Production

PRODUCTION

By Group 3 III-CCSAD

Topic GuideA. Factors of ProductionB. Production FunctionC. Law of Diminishing ReturnsD. Message of the LawE. The Costs of ProductionF. Economic CostsG. Marginal Cost and Average Cost RelationshipH. Short Run and Long RunI. Economies of ScaleJ. Appropriate Techniques of ProductionK. RevenueL. Total Revenue- Total Cost ApproachM. Marginal Revenue- Marginal Cost Approach

Man can produce goods and services without utilizing land, labor, capital or management .

Goods produced by man are called economic goods . However there are goods which are produce by nature. Such goods are called free goods.

In the production of goods and services, the various factors of production receive their corresponding payment like wages rents, interest and normal profits.

A. Factors of ProductionLand- is an original gift of nature. It includes the soil, river, oceans, mountains etc…Labor- is an exertion of physical and mental efforts of individuals. This implies not only to workers, farmers or laborers but also to professionals like accountants economist and scientist.Capital- is a finished product which is used to produce goods. However, money is a medium of exchange. It can not produce goods it can only buy goods.Entrepreneur- is an organizer and coordinator of the land, labor and capital.

B. Production FunctionProduction- is the creation of goods and services to satisfy human wants.The factors of production are called the inputs of production, and the goods and services that have been created by the inputs are called outputs of production.The factors of production are classified as fixed factor (fixed input) and variable factor (variable input) A fixed factor remains constant regardless of the volume of production. This means whether you produce or not, the factor of production is unchanged.

B. Production Function

In case of a variable factor, it changes in accordance with the volume production. No production means no variable factor. More production means more variable factors.The process of transforming both fixed and variable inputs into finished goods and services is called theory of production. The quantity and quality of goods and services being produced depend on the state of technology.

C. Law of Diminishing Returns

Also known as the law of diminishing marginal productivity. It is a basic law of economics and technology.The law states that when successive units of variable input (like farmers) work with a fixed input (like one hectare of land), beyond a certain point the additional product ( output) produced by each additional unit of variable, input decreases.The validity of the law of diminishing returns is based on two assumptions. The successive units of a variable input to should be identical, and the same technology is applied.

C. Law of Diminishing Returns

It is noted that in the work combination of variable input and fixed input, total output and additional output (or marginal product) increase up to a certain point. Beyond this point, the rate of increase of total product declines, and later on total product decreases as more units of a variable factor are employed.In the case of marginal product, it also diminishes beyond a certain point until it reaches negative returns as more variable inputs are added (see table and graph).

Table 4.1. The Law of Diminishing Returns

3-Hectare Rice Field

Farmers Total Product Marginal Product 1 40 0 2 55 15 3 75 20 4 100 25 5 120 20 6 135 15 7 145 10 8 145 0 9 135 -10 10 120 -15

Figure 4.1. The Law of Diminishing Returns

As shown in Table 4.1, the contribution of farmer 1 to production is 40 cavans. Marginal product is 0 because there is no additional farmer yet. The contribution of farmer 3 to production is 15 cavans. This is the additional or marginal product produced by farmer 2. Total product of the 2 farmers (farmer 1 and farmer 2) is 55 cavans (40 + 15). Up to farmer 4, marginal product is increasing. But after this point, marginal product decreases progressively until it becomes negative.

D. Message of the LawThe production of goods greatly depends on available resources or inputs.Marginal product is defined as the additional product brought about by one additional unit of a variable input (farmer).It is noted that when marginal product increases, total product also increases. When marginal product decreases, total product increases and at a decreasing rate, and when marginal product is below zero or negative, total product falls.The message of the law is that there is a proper combination of variable input and a fixed input in order to attain the maximum output.

E. The Costs of Production One of the determinants of supply is cost of production.A producer have greater ability and willingness to supply a product which has a lower cost of production.Cost does not only affect the producers but also the buyers. Since in an increase in the cost of production consequently increases the prices of products, the tendency of buyers is to reduce their purchases.Lower cost means lower price.Lower price means more sale – and more profitMore abundant resources are cheaper. In less developed countries, labor is cheap while capital (machine) is expensive.

F. Economic Costs

Total Cost- is the sum total cost of production. Normal profit is a part of total cost of production. Pure profit is the excess of the cost production. Total cost is also equivalent to fixed cost plus variable costFixed Cost- remains constant regardless of the volume of production. If there is no production, there is still cost.Variable Cost- changes in proportion to volume of production. If there is no production, there is no cost. More production means more cost.

F. Economic CostsAverage Cost- also called unit cost. It is equivalent to total cost divided by quantity.

AC = TC Q

Marginal Cost – additional or extra cost brought about by producing one additional unit.

MC = TC Q

Explicit Cost- expenditure cost.Implicit Cost- non-expenditure cost. They do not pay. You do not pay rent to your own land.Opportunity Cost- opportunity or alternative benefit.

Figure 4.2. Total, fixed, and variable costs.

Category 1 Category 2 Category 3 Category 40

1

2

3

4

5

6

Series 2Series 1

G. Marginal Cost and Average Cost

When MC is falling, it pulls down AC, and when MC is rising, it pulls up AC.At the start of production, AC is greater than MC. But when MC continues to rise, it reaches a point where it is equal to Figure 4.3, the MC curve intersects the AC curve at its lowest point. Beyond this intersection point, the curve rises at a faster rate than the AC curve.The AC curve has a U-Shape. This explains the fact that AC is high when less units are produced.The effects of MC on AC are due to mathematical relationship. As long as MC is less than AC, the latter falls. AC will only rise if MC is more than AC as shown in Table 4.2. illustrated in

Figure 4-3. MC and AC Relationship – when MC is falling, it pulls down AC; when MC is rising, it pulls up AC. MC intersects AC at its lowest portion.

Table 4.2: Mathematical relationship between MC and AC.Product Cost Total

CostAC MC

1 P 160 P 160 P 160 P 140

2 140 300 150 120

3 120 420 140 140

4 140 560 140 160

5 160 720 144 180

6 180 900 150

200 1,100 200

157.14

Said table, the cost of product 1 is P160. Total cost is P160 and AC is P160 (P160 divided by 1). The cost of an additional product (product 2) is P140. Total cost of product 1 and 2 is P300. AC is P150 (300 divided by 2). MC is P140 which is the cost of the additional product. The cost of the third product is P120. The total cost of the 3 products is P420. AC is P140 while MC is P120. However, the cost of the fourth product is P140 which is higher than the cost of product 3. Total cost is P560, AC is P140 and MC is also P140. At this point MC equals AC.It is noted that as MC increases, AC also rises, as shown in table. MC is equal at the point when AC is at the lowest point.

H. Short Run and Long RunShort run refers to a period of time which is too short to allow an enterprise to change its plant capacity, yet long enough to allow a change in its variable resources.

Cost of production under the short-run period is both fixed and variable.

Long run refers to a period of time which is long enough to permit a firm or enterprise to alter all its resources or inputs(both fixed and variable factors).

I. Economies of Scale

Can be classified as: External Economies of Scale- Factors outside the firm or enterprise- Contribute to the efficiency of the latter in

terms of increased output and decreased unit cost of production

Internal Economies of Scale- Factors inside the firm or enterprise- Contribute to the efficiency of the latter

Note: • Firms that enjoy both scales have

become very efficient and big• They survived competition and

therefore have remained in the industry

• They are capable of undertaking mass production which incurs a lower average cost of production

• They are involved on global supply of goods; and they have maximized their profits

I. Appropriate Techniques of Production

Based on the law of supply and demand, resources which are abundant have lower prices than those which are scarce. There is surplus of labor in less developed countries, on the other hand highly developed countries which their price of labor is high because it is not abundant.

• Labor-Intensive TechnologyProsMore labor inputs and less capital inputsMore plentiful resources should be

utilized because these are cheaper.

I. Appropriate Techniques of Production

• Why should they use this•Capital inputs are imported, and usually expensive. Poor countries can hardly afford to purchase them with their small foreign exchange earnings. Success of China•A huge human resource had been properly utilized, almost 100 percent of labor input.•They manufactured their own tools of production; never bought western technology.•It resulted that their rural development program has been one of the most successful program in the world.•It didn’t need foreign assistance, so it should be a lesson to poor countries who actually depend on western economic development

I. Appropriate Techniques of Production

• Capital-Intensive Technology- Technology used by Western countries, mainly Americans and Europeans.- Capital is cheaper in Western countries while labor is expensive, in contrary to the Eastern countries. Pros• Uses more capital inputs and less labor input.• In many economic activities, their operations

are computerized• Such modern technology does not adversely

affect the labor force, because there has been an increasing demand for workers in other sectors. Thus making this kind of technology almost flawless and perfect.

J. Revenue

Cost of production refers to the total payments by a firm to the owners of the factors of production like land, labor, capital and entrepreneur. These are other expenditure –side of a firm in the process of creating goods and services. For a firm to remain in business, it has to earn an income which is greater than its expenses . The income side of a firm is called revenue. The difference between cost and revenue is either profit or loss, depending on which one is higher.

K. Total Revenue – Total Cost Approach

•Total Revenue = price times units sold•TR = P *Q•Total Revenue – Total Cost = ProfitRule: if total revenue is greater than variable cost, operates; if total revenue is less than variable cost, shut down.

7,000 – total revenue

10,000 – fixed cost of the firm 5,000 – variable cost

---------15,000 – Total cost

K. Total Revenue – Total Cost Approach

The Rules Are:TR > TC: Produce moreTR < TC: Stop productionTR = TC: Maintain production

•Profit Maximization(under pure competition)

M. Marginal Revenue – Marginal Cost Approach

Marginal revenue is the additional income of a firm brought about by producing and selling one additional unit of a product.

The rule is: if marginal revenue is greater than marginal cost, increase production; if marginal revenue is less than marginal cost do not increase production.

Profit maximization of a firm is attained when MR=AC.

It can be stated therefore: profit maximization is attained at a point where price equals marginal cost (P = MC).