MANAGERIAL ECONOMICS 2. Conversion Process includes operations (actual production process).

Operations may be either manual

or mechanical or chemical. Operations convert inputs into output. Conversion process also includes
PRODUCTION THEORY supporting activities, which help the process of conversion. The supporting activities include: production
MEANING OF PRODUCTION planning and control, purchase of raw-materials, receipt storage and issue of materials, inspection of
parts and work-in-progress, testing of products, quality control, warehousing of finished products, etc.
Production can be explained as an act of either manufacturing or mining or growing of goods (commodities) 3. Output includes finished products, finished goods (parts), and services.
generally in bulk for trade.
The three components of a production system are depicted in this diagram.
Production is a method employed for making or providing essential goods and services for consumers.it is a
process that puts intangible inputs like ideas, creativity, research, knowledge, wisdom, etc. in use or action. It is Examples of a production system are as follows:
a way that transforms (convert) tangible inputs like raw-materials, semi-finished goods and unassembled goods 1. Tangible Goods – consider an example of a manufacturing industry like a sugar industry. Here,
into finished goods or commodities. sugarcane is first used as an input, then the juice or sugarcane is processed through a conversion process.
PRODUCTION THEORY Finally, to get an output known as a refined sugar (used for mass consumption).
2. Intangible Goods – consider an example from a service industry that of a software-development firm
Production – refers to the transformation of inputs or resources into outputs of goods and services. Refers to the or company. Here, initially, written program codes are used as an inputs. These codes are then integrated
conversion of raw materials to human satisfying goods. in some database and are provided with a user-friendly interface through a conversion process. Finally,
an output is made available in form of an executable application program.
Inputs – are the resources used in the production of goods and services.
PRODUCTION TIME PERIOD
1. Variable Inputs – varies with outputs (e.g. raw materials and direct labor).
2. Fixed Inputs – does not vary with output (e.g. rental/building, machines, tools, equipment, payment for 1. Short-Run Production Time Period – at one least on input is fixed while the others are variables
support employees, etc.) (customized production) which leads to diseconomies of scale. The cost per unit of output is relatively
high.
PRODUCTION SYSTEM
2. Long-Run Production Time Period – when all inputs are variables (mass production/long range
production) which leads to economies of scale. The cost per unit of output is lesser.

PRODUCTION FUNCTION

Is an equation, table, or graph showing the maximum output of a commodity that a firm can produce per period
of time with each set of inputs. Both inputs and outputs are measured in physical rather than in monetary units.

Technology assumes to remain constant during the period of the analysis.

For simplicity, we assume here that a firm here produces only one type of output (commodity or service)
MEANING OF SYSTEM with two inputs, labor (L) and capital (K). Thus, the general equation of this simple production function
is:
System is an arrangement or assembly of inter-dependent processes (activities) that are based on some logic and
function. It operates as a whole and is designed (build) with an intension to achieve (fulfill) some objective or do Q=f(K,L)
some work. Huge systems are often a collection (assembly) of smaller sub-systems.
Cobb Douglas Standard Production Function
MEANING OF PRODUCTION SYSTEM
K for capital is taken from Karl Marx’s The Das Capital
Production system consists three main components viz., Inputs, Conversion Process, and Output.

1. Inputs include raw-materials, machines, man-hours, components or part drawing, instructions and other
paper works.
DISCRETE PRODUCTION SURFACE By holding the quantity of one input constant and changing the quantity used of the other input, we can
derive the total product (TP) of the variable input.

From the total product schedule, we can derive the marginal and average product schedules of the
variable input.

The marginal product (MP) of labor (MPL) is the change in the total product or extra output per unit
change in the labor/input used, while the average product (AP) of labor (APL) equals total product
divided by the quantity labor used. That is:

MPL= ΔTP/ΔL or MP= ΔTP/ΔI (Input)

APL= TP/L or AP= TP/I (Inputs)

PRODUCTION OR OUTPUT ELASTICITY

Production or output elasticity of labor (EL). This measures the percentage change in output divided by the
percentage change in the quantity of labor used.

EL= %ΔQ/%ΔL or

EL= ΔQ/Q = ΔQ/ΔL = MPL

The height of the bar refers to the maximum output (q) that can be produced with each combination of labor (L)
ΔL/L = Q/L APL
and capital (K) shown on the axis. Thus, the tops of all the bars form the production surface of the firm.
TOTAL, AVERGAE, AND MARGINAL PRODUCT OF LABOR CURVES
TOTAL, AVERAGE, AND MARGINAL PRODUCT OF VARIABLE INPUT

Total Product (TP/Q) – The firm uses a number of inputs to produce its output. If the firm varies the quantity of
only one input, keeping the other inputs quantities unchanged, then the quantity of its output obtained at any
quantity of the variable input is called the total product of the input.

For example, if the said variable input is labour and it is obtained that the firm produces 42 units of
output when it uses 6 units of labor along with the fixed inputs, then we say that the total product is 42
units of labour.

TPL, APL, and MPL Schedules of a Firm

Quantity of Labour Total Product of Average Product of Marginal Product of

used (L) Labour (TPL)
(units) (units)
(1) (2)
1 5
2 12
3 24
4 32
5 40
6 42
7 35
8 24
Labour (APL) Labour (MPL)
(units) (units)
(3) (4)
5 5
6 7
8 12
8 8
8 8
7 2
5 -7
3 -11
LAW OF DIMINISHING RETURNS AND STAGES OF PRODUCTION Stages of Production

It states that an additional amount of a single factor of production will result in a decreasing marginal output of • Stage 1- TP increases faster; +MP- increasing; AP>1;
production. • Stage 2- TP increases slower; +MP declining until-zero
• Stage 3- TP decreases; -MP; AP>1
• Stage 4- TP decreases;-MP; AP

RETURNS TO SCALE

Describe what happens to long-run returns/ output as the scale of production increases, when all input levels
including physical capital are variable.

Explains what will happen to the outputs if inputs are increased.

It explains the long-run linkage of the rate if there is an increase in output (production) relative to associated
increase in the inputs (factors of production).

R=%ΔQ/%ΔI = (Q2-Q1) * 100 / (I2-I1)*100

Q1 I1

When the input of Company Z increased from 120 to 240 man hours of labor, the output increases from 300 to
600 units. How much is the value of returns?

R=(600-300)/300*100)/(240-120)/120)*100

R= 1 (constant returns to scale)

Increasing Returns to Scale – when inputs are doubled/ increased, the outputs also increased more than double
(R>1).

Constant Returns to Scale – when inputs are doubled/ increased, the outputs will also increase in doubled
quantity (R=1).

Decreasing Returns to Scale – when inputs are doubled/ increased, the outputs also decreased (R<1).
INCREASING RETURNS TO SCALE

DECREASING RETURNS TO SCALE

CONSTANT RETURNS TO SCALE