several characteristics of labour in terms of being a factor of

production:

• First, labour is considered to be heterogeneous, which refers to the idea

of how the efficiency and quality of work are different for each person. It
differs because it depends on an individual’s unique skills, knowledge,
motivation, work environment, and work satisfaction.
• Additionally, labour is also perishable in nature, which means that
labour cannot be stored or saved up. If an employee does not work a shift
today, the time that is lost today cannot be recovered by working another
day.
• Also, another characteristic of labour is that it is strongly associated
with human efforts. It means that there are factors that play an important
role in labour, such as the flexibility of work schedules, fair treatment of
employees, and safe working conditions.

Capital as a Factor of Production

Capital, or capital goods, as a factor of production, refers to the money that is

used to purchase items that are used to produce goods and services. For example,
a company that purchases a factory to produce goods or a truck that is purchased
to do construction are considered to be capital goods.

Other examples of capital goods include computers, machines, properties,

equipment, and commercial buildings. They are all considered to be capital goods
because they are used in a production process and contribute to the productivity
of work. The income that comes from capital is referred to as interest.

Below are several defining characteristics of capital as a factor of production:

• Capital is different from the first two factors because it is created by

humans. For example, capital goods like machines and equipment are
created by individuals, unlike land and natural resources.
• Additionally, capital is also a factor that can last a long time, but it
depreciates in value over time. For example, a building is a capital good
that can endure for a long period of time, but its value will diminish as the
building gets older.
• Capital is also considered to be mobile because it can be transported to
different places, such as computers and other equipment.

Entrepreneurship as a Factor of Production

Entrepreneurship as a factor of production is a combination of the other three

factors. Entrepreneurs use land, labour, and capital in order to produce a good or
service for consumers.

Entrepreneurship is involved with establishing innovative ideas and putting that

into action by planning and organizing production. Entrepreneurs are important
because they are the ones taking the risk of the business and identifying
potential opportunities. The income that entrepreneurs earn is called profit.
SHORT-RUN PRODUCTION ANALYSIS:

An analysis of the production decision made by a firm in the short run, with the
ultimate goal of explaining the law of supply and the upward-sloping supply
curve. The central feature of this short-run production analysis is the law of
diminishing marginal returns, which results in the short run when larger amounts
of a variable input, like labour, are added to a fixed input, like capital. A
contrasting analysis is long-run production analysis.

The analysis of short-run production sets the stage to better understand

the supply-side of the market. How producers respond to price depends, in part,
on their ability to combine inputs to produce output. This ability is guided by
the law of diminishing marginal returns, which states that the productivity of
a variable input declines as more is added to a fixed input.

If productivity declines, then more of the variable input is needed as

the quantity produced increases. This results in an increase in production cost,
which means producers need to receive a higher price. The connection between
higher price and more production is essence of the law of supply.

Two Runs: Short and Long

The first step in the analysis of short-run production is a distinction between the
short run and the long run. This distinction is intertwined with the distinction
between fixed and variable inputs.

• Short Run: The short run is a period of time in which at least one input
used for production and under the control of the producer is variable and
at least one input is fixed.
 • Long Run: The long run is a period of time in which at all inputs used for
production and under the control of the producer are variable.

The difference between short run and long run depends on the particular
production activity. For some producers, the short run lasts a few days. For others,
the short run can last for decades.

Two Inputs: Fixed and Variable

The analysis of short-run production assumes that at least one input in the
production process is fixed and at least one is variable. As already noted, the fixed
and variable inputs are intertwined with the notion of short run and long run.

• Fixed Input: A fixed input is an input used in production and under the
control of the producer that does not change during the time period of
analysis (the short run).

• Variable Input: A variable input is an input used in production and under

the control of the producer that does change during the time period of
analysis (the short run).

The variable input used by most producers is more often than not labor. The fixed
input for most production operations is usually capital. The presumption is that
the size of a firm's workforce can be adjusted more quickly that the size of
the factory or building, the amount of equipment, and other capital.

Note that the phrase "under the control of the producer" is included in the
specifications of short run, long run, fixed input, and variable input. The reason
is that short-run production analysis is most concerned with how producers adjust
the inputs under the control in response to changing prices.
Any production activity invariably includes inputs (fixed and variable) that are
beyond the control of the producer, including government laws and regulations,
social customs and institutions, weather, and the forces of nature. These other
variables are certainly worthy of consideration, but are not fundamental to
explaining and understanding the basic principles of market supply.

Three Returns: Increasing, Decreasing, and Negative

The addition of a variable input (like labour) to a fixed input (like capital) can
have one of three basic results. First, production might increase at a increasing
rate. Second, production might increase at a decreasing rate. Third, production
might actually decrease. These three alternatives are technically
termed increasing marginal returns, decreasing marginal returns, and negative
marginal returns.

• Increasing Marginal Returns: This occurs if each additional unit of a

variable input added to a fixed input causes incremental production to
increase. For example, the one worker contributes 10 units of output to
production, the next worker contributes another 12 units, and the
subsequent worker contributes 14 units. With increasing marginal returns,
each worker contributes more to production that the previous worker.

• Decreasing Marginal Returns: This occurs if each additional unit of a

variable input added to a fixed input causes incremental production to
decrease. For example, the one worker contributes 10 units of output to
production, the next worker contributes another 8 units, and the subsequent
worker contributes only 6 units. With decreasing marginal returns, each
worker contributes less to production that the previous worker.
 • Negative Marginal Returns: This results if the addition of a variable input
added to a fixed input actually causes the total production to decline. For
example, if 10 workers produce a total of 100 units of output, and 11
workers produce a total of 99 units, then the eleventh worker is said to have
negative marginal returns.

Most short-run production involves increasing marginal returns with the addition
of the first few units of a variable input. This inevitably gives way to decreasing
marginal returns. While negative marginal returns are somewhat rare, they do
eventually result if too many units of a variable input are added.

One Law

The inevitability of decreasing marginal returns is captured by the most important

economic principle in short-run production analysis--the law of diminishing
marginal returns.

• The Law of Diminishing Marginal Returns: This law states that as more
and more of a variable input is added to a fixed input in short-run
production, then the marginal product (that is, the marginal returns) of the
variable input eventually declines.

While most short-run production is likely to see increasing marginal returns,

eventually, inevitably, most certainly, decreasing marginal returns occur.

The law of diminishing marginal returns means that increased production of a

good requires more and more of the variable input. For example, the first 50 units
of production can be had with only 5 workers. However, the next 50 units might
required an additional 10 workers.

The positive law of supply connection between price and quantity, as such, can
be traced to the law of diminishing marginal returns.
Three Product Curves
This graph presents the three "product" curves that form the foundation of short-
run production analysis. This particular set of curves depict the hourly
production of Waldo's Super Deluxe TexMex Gargantuan Tacos (with sour
cream and jalapeno peppers) for different quantities of labor, the variable input.
The fixed input is the building, cooking and preparation equipment, cash
register, tables, chairs, and other capital that comprise Waldo's TexMex Taco
World restaurant.

• Total Product Curve: The curve labelled TP is the total product curve, the
total number of Tacos produced per hour for a given amount of labour. If
Waldo (the owner of Waldo's TexMex Taco World) hires more
employees, he can expect a greater production of Tacos until he reaches
peak production at 7 and 8 workers. Click the [TP] button to highlight
this curve.
• Marginal Product Curve: The MP curve is the marginal product curve,
and the one that is key to the study of short-run production. The MP
curve indicates how the total production of Tacos changes when an extra
worker is hired. For example, hiring a fifth worker means that Waldo's
Taco World can produce an additional 10 Tacos per hour. Most
important, the marginal product declines after the second worker is hired,
which is the law of diminishing marginal returns, the driving principle in
the study of short-run production. Click the [MP] button to highlight this
curve.
• Average Product Curve: The average product curve, labelled AP,
indicates the average number of Tacos produced by Waldo's workers. If,
for example, Waldo has a staff of 7, then each produces about 17 Tacos
per hour--on average. Click the [AP] button to highlight this curve.
Three Production Stages
Short-run production exhibits three distinct stages reflected by the shapes and
slopes of the three product curves--total product, marginal product, and average
product.

• Stage I: The first stage is increasing marginal returns and is characterized

by the increasingly steeper positive slope of the total product curve, the
positive slope of the marginal product curve, and the positive slope of the
average product curve. Moreover, the marginal product curve reaches a
peak at the end of Stage I.
• Stage II: The second stage is decreasing marginal returns and is reflected
in the positive but flattening slope of the total product curve and the
negative slope of the marginal product curve. Moreover, the average
product reaches a peak and is equal to marginal product in this stage. The
marginal product curve intersects the horizontal quantity axis at the end
of Stage II.
• Stage III: The third and last stage is negative marginal returns illustrated
by the negative value of marginal product and the negative slope of the
total product curve. Average product is positive, but the average product
curve has a negative slope.
One Step
This analysis of short-run production is but the first step in a brisk walk toward
a better understanding market supply. Further steps include the cost of short-run
production, especially marginal cost, and the market structure in which a firm
operates, such as perfect competition or monopoly.

• Production Cost: An understanding of market supply builds on the short-

run production analysis and the key role played by the law of diminishing
marginal returns. Because the productivity of the variable input
decreases, a larger quantity is needed as production increases. This larger
quantity, however, entails greater production cost, as reflected in a
positively-sloped marginal cost curve.
• Market Structure: The market supply also depends on the structure of the
market, especially the degree of competition and the resulting market
control of each firm. Competitive markets, with limited control over the
price, tend to produce output by equating price and marginal cost.
Because marginal cost increases with production, so too does price.
However, less competitive markets, with greater market control by the
participating firms, need not equate price and marginal cost. As such, a
higher price might not correspond with a larger quantity.
References :-

• https://www.amosweb.com/cgi-
bin/awb_nav.pl?s=wpd&c=dsp&k=short-run+production+analysis
• https://www.amosweb.com/cgi-
bin/awb_nav.pl?s=wpd&c=dsp&k=production+stages#:~:text=The%
20three%20stages%20of%20short,in%20this%20example%20is%2
0labor.
• https://en.wikipedia.org/wiki/Production_(economics)#:~:text=Produ
ction%20is%20the%20process%20of,to%20the%20utility%20of%2
0individuals.
• https://corporatefinanceinstitute.com/resources/knowledge/economic
s/factors-of-production/
• https://www.investopedia.com/terms/f/factors-production.asp