Theory of Production
Topic Nine

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Production and Productivity

Production is simply the conversion of inputs into outputs. It is an economic process that uses resources to create a commodity that is suitable for exchange. Productivity is the increase in output from each unit in the production process. Firms attempt to boost productivity by the training of employees and introducing and modernizing technology.

Figure 1

The Short Run versus the Long Run in Production Decisions

The short run is defined as the time horizon over which the scale of operation is fixed and the only variable input is labour; therefore, at least one input is fixed. In this period, the firm can make decisions to increase some of factors of production but not all. A good example is where a bus factory wants to increase his production. He cannot increase technology or even expand his building in the short run because the period is too short to allow for this. The only way in which the firm can increase its output in the short run is for it to rely exclusively on his variable factor which is labour.

By contrast, the long run is defined as a period in which all inputs are variable. In this case, all of the factors of production are variable because the firm will have sufficient time to adjust its inputs. As in the case of the bus factory above, the firm can now increase its technology and even expand its factory.

Measures of Output: Total, Average, and Marginal Product

There are three main measures of output which are total product, average product and marginal product. Total product (TP) is the total amount of output produced. The average product (AP) is the total product divided by the number of units of the variable input employed. It is the output of each unit of input.

For example:

If there are 10 employees working on a production process that manufactures 60 units per day, then the average product of the variable labour input is 6 units per day which is AP = 60/10 = 6. Marginal product (MP) is the increase in output resulting from a one-unit increase in the amount of the variable input employed.

For example:

Figure 2

The Relationship between the Product Curves

When the marginal product of labour curve rises, the firm experiences increasing marginal returns. That is, the marginal product of an additional worker exceeds the marginal product of the previous worker. At this time, the rate of increase in total product is accelerating. When the marginal product of labour curve falls, the firm experiences diminishing marginal returns. That is, the marginal product of an additional worker falls short of the marginal product of the previous worker. This is when the total product grows at a diminishing rate. As the marginal product continues to decrease, it will eventually become zero, then negative. This is when the total product declines. The law of diminishing returns states that as successive units of a variable resource are added to a fixed resource, the marginal product of the variable input eventually diminishes, assuming all units of variable inputs, workers in this case, are of equal quality.

The average product increases when the marginal product exceeds the average product. The average product falls when the marginal product is smaller than the average product. The average product is at its maximum and does not change when the marginal product equals the average product. This is the usual relationship between average and marginal variables.

Stages of Production

The production process has three stages.

Stage One

Stage one is the period of most growth in a company's production. In this period, each additional variable input will produce more products. This signifies an increasing marginal return; the investment in the variable input outweighs the cost of producing an additional product at an increasing rate. All three curves, the total product curve, the average product curve and the marginal product curve, are increasing and positive in this stage.

Stage Two

Stage two is the period where marginal returns start to decrease. Each additional variable input will still produce additional units but at a decreasing rate. This is because the law of diminishing returns starts to set in. Output decreases on each additional unit of variable input, holding all other inputs fixed. The total product curve is still rising in this stage, while the average and marginal curves both start to decline.

Stage Three

In stage three, marginal returns start to become negative. Adding more variable inputs to the amount of fixed inputs becomes counterproductive. In this stage, the total product curve starts to trend down, the average product curve continues its descent and the marginal curve becomes negative.

The three stages in the production process and the relationship between the total product curve, the average product curve and the marginal product curve can be seen in the graph below.

  • In Stage 1 (from the starting point to point A) the variable input is being used with increasing efficiency and all three product curves are rising.
  • In Stage 2, (from point A to point B) output or total product increases at a decreasing rate.
  • In Stage 3, (beyond B) output is decreasing and production after point B must be stopped.

Figure 3

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