Theory of Production

Graphs and Economic terms-

An economic variable is an economic measurement which can take a different

set of values. This included measurement such as prices, unemployment rates ,
production levels , wage levels, exchange rates etc.

We can examine values as either being Total Values, Marginal Values and
Average values.

The tables shows some values/runs scored for a Cricketer based on his games
played

It Can be observed that:

-The total value/total runs is seen as the total output or absolute amount (sum of
all)

-And the average value would be the total value divided by the quantity (shown in
the table by the number of cricket matches).

-The marginal value is the increase in total value after an additional output (or in
this case an additional match.)
Exercise Complete by finding out Total Revenue(Quantity x Price) ,
Average Revenue and Marginal Revenue
Total Revenue Average Marginal
Revenue=(TR/Q) Revenue

100 100 —
190 95 90

270 90 80

340 85 70
400 80 60

450 75 50

490 70 40
520 65 30

540 60 20

500 50 -40
 Production in the short and Long Run

The quantity of factors of production which a firm can employ depends on the amount of time
the firm has to make arrangements to organise the factors of production. (land ,labour ,capita l,
entrepreneur)

Short Run

This is the period of time where a firm can make arrangements to increase some factors of
production but not all. In the short run there is at least one factor of production which cannot be
increased. This factor is called the fixed factor, and the other factors are called variable factors.
Some economists say the short is the period of time where there is at least one fixed
factor of production.

Example .

A car company wants to increase output, but it is in a short period of time and they
cannot build a new factory. However they increase/hire more workers to the factory .
Here the factory or capital is the fixed factor whereas labour is the variable.

Long Run
This is the period of time when a firm can make arrangements to increase all factors of
production, as such all factors in the production process are variable . There are no fixed
factors.

The short run and long run differ from business to business .
The long run as it is made up of several short run periods.

Measures of Output: Total Product, Average Product and Marginal Product.

Economists use these output measures to quantify the amount produced by firms . They use
three different measurements:

-Total Product - refers to the total output produce by a firm from a given amount of labour

-Average Product - refers to the output produced per unit of labour. This is calculated by
dividing the total product by the number of workers employed.
AP=Total Product/ Quantity (Units of Labor

Interpretation: This tells on average how much output one worker produces

-Marginal Product- refers to an increase in output as one more unit of a factor of production is
hired. This is calculated by taking the change in total product as one more worker is employed.
MP= Δ(change) in Total Product / Δ(change) in labour input
Interpretation: This tells how much an additional unit of labour contributes to the total
production(product)
eg
Labour(Input)Q Total Product MP AP =(TP/Q)
0 0 00 0
1 2 f2 2
2 8 6 4
3 12 4 4
4 15 3 3.75
5 16 1 3.2
6 14 -2 2.33

Graph showing Total Product

Graph Showing Marginal Product and Average Product
Short Run /Input /output relationship

In the short run when one factor of production is fixed and a business employs more units of the
variable factor, after some time each additional unit of input will begin to add less and less to
final production( to diminish)
The law of diminishing returns therefore implies that if more units of labour are employed
with a fixed amount of capital, the marginal product after some time will decrease.

Relationship between Average product and marginal product

In the figure above the average and marginal product are shown together . This diagram
shows that both curves first go upward , they intersect then eventually they become
downward sloping .

NB.
1.The reason for this is because of diminishing return (why both begin to go up then
down)
2. The marginal product curve passes through the highest point on the average product.

When the marginal product is higher than the average product,the average product
curve is upward sloping

When the marginal product is lower than the average product ,the average product
curve is downward sloping.

Points to remember:
Law of Diminishing return implies that as more units of a variable factor are added to one unit
of a fixed factor, after some time each additional output will begin to diminish. (Marginal
Product)

In the long run, the firm is able to increase the amount of all factors of production (so there will
be no fixed factor), therefore diminishing return will not be a problem as it is a short run concept.

NB. In the long run When all factors of production have been increase, this is referred to
as an increase in the scale of production

Example:
Supposed a farmer has 5 acres of land and 2 workers. He decides to expand his scale of
production by 100%. Now has access to 10 acres and 4 workers.

The effect of an increase in the production is known as returns to scale.

There are 3 possible scales/scenarios.
1. Increasing returns to scale: This occurs when output increases more than
proportionately to the increase in inputs. E.g If a pineapple farmer increases its
production/ inputs by 50% and levels of output therefore increase by 80% ,then this is
achieving increasing returns to scale
2. Decreasing returns to scale - This occurs when output increases less than
proportionately to the increase in inputs .
Example .If an electricity generation plant like GPL expands its scale of production by
50% but the amount of electricity generated (output) is only 30% there is decreasing
returns to scale.
3. Constant Returns to scale- This occurs when output increases propionate by the same
amount of inputs . EG if a cement company increases inputs by 50% the production of
cement therefore increases my 50%.
Stages of Production
The production process has three stages :
 x

HW. complete the table

Labor(input/ Total Product Marginal Average

variable factor) Product Product (TP/Q)

0 0 - -

10 2 2 1

20 8 6 8/2=4

30 12 4 12/3=4

40 15 3 15/4= 3.75

50 16 1 3.2
Labor(Q Total Product Average Product Marginal Product

0 0 - -

1 10 10 10

2 24 12 14

3 35 11.66 11

4 45 11.25 10

5 50 10 5

6 54 9 4

7 56 8 2

8 59 7.4 3