PRODUCTION

DR. JOFREY R. CAMPOS

• Man cannot produce goods and services without utilizing land,
labor, capital, or management.
• Goods produced by man are called economic goods.
• Three are goods which are produced by nature. Such goods are
called free goods. Examples are fresh air, sunshine, a pool or
clear water.
• What about those goods which are being given free by the
government or civic organizations? These are fee in the sense
that they are give free. But still they are economic goods. The
government paid the these goods with taxes – which are the
money of the people.
 Factors of Production
1. Land – is the original gift or nature. It includes the rivers, lakes,
oceans, mountains, forests, mineral resources and climate.
2. Labor – is the exertion of physical and metal efforts of individuals.
This applies not only to workers, farmers or laborers but also to
professional like accountant, economists, or scientist.
3. Capital – is a finished product which is used to produce other goods.
Example of capital goods are machines as far as economics is
concerned. In finance and laymen, capital refers to money. However,
money is a medium of exchange. It cannot produce goods.
4. Entrepreneur - is the organizer and coordinator of the land, labor,
and capital.
 Factors of Production
• Production is the creation of goods and services to satisfy
human wants.
• The factors of production are called the inputs of production, 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. A fixed
factor remain constant regardless of the volume of production.
• In case of variable factor, it changes in accordance with the
volume of production. No production means no variable factor.
• The process of transforming both fixed and variable
inputs into finished goods and services is called theory
of production.
• Such technical relationship between the application of
inputs (factors of production) and the resulting
maximum obtainable output is known as production
function.
 Law of Diminishing Returns
• The law of diminishing returns is also known as the law of
diminishing marginal productivity.
• The law states that when successive units of a variable input
(like farmer) 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 variable input should be
identifiable, and the same technology is applied.
 The law of diminishing returns
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
 Message of the Law
• The production of goods are greatly depends on available
resources or inputs.
• Marginal product is defined as the additional product brought
about by one additional unit of variable input.
• When marginal product decreases, total product increases 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
a variable input and a fixed input in order to attain the maximum
output.
 The Cost of Production
• One of the determinants of supply is cost of production.
Producers have greater ability and willingness to supply a
product which has a lower cost of production. Resources which
are scarce, and there is a great demand for them to command
higher prices. This means higher cost of production, and this
results to a higher price of the products.
• Producers have been always in search of ways and means of
cost-reduction ethnizes. Lower cost means lower price. Lower
price means more sales – and more profits.
 Economic Costs
• 
• 
 Marginal Cost and Average Cost
Relationship

• When MC is falling, it pulls down AC, and when MC is

rising it pulls up AC.
• 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.
Mathematical relationship between MC and AC

Product Cost Total Cost AC MC

1 160 160 160

2 140 300 150 140

3 120 420 140 120

4 140 560 140 140

5 160 720 144 160

6 180 900 150 180

7 200 1100 157 200

 Short Run and Long Run
• Short run refers to a period of time which is too short to allow
the enterprise to change its plant capacity, yet long enough to
allow a change in its variable resources.
• 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).
 Economies of Scale
• External economies of scale refers to those factors which are
outside the firm or enterprise, but they contribute to the efficiency
of the latter. Examples of such external factors are government
policies, electrification, and transportation, and communication
facilities.
• Internal economies of scale, these are the factors inside the firm
or enterprise which contribute to the efficiency of the latter.
Examples of such factors are division of labor, human resources
development, managerial specialization, proper use of machines
and equipment, favorable management policies, effective
utilization of by product and modern techniques of production.
Appropriate Techniques of Production
• Based on the law of supply and demand, resources which are
abundant have lower prices than those which are scarce.
• Clearly, poor countries should use labor-intensive technology.
This means more labor inputs and less capital inputs.
• American and European technology (Western model) is capital
intensive. Capital is cheaper in Western countries while labor is
expensive. So they use more capital inputs and less labor
inputs.
 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.
• The income-side of the firm is called revenue.
• Profit maximization is also determined thought the relationship
of total cost and total revenue, or marginal cost and marginal
revenue
 Total Revenue – Total Cost Approach
• 
 Short Run and Long Run
• Under a short-run period, a firm has both
Fixed Cost 10,000 fixed cost and variable cost. Under the
conditions would a businessman operate
Variable Cost: 5,000 or shut down his firm?
• The rule is: if total revenue is greater than
TOTAL 15,000 variable cost, operate; if total revenue is
less than variable cost, shut down.

If: Total Revenue is 7,000, this is greater than the

Variable Cost, so it is better to operate.
However, in the long-run, all costs are variable,
this means total cost is equivalent to variable cost.
When does a firm under a long-run period operate
or close down? The rule are:

TR > TC : Produce more

TR < TC : Stop production
TR = TC : Maintain production
When TR = TC, the firm gets a normal profit

Revenue Cost
1 2
2 3
3 3
4 4
5 5
6 6
7 7
8 8
9 10
10 11
 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 = MC. This
means in producing one additional unit of output, the additional
income given by the additional unit is exactly equal to the
additional cost brought about by the same additional unit of
output.
• Profit maximization is attained at a point when price is equals to
marginal cost (P = MC).
 ACTIVITY 1

Define the following:

1. Economic goods
2. Economic profits
3. Expenditure cost
4. Short-run
5. Free goods
6. Business profits
7. Non-expenditure cost
8. Long run
9. Opporutnity cost
 ACTIVITY 2

Answer the following questions:

1. Do you consider money as capital in economics? Why?

2. What is the significance of the Law of Diminishing
Returns?
3. Why should a firm continue to operate under the short-run
period when TR is greater than VC but less than TC?
4. Explain the economies of scale.