Unit 4 - The Theory of Production
OVERVIEW
Production theory is the study of production, or the economic process of producing outputs
from the inputs used. Production uses resources to create a good or service that are suitable
for use or exchange in a market economy. This can include manufacturing, storing, shipping,
and packaging. Some economists define production broadly as all economic activity other than
consumption. They see every commercial activity other than the final purchase as some form of
production.
Production is a process, and as such it occurs through time and space. Because it is a flow
concept, production is measured as a “rate of output per period of time”. There are three
aspects to productions processes:
1. The quantity of the good or service produced.
2. The form of the good or service created.
3. The temporal and spatial distribution of the good or service produced.
A production process can be defined as any activity that increases the similarity between the
patter of demand for goods and services, and the quantity, form, shape, size, length and
distribution of these goods and services available to the market place.
LEARNING OUTCOME: After the completion of this unit, the students will be able to:
1. Differentiate Fixed and Variable Inputs and their value to the firm.
2. Apply the Law of Diminishing Return principle in actual firm case analysis.
3. To compute and plot total input and total product output
COURSE MATERIAL:
Watch a documentary of General Motors
A print soft copy of General Motors Case Study, with questions to be answered as
part of the student’s assignment
General Motors Case Study Analysis
MEASUREMENT:
Twenty (20) points Multiple Choice Quiz
REFERENCES:
https://www.khanacademy.org/economics-finance-domain/ap-microeconomics/production-cost-and-
the-perfect-competition-
Lesson 9 - The Production Function and Stages of Production
Display slide, to define few words such as:
Production is the creation of goods and services using the inputs of production.
Production Function is the physical relationship between inputs and outputs of goods and
services
Inputs of production refers to the factors of production which include land, labor, capital and
entrepreneurship. Inputs are classified as follows:
Fixed inputs - they are those that remain constant regardless of the volume or
quantity of production. This means that whether you produce or not, the factors of
production is unchanged. Ex. Land, building
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Variable inputs - these are those that vary in accordance to the volume or quantity of
production. If there is no production; then, there is no variable inputs.
Ex. Labor, raw materials
The Law of Diminishing Returns
Display slide to define, It states when successive units of variable input is combined with a
fixed input, the total product (TP) or output (Q) will increase, but beyond some points the
resulting increases in output will become smaller and smaller.
Total Product (TP) refers to the total production or output (Q).
Marginal (Physical) Product (MP) is the additional output produced by employing one
additional unit input (X) holding the level of usage of all other inputs constant.
ΔQ
MP = ΔTP/ Δx or using Q to denote TP MP = -------
Δx
Average (Physical) Product (AP) is the output produced per unit of the input
AP = TP/x or using Q to denote TP AP = Q
-----
X
Display Slide, to show the total product (in cavans) schedule of rice production with
workers as variable inputs (x). Applying the formula we can find the solution below.
On another slide, below is the graphical presentation of the schedule, showing the
increasing rate of production as inputs (workers) were added, thus, total product and
marginal product increases at a certain point.
Table 10.1
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Display slide, to see the plotted data below and explain to the students the theory in this
drawing.
Fig. 10.1
The Three Stages of Production
Display the slide, present the table and the illustration above to explain the 3 stages of
production as follows:
1. Stage of Increasing Returns - this stage shows that as additional variable input is used,
Total Product (TP) increases at an increasing rate.
2. Stage of Decreasing Returns - This is the stage where the producer continuously
employs more labor input to a fixed land, Total Product (TP) continuously increases but
at a decreasing rate.
3. Stage of Negative Returns - it is the stage of over-utilization of the fixed input. Note that
as labor input increases, Total Product is then decreasing so the contribution of
additional labor input is already negative.
LEARNING ACTIVITY:
Group the students into 4 and let the students choose a local business. Make an evaluation of
its existence since date of operation until 6 months, one year, two years or more.
Choose the line of business below:
1. Real Estate
2. Fast Food Chain
3. Beauty Salon and Spa
4. Eatery or Carinderia
5. Funeral Parlor
6. Mineral Water Supply
4
7. Parcel Service
8. Transport Business
Follow Format as designed
MEASUREMENT:
Twenty (20) points Multiple Choice via Google form
REFERENCES:
https://people.wou.edu/~leadlej/Old/Winter%202011/EC%20460/Perloff_Chap6.pdf
https://www.google.com/search?
q=stages+of+production&oq=Stages+of+Production&aqs=chrome.0.0l7.5878j0j7&sour
https://study.com/academy/lesson/law-of-diminishing-returns-definition-examples-quiz.html
Lesson 11 – Production Isoquants and Isocost
Display slide, to explain that Isoquants represent the various combinations of two inputs that
can be used to produce the same level of output.
Characteristics of Isoquants
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1. They slope downward to the right for those combinations of inputs that firms will want to
use.
2. They do not intersect.
3. They are convex to the origin.
Display slide, and explain that Isocost line contains all combinations of inputs that the same
budget can purchase at constant prices.
Below is an example of isoquant and isocost schedules and graphs.
Table 9.1 Isoquant Schedules
The point of tangency of the Isoquant and Isocost curves shows the best combination of
inputs (labor and capital) given the capital outlay of P16,000.00. The firm must employ 20 units
of labor and 15 units of capital in its production process. The maximum output that the firm can
produce is 1000 units.
Table 9.2 Production Input Combination Schedule
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Theory of Cost and Profit
Display slide on cost concepts.
Cost of production - refers to the total payment by a firm to the owners of the factors of
production.
Factors of Production Factor Payment
Land Rent
Labor Wage or Salary
Capital Interest
Entrepreneurship Profit
The price of resources is measured in terms of opportunity cost.
Opportunity cost - is the value of alternative product foregone
Explicit cost (Visible cost) is the actual expenditures made by the firm (that is usually
thought of as its only expenses).
Implicit cost (Invisible cost) is the cost of self-owned, self-employed resources frequently
overlooked in computing the expenses the company keeps
Short run and Long run viewpoints
Short run is the planning period of the firm so short that some resources can be
classified as fixed while some are considered variable, while Long run is the planning
period pf the firm so long that all resources eventually become variable.
Short Run Cost Curves
In the short run, the total costs of a firm depend on the firm’s size and on the level (or
volume) of production. The component parts of Total Costs (TC) are Total Fixed Costs (TFC)
and Total Variable Cost (TVC).
TC = TFC + TVC
Fixed cost is the kind of cost which remains constant regardless of the level (or volume) of
production. The summation of all the fixed costs incurred by a firm in its production is the Total
Fixed Cost (TFC).
Variable cost is the kind of cost which changes in proportion to the level (or volume) of m
production. Total Variable Cost (TVC) is the totality of all the variable cost spent by the firm in
its production.,
Average and Marginal Cost Curves
AFC = TFC/ Q
AVC = TVC/ Q
AC = TC/Q
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AC = AFC + AVC
MC = ΔTC/ΔQ
Fig. 11.1
Profit, Loss and Break-even
Profit maximization involves the comparison of TR and TC. The mathematical formula to
derive profit (r) is by getting the difference between total revenue (TR) and total cost (TC).
Profit = TR -TC
LEARNING ACTIVITY:
Illustrate a Production Office and Warehouse in one (1) short Bond Paper
MEASUREMENT:
Case Study Analysis on “Self Managed Teams: A Case of New Productivity Breakthrough.”
REFERENCES:
Manual for Mathematical Economics with Work Exercises by Silon, 2009
Understanding Economics by Payumo, Maniago and Camba, 2014
http://www.darshan.ac.in/Upload/DIET/Documents/CE/Theory%20of
%20production_05012015_060332AM.pdf
