THEORY OF PRODUCTION
Law of Variable Proportions, Production Function, Stages of
Production, Measures of Cost
*The theory of production deals with the relationship between the factors of production and
output of goods and services.
*Short run – allows producers to only change the amount of variable input (labor)
*Long run – allows producers to adjust all variables of inputs including capital
*Law of Variable Proportions states that, in the short run, output will change as one input is varied
while the others stay the same(ex: adding salt to food – after a while too much salt is bad).
*Production Function – illustrates the Law or
Variable Proportions; concept that describes
the relationship between changes in output to
different amounts of a single input while
other inputs are held constant (ex: farmer
hires more workers but keeps same number of
machines and fertilizer)
*Total product – total output produced by
the firm
*Three States of Production
Increasing returns – variable inputs
increase output
Diminishing returns – stage where
output increases at a diminishing rate
as more units of variable input added
Negative returns – total output
decreases due to variable input
*Measures of Cost
Fixed cost(overhead) – the cost that a business
occurs even if the plant is idle and output is zero (executive salaries, interest charges on bonds, rent
payments, property taxes, depreciation).
Variable cost – changes when the business rate of operation or output changes (labor, raw
materials).
Total cost – sum of fixed and variable cost
Marginal cost – extra cost incurred when a business produces 1 additional unit of a product
*E-commerce – electronic business conducted over the internet