Production and Business Organization: Chapter Six

Chapter Six
PRODUCTION AND BUSINESS

ORGANIZATION
PRODUCTION
 Everything that we see around us is the

result of production. Every GOOD,
PRODUCT or SERVICE is the consequence
of production.
 We can observe, as we delve further into the
study of economics, that much of its ideas
revolve around the concept of production.
PRODUCTION….
 We have studied the basic economic problem —
that of scarcity — and with people’s unlimited
wants and needs, that would indeed be a problem.
 Economics have pointed to the power allocation of
resources as the main solution to the problem.
However, nothing could be allocated if it is not first
produced.
 Production of goods and services is the first
stages in solving the problem of scarcity and
makes possible the allocation of resources.
PRODUCTION FUNCTION
 Input – land , labor

 Output – wheat, toothpaste (any product)
If you have a fixed amount of inputs, how much

outputs can you get?
In practice, the answer depends on the state of
technology and engineering knowledge
 The relationship between the amount of input required and the
amount of output that can be obtained
 Specifies the maximum output that can be produced with a given
quantity of inputs
 Defined for a given state of engineering and technical knowledge
 There are literally millions of different production functions--- one
for each and every product or service. Most of them are not
written down but are in people’s minds.
 In areas of the economy where technology is changing rapidly,
production functions may become obsolete soon after they are
used. And some (like the blueprints of a medical laboratory) are
specifically designed for a specific location or purpose and would
be useless anywhere else. Nevertheless, the concept of a
production function is a useful way of describing the productive
capabilities of a firm.
TOTAL, MARGINAL AND AVERAGE PRODUCT
 Total Product: total amount of outputs

produced
 Marginal Product(of an input): the extra output
produced by one additional unit of that input
while other factors are held constant
 Average Product: total output divided by total
units of input.
THE LAW OF DIMINISHING RETURNS
 This law holds that we will get less and less extra
output when we add additional doses of an input
while holding other inputs fixed.
 The marginal product of each unit of input will
decline as the amount of that input increases,
holding all other inputs constant.
 A widely observed empirical regularity rather than
a universal truth
 Diminishing returns and Marginal Products refer to
the response of output to an increase of a single
input when all other inputs are held constant
RETURN TO SCALE
 Returns to Scale: the effects of scale increases

of inputs on the quantity produced.
 Three Important Cases:
1. Constant Returns to Scale: denote a case
where a change in all inputs leads to a
proportional change in output.
Example: if labor, land, capital and other inputs
are doubled, then under constant returns to scale
output would also double.
2. Increasing Returns to Scale: also called economics of
scale, arise when an increase in all inputs leads to a more-
than-proportional increase in the level of output.
Example: an engineer planning a small-scale chemical
plant will generally find that increasing the inputs of labor,
capital and materials by 10% will increase the total output
by more than 10%.
3.Decreasing Returns to Scale: Occur when a balanced

increase of all inputs leads to a less-than-proportional
increase in total output
SHORT RUN AND LONG RUN
Production requires not only labor and land but also time. To
account for the role of time in production and costs,
we distinguished between two different time periods:
 Short Run – period in which a firm can adjust production by
changing variable factors(i.e., materials & labor) but cannot
change fixed factors (i.e., capital)
 Long Run – period sufficiently long that all factors including
capital can be adjusted.
TECHNOLOGICAL CHANGE
Much of the increase in output has come from

technological change, which improves productivity
and raises living standards.
 Process Innovation – occurs when new

engineering knowledge improves production
techniques for existing products
 Product Innovation – new or improved products

are introduced in the market place
 Productivity grows because of economies of
scale and because of technological change.
While technology might ideally allow constant
or increasing returns to scale, the need for
management and supervision may eventually
lead to decreasing returns to scale in giant
firms.
BUSINESS ORGANIZATION
 THE NATURE OF THE FIRM
Business firms are specialized organizations

devoted to managing the production of
production. Among their important functions are
exploiting economies of mass production, raising
funds and organizing factors of production.
BIG, SMALL AND INFINIRESIMAL BUSINESSES
 The Individual Proprietorship: classic small businesses often called

“mom-and-pop stores”; might do a few hundred dollars of business
per day and barely provide a minimum wage for the owner’s efforts.
 The Partnership: combination of talents. Partnerships pose

disadvantages that make them impractical for large businesses. The
major disadvantage is unlimited liability. General partners are
liable without limit for all debts contracted by the partnership.
 The Corporation: a separate legal entity that may on its own behalf
buy, sell, borrow money, produce goods and services, and enter into
contracts.

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Chapter Six

PRODUCTION AND BUSINESS

 Everything that we see around us is the

 Input – land , labor

If you have a fixed amount of inputs, how much

 Total Product: total amount of outputs

 Returns to Scale: the effects of scale increases

3.Decreasing Returns to Scale: Occur when a balanced

Much of the increase in output has come from

 Process Innovation – occurs when new

 Product Innovation – new or improved products

 THE NATURE OF THE FIRM

Business firms are specialized organizations

 The Individual Proprietorship: classic small businesses often called

 The Partnership: combination of talents. Partnerships pose

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