Topic GuideA. Factors of ProductionB. Production FunctionC. Law of Diminishing ReturnsD. Message of the LawE. The Costs of ProductionF. Economic CostsG. Marginal Cost and Average Cost RelationshipH. Short Run and Long RunI. Economies of ScaleJ. Appropriate Techniques of ProductionK. RevenueL. Total Revenue- Total Cost ApproachM. Marginal Revenue- Marginal Cost Approach
Man can produce goods and serviceswithout utilizing land, labor, capital ormanagement . Goods produced by man are calledeconomic goods . However there are goodswhich are produce by nature. Such goods arecalled free goods. In the production of goods and services,the various factors of production receive theircorresponding payment like wages rents,interest and normal profits.
A. Factors of ProductionLand- is an original gift of nature. It includes the soil,river, oceans, mountains etc…Labor- is an exertion of physical and mental effortsof individuals. This implies not only to workers, farmersor laborers but also to professionals like accountantseconomist and scientist.Capital- is a finished product which is used toproduce goods. However, money is a medium ofexchange. It can not produce goods it can only buygoods.Entrepreneur- is an organizer and coordinator of theland, labor and capital.
B. Production FunctionProduction- is the creation of goods and services tosatisfy human wants.The factors of production are called the inputs ofproduction, and the goods and services that have beencreated by the inputs are called outputs ofproduction.The factors of production are classified as fixedfactor (fixed input) and variable factor (variableinput)A fixed factor remains constant regardless of thevolume of production. This means whether youproduce or not, the factor of production is unchanged.
B. Production FunctionIn case of a variable factor, it changes in accordancewith the volume production. No production means novariable factor. More production means more variablefactors.The process of transforming both fixed and variableinputs into finished goods and services is called theoryof production. The quantity and quality of goods andservices being produced depend on the state oftechnology.
C. Law of Diminishing ReturnsAlso known as the law of diminishing marginalproductivity. It is a basic law of economics andtechnology.The law states that when successive units of variableinput (like farmers) work with a fixed input (like onehectare of land), beyond a certain point the additionalproduct ( output) produced by each additional unit ofvariable, input decreases.The validity of the law of diminishing returns is basedon two assumptions. The successive units of a variableinput to should be identical, and the same technologyis applied.
C. Law of Diminishing ReturnsIt is noted that in the work combination of variableinput and fixed input, total output and additionaloutput (or marginal product) increase up to a certainpoint.Beyond this point, the rate of increase of total productdeclines, and later on total product decreases as moreunits of a variable factor are employed.In the case of marginal product, it also diminishesbeyond a certain point until it reaches negative returnsas more variable inputs are added (see table andgraph).
As shown in Table 4.1, the contribution of farmer 1 toproduction is 40 cavans. Marginal product is 0 becausethere is no additional farmer yet. The contribution offarmer 3 to production is 15 cavans. This is theadditional or marginal product produced by farmer 2.Total product of the 2 farmers (farmer 1 and farmer 2)is 55 cavans (40 + 15). Up to farmer 4, marginalproduct is increasing. But after this point, marginalproduct decreases progressively until it becomesnegative.
D. Message of the LawThe production of goods greatly depends on availableresources or inputs.Marginal product is defined as the additional productbrought about by one additional unit of a variable input(farmer).It is noted that when marginal product increases,total product also increases. When marginal productdecreases, total product increases and at a decreasingrate, and when marginal product is below zero ornegative, total product falls.The message of the law is that there is a propercombination of variable input and a fixed input inorder to attain the maximum output.
E. The Costs of Production One of the determinants of supply is cost ofproduction.A producer have greater ability and willingness tosupply a product which has a lower cost of production.Cost does not only affect the producers but also thebuyers. Since in an increase in the cost of productionconsequently increases the prices of products, thetendency of buyers is to reduce their purchases.Lower cost means lower price.Lower price means more sale – and more profitMore abundant resources are cheaper. In lessdeveloped countries, labor is cheap while capital(machine) is expensive.
F. Economic CostsTotal Cost- is the sum total cost of production.Normal profit is a part of total cost of production.Pure profit is the excess of the cost production.Total cost is also equivalent to fixed cost plus variablecostFixed Cost- remains constant regardless of thevolume of production. If there is no production, there isstill cost.Variable Cost- changes in proportion to volume ofproduction. If there is no production, there is no cost.More production means more cost.
F. Economic CostsAverage Cost- also called unit cost. It is equivalentto total cost divided by quantity. AC = TC QMarginal Cost – additional or extra cost broughtabout by producing one additional unit. MC = TC QExplicit Cost- expenditure cost.Implicit Cost- non-expenditure cost. They do notpay. You do not pay rent to your own land.Opportunity Cost- opportunity or alternative benefit.
Figure 4.2. Total, fixed, and variable costs.6543 Series 2 Series 1210 Category 1 Category 2 Category 3 Category 4
G. Marginal Cost and Average CostWhen MC is falling, it pulls down AC, and when MC isrising, it pulls up AC.At the start of production, AC is greater than MC.But when MC continues to rise, it reaches a point whereit is equal to Figure 4.3, the MC curve intersects the ACcurve at its lowest point. Beyond this intersectionpoint, the curve rises at a faster rate than the AC curve.The AC curve has a U-Shape. This explains the fact thatAC is high when less units are produced.The effects of MC on AC are due to mathematicalrelationship. As long as MC is less than AC, the latter falls.AC will only rise if MC is more than AC as shown in Table4.2. illustrated in
Figure 4-3. MC and AC Relationship – when MC isfalling, it pulls down AC; when MC is rising, it pulls up AC.MC intersects AC at its lowest portion.
Table 4.2: Mathematical relationship between MC and AC. Product Cost Total AC MC Cost 1 P 160 P 160 P 160 P 140 2 140 300 150 120 3 120 420 140 140 4 140 560 140 160 5 160 720 144 180 6 180 900 150 200 1,100 200 157.14
Said table, the cost of product 1 is P160. Total cost isP160 and AC is P160 (P160 divided by 1). The cost of anadditional product (product 2) is P140. Total cost ofproduct 1 and 2 is P300. AC is P150 (300 divided by 2).MC is P140 which is the cost of the additional product.The cost of the third product is P120. The total cost of the3 products is P420. AC is P140 while MC is P120. However,the cost of the fourth product is P140 which is higher thanthe cost of product 3. Total cost is P560, AC is P140 andMC is also P140. At this point MC equals AC.It is noted that as MC increases, AC also rises, as shownin table. MC is equal at the point when AC is at the lowestpoint.
H. Short Run and Long RunShort run refers to a period of time which is too shortto allow an enterprise to change its plant capacity, yetlong enough to allow a change in its variable resources.Cost of production under the short-run period is bothfixed and variable.Long run refers to a period of time which is longenough to permit a firm or enterprise to alter all itsresources or inputs(both fixed and variable factors).
I. Economies of ScaleCan be classified as: External Economies of Scale - Factors outside the firm or enterprise - Contribute to the efficiency of the latter in terms of increased output and decreased unit cost of production Internal Economies of Scale - Factors inside the firm or enterprise - Contribute to the efficiency of the latter
Note:• Firms that enjoy both scales have become very efficient and big• They survived competition and therefore have remained in the industry• They are capable of undertaking mass production which incurs a lower average cost of production• They are involved on global supply of goods; and they have maximized their profits
I. Appropriate Techniques of Production Based on the law of supply and demand, resourceswhich are abundant have lower prices than those whichare scarce. There is surplus of labor in less developedcountries, on the other hand highly developed countrieswhich their price of labor is high because it is notabundant. • Labor-Intensive Technology Pros More labor inputs and less capital inputs More plentiful resources should be utilized because these are cheaper.
I. Appropriate Techniques of Production• Why should they use this•Capital inputs are imported, and usually expensive. Poorcountries can hardly afford to purchase them with their smallforeign exchange earnings. Success of China•A huge human resource had been properly utilized, almost100 percent of labor input.•They manufactured their own tools of production; neverbought western technology.•It resulted that their rural development program has beenone of the most successful program in the world.•It didn’t need foreign assistance, so it should be a lesson topoor countries who actually depend on western economicdevelopment
I. Appropriate Techniques of Production • Capital-Intensive Technology- Technology used by Western countries, mainlyAmericans and Europeans.- Capital is cheaper in Western countries while labor isexpensive, in contrary to the Eastern countries. Pros • Uses more capital inputs and less labor input. • In many economic activities, their operations are computerized • Such modern technology does not adversely affect the labor force, because there has been an increasing demand for workers in other sectors. Thus making this kind of technology almost flawless and perfect.
J. RevenueCost of production refers to the total payments bya firm to the owners of the factors of productionlike land, labor, capital and entrepreneur.These are other expenditure –side of a firm in theprocess of creating goods and services. For a firmto remain in business, it has to earn an incomewhich is greater than its expenses . The income side of a firm is called revenue. Thedifference between cost and revenue is either profitor loss, depending on which one is higher.
K. Total Revenue – Total Cost Approach•Total Revenue = price times units sold•TR = P *Q•Total Revenue – Total Cost = ProfitRule: if total revenue is greater than variablecost, operates; if total revenue is less thanvariable cost, shut down. 7,000 – total revenue 10,000 – fixed cost of the firm 5,000 – variable cost --------- 15,000 – Total cost
K. Total Revenue – Total Cost ApproachThe Rules Are:TR > TC: Produce moreTR < TC: Stop productionTR = TC: Maintain production•Profit Maximization(under pure competition)
M. Marginal Revenue – Marginal Cost ApproachMarginal revenue is the additional income of a firmbrought about by producing and selling one additionalunit of a product.The rule is: if marginal revenue is greater than marginalcost, increase production; if marginal revenue is less thanmarginal cost do not increase production.Profit maximization of a firm is attained when MR=AC.It can be stated therefore: profit maximization is attainedat a point where price equals marginal cost (P = MC).