Theory of Production, Schemes and Mind Maps of Industrial economy

Download Theory of Production and more Schemes and Mind Maps Industrial economy in PDF only on Docsity!

Theory of Production

What is Production?

• (^) Production is basically an activity of transformation, which connects factor inputs and outputs. The process of transforming inputs into outputs can be any of the following kinds: Change in the Form (Raw material transformed to finished goods). Change in Place (Supply chain, Factory to Retailer).

Basic Concepts of Production Theory

• (^) Classifications of Inputs Land – all natural resources of the earth – not just ‘piece of land’. Price paid to acquire land = Rent. Labour – all physical and mental human effort involved in production. Price paid to labour = Wages. Capital – buildings, machinery and equipment used to produce goods & services. Price paid for capital = Interest. Entrepreneurship – a person who coordinates other factors of production. Price paid for Entrepreneurship = Profit.

Basic Concepts of Production Theory

• (^) Inputs are considered variable or fixed depending on how readily their usage can be changed.
• (^) Fixed input – An input for which the level of usage cannot readily be changed - (^) In economic sense, a fixed input is one whose supply is inelastic in the short run. - (^) In technical sense, a fixed input is one that remains fixed (or constant) for certain level of output. - (^) Typically fixed input will include land and machinery, it may also include certain type of labour.

Basic Concepts of Production Theory

• (^) Short run – At least one input is fixed. Example, Land and Machinery.
• All changes in output achieved by

changing usage of variable inputs.

• (^) Long run – All inputs are variable.
  • Output changed by varying usage of

all inputs.

Production Function

• (^) The production function is a purely technical relation which connects factor inputs and outputs.
• (^) The production function represents the technology of a firm of an industry, or of the economy as a whole.
• (^) A production function may take the form of a schedule, a graph line or a curve, an algebraic equation or a mathematical model.
• (^) The production function includes all the technically efficient methods or production

Method of production

• (^) A method of production (process, activity) is a combination of factor inputs required for the production of one unit of output.
• (^) Usually a commodity may be produced by various methods of production.
• (^) For example, a unit of commodity x may be produced by the following processes:

• (^) A process of production is technically efficient if it uses less of one factor and no more from the other factor, compare to any other process of production.
• (^) Which is efficient process A or B?

Production Function

• (^) For sake of convenience, economists have reduced the number of variables used in a production function to only two: capital (K) and labour (L).
• (^) Therefore, in the analysis of input-output relations, the production function is expressed as Q = f(K, L).

• (^) To increase production, Q, firm require K and L.
• (^) The firm can increase both K and L or only L will depend on the time period it takes into account for increasing production, i.e., whether the firm is thinking in terms of the short run or the long run.
• (^) Economists believe that the supply of capital (K) is inelastic in the short run and elastic in the long run.
• (^) Thus, in the short run firms can increase production only by increasing labour, since the supply of capital is fixed in the short run.
• (^) In the long run, the firm can employ more of both capital and labour, as the supply of capital becomes elastic over time.

Example: Alpha Clothing

• (^) Alpha Clothing, a shop that produces jackets.
• (^) Alpha Clothing leased building and equipment and is considered as its fixed factors of production.
• (^) Variable factors of production include things such as labor, cloth, and electricity.
• (^) To keep the analysis simple, we assumed Alpha clothing uses only one variable factor Labor.

Total Product Curve (TP) A total product (TP) curve shows the quantities of output that can be obtained from different amounts of a variable factor of production, assuming other factors of production are held constant.

Average Product (AP)

• (^) The Average product (AP) of a variable factor is the output per unit of a variable factor.
• (^) With reference to our example, the average product of labor (APL), is the ratio of output to the number of units of labor (Q/L).
• (^) It is used for comparing productivity levels over time or in comparing productivity levels among nations.

From Total Product to the Average and Marginal Product of Labor