THEORY OF PRODUCTIONProduction

is the transformation of inputs into outputs factors of production (capital and labor) are

called the inputs of productionOutput

is the result that has been created by the inputs (when labor and capital are combined)

two types of output: goods and servicesthe quality and quantity of labor and other capital and all other inputs have a direct impact on the quality and quantity of outputthe technology of a firm is the process by w/c inputs are turned into outputsthe ultimate objective of production is to create goods and services that will yield utility to consumersfactor of production are classified into: fixed factor and variable factorfixed factor remains constant regardless of the volume of production while variable factor changes in accordance w/ the volume of production

The production functionit shows the relationship between quantities of various inputs used and the maximum (technically feasible) output that can be produced with those inputs used per unit of time expressed in a table, graph, or an equationis a mathematical equation to find out the different variables in computing or solving production. In production function, Q = F (K,L); where Q stands for output, K stands for capital , and L stands for labor.

The Short-run vs. Long-run Analysis of Productionthe difference is not based on time but on the production inputsin short-run, the use of at least one factor of production cannot be changed, or there are fixed inputsin long-run, all factors can be changedthe time factor is dependent across firms and industriesEXAMPLE: A laundry business can be adjusted in a moths or two, but for Isuzu Motors Philippines capital adjustment could take two or three years

PRODUCTION W/ ONE VARIABLE INPUTLaw of Diminishing Marginal Returns

Describes a pattern in most production portion in the short-runIt says that output will decrease even if there is an increase in one of the inputs

Three stages of productionIt is important to describe the three stages of production because it will help us define the quantity of labor ( or any other input) that a profit maximizing form will employSTAGE I of production starts at the origin until the highest portion of the APL.STAGE II goes from the highest portion of the APL

until MPL is zero.

STAGE III of production begins where MPL is zero until its negative range

Return to ScaleIf doubling all inputs causes output to increase more than double, the firm is operating under increasing returns to scale.If doubling all inputs causes doubling of output, there are constant returns to scale.If doubling all inputs results to less than double output, the firm is experiencing decreasing returns to scale.

PRODUCTION W/ TWO VARIABLE INPUTSIsocost

Shows the different combinations of capital (K) and labor (L) that a producer can purchase or hire given his total outlay and the factor prices.

IsoquantIs a curve w/c shows the different combinations of capital (K) and labor (L) w/c yield the same level of output.Isoquant have three characteristics:

1. Negatively sloped2. Convex to the origin3. Do no intersect

The negatively sloped isoquant can be explained through the diminishing marginal rate of technical substitution (MRTS). MRTS is the amount of capital that a producer is willing to give up in exchange for labor and still lie on the same isoquantAn isoquant is convex to the origin because of the diminishing MRTS, meaning a producer is willing to give up0 less and less of capital to gain additional amount of labor. The less of the remaining capital makes it more valuable than additional labor.