THE THEORY OF
PRODUCTION
Chapter 5 Section 2
The Theory of Production
• What are the four Factors of Production?
1. Land
2. Labor
3. Capital
4. Entrepreneurship
• The Theory of Production = the relationship
between the factors of production (inputs) and the
output of goods and services. It examines how
output changes when inputs change.
The Theory of Production Con’t
• The short run = short period of time
during which producers can change
variable (change-able) inputs. Most
often, LABOR is the input producers
change in the short run.
• The long run = longer period of time,
where producers can adjust all inputs,
like land, capital and labor.
Law of Variable Proportions
• The law of variable proportions states that in
the short run, output (what you make) will change
as one input (like labor) is varied while the others
are held constant.
• In our lemonade example water stayed the same
and we change the input of lemonade powder.
The book discusses the addition of chili powder to
chili.
• How can the input of one resource change the
final product?
The Production Function
• Production Schedule / Function = Graphs or
charts which illustrates INPUT and OUTPUT, see
p112, Figures 5.4
• Total Product = The total amount of goods or
services produced by the business (Examples:
Number of donuts made by Donut Connection)
• Marginal Product = The extra output generated
by adding one more unit of variable input.
• Example: the number of additional haircuts performed
by adding one more stylist
Three Stages of Production
• Stage I – Increasing Returns = Adding one more input
increases production and increases the total output. In
this stage, marginal product is increasing.
• Stage II – Diminishing Returns = Adding one more input
still continues to make output greater, but the increase
becomes smaller and smaller, so the benefit is not as
much as in Stage 1.
• Stage III – Negative returns = Adding one more input
makes marginal product decrease; there is no added
benefit .
Workers
(Input)
Total
Product
(Output)
Marginal Product
(what you get for
each additional
worker)
Stage of
Production
3
75
4
112
112 – 75 = 37
5
150
150 – 112 = 38
6
180
180 – 150 = 30
Stage II
7
203
203 – 180 = 23
Diminishing
Returns
8
216
216 – 203 = 13
9
207
207 – 217 = -9
Stage III
10
190
190 – 207 = -17
Negative Returns
Stage 1
Increasing
Returns