5.

2 Theory of Production
Objectives
After studying this section, you will be able to: Explain the theory of production.

Describe the three stages of production.

Lets Think About This

Diminishing Returns Has the quality of your work ever declined because you worked too hard at something? Sometimes you reach a stage where you still make progress but at a diminished rate.
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Introduction
Suppliers face a difficult task.

Producing an economic good or service requires the 4 factors of production. The theory of production deals with the factors of production and the output of goods and services.

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Introduction (cont.)
The theory of production generally is based on the TWO runs.

Short run, brief period of production that allows producers to change only the amount of the variable input (workers/labor). For example, Ford Motors hiring 300 extra workers for one of its plants is a short-run adjustment.

 Long run, a period of production long enough for producers to adjust the quantities of all their resources, including capital.
If Ford builds a new factory, this is a longrun adjustment.

The Production Function

Shows how total output changes when the amount of a single variable input (labor) changes while all other inputs are constant.

The Production Function (cont.)

Figure 5.5a

total output the company produces.

extra output or change in total product caused by adding one more unit of variable input. 6

as more workers are added, total product rises until a point that adding more workers causes a decline in total product.

Discussion Question
From your experience in working in groups for a class assignment, how many students make up a productive team? When is adding more group members likely to cause a decline in total product?

Stages of Production
In Stage I, (increasing returns), marginal output increases with each new worker. Companie s are tempted to hire more workers, which moves them to Stage II.
Figure 5.5b

Three Stages of Production In Stage II, (diminishing returns), total production keeps growing but 5.5b the rate of Figure increase is smaller;
each worker is still making a positive contribution to total output, but it is diminishing.
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Three Stages of Production (cont.)

In Stage III (negative returns), marginal product becomes negative, decreasing total plant output. Figure 5.5b

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