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1. PRODUCTION FUNCTION
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2. PRODUCTION AND FIRM
 Production:
 Is the process of using the factors of
production to produce goods and services.
 In other words, it can be stated as the
“transformation of inputs into outputs”.
 Usually, by firm
 Firm:
 An output producing organization
 Demand production factors from input
market

3. COST & PROFIT
ECONOMICS & ACCOUNTING CONCEPTS
 Accounting Cost (Explicit Cost)
 Considered as “normal” cost (or profit)
 What was paid out (in money)
 Example: wages or rental
 Economics Cost (Implicit Cost)
 Reflex the opportunity cost
 The 2nd best alternative lost
 Considered as implicit cost
 Example: Owner time/effort or using own
building

4.  Accounting Profits
 A firm’s total revenue minus its
explicit costs.
 Formula:
 Economics Profits
 A firm’s total revenue minus its
explicit and implicit costs.
licitTR exp
)(exp implicitlicitTR 
Explicit Cost: What was paid out (in money)
Implicit Cost: The opportunity Cost

5. THE PRODUCTION DECISION
 All firms must make several basic decisions to
achieve what we assume to be their primary
objective—maximum profits.
1.
How much
output to
supply
2.
Which production
technology
to use
3.
How much of
each input to
demand
THE THREE DECISIONS THAT ALL FIRMS MUST MAKE
Market price Techniques Prices of inputs

6. q = f (K, L, M…)
THE PRODUCTION PROCESS
Input:
Raw Material
Input:
Capital
Input:
Labour Output
Technology
Input decision:
>>How many
>>Which types
Cost decision Selling price

7.  Production Function:
 Refers to the relationship between inputs and
outputs.
 It can be represented in the form of a
mathematical equation such as:
 Q=f(K,L,M…)
 Marginal Product (MP):
 Additional output that can be produced by
adding one more unit of a particular input,
ceteris paribus.
 MP slopping down reflex the law of diminishing
marginal returns
 Formula: ∆ TP / ∆L
 Average Product of labor (AP):
 Average amount produced by each unit of a

8. PRODUCTION
THEORY Short run – Period of time which
quantities of one or more inputs
cannot be changed and firm is
operating under fixed scale, firms can
neither enter nor exit an industry.
 Long run – Period of time which
quantities of all inputs can be varied
(no fixed input). Firms can change the
scale of production (increase/decrease).

9. QUANTITY
OF
WORKERS
OUTPUT MP AP COST OF
FACTORY
COST OF
WORKERS
TOTAL
COST
0
1
2
3
4
5
6
7
8
0
2
5
9
12
14
15
15
14
-
2
3
4
3
2
1
0
-1
-
2
2.5
3
3
2.8
2.5
2.1
1.8
$30
30
30
30
30
30
30
30
30
$0
10
20
30
40
50
60
70
80
$30
40
50
60
70
80
90
100
110
A PRODUCTION FUNCTION AND TOTAL
COST FOR HUNGRY HELEN’S COOKIE
FACTORY

10. 0
2
4
6
8
10
12
14
16
18
20
0 1 2 3 4 5 6 7 8
Number of Workers Hired
Quantity of output
TP
HUNGRY HELEN’S PRODUCTION FUNCTION

11. 11
Relationship between TP& MP
 When MP is increasing, TP will increase at
an increasing rate. (stage 1)
 When MP is decreasing, TP will increase at a
decreasing rate. (stage 2)
 When MP is zero, TP is at its maximum
 When MP is negative, TP declines. (stage 3)
Stage 1
Stage 2
Stage 3
Relationship between MP& AP
 When MP is above AP, AP is increasing
 When MP is below AP, AP is decreasing
 When MP equals to AP, AP is at maximum.

12. LAW OF DIMINISHING
MARGINAL RETURN
 Definition
This law explains the behavior of
production functions in the short run, when
at least one of the inputs must be fixed.
The law of diminishing marginal returns
states that as more of variable inputs is
used, while other inputs are fixed, the
marginal product of the variable input will
eventually declines.
12

13. STAGE OF
PRODUCTION
 Increasing Marginal Returns (Stage 1: A to B)
 The marginal product (MP) of a variable resource
increases as each additional unit of that resource is
employed.
 TP increase at an increasing rate (specialization)
 Diminishing Marginal Returns (Stage 2: B to C)
 As more of a variable resources is added to a given
amount of another resource, marginal product (MP)
eventually declines.
 TP increases at a decreasing rate (less efficient /
abundant)
 Negative Marginal Returns (Stage 3: After C)
 The marginal product (MP) of a variable resource turn
to negative as each additional unit of that resource is
employed
 TP decreases (overcrowded).

14. 14
Labor
Labor
TP
AP, MP
Stage 1 Stage 2 Stage 3
TP
AP
MP
STAGES OF PRODUCTION
B
CA

15. 15
INCREASING
MARGINAL RETURNS
TotalProduct,TP
Quantity of Labor
AverageProduct,AP,and
MarginalProduct,MP
Quantity of Labor
Total Product
Marginal
Product
Average
Product
Increasing
Marginal
Returns

16. 16
DIMINISHING MARGINAL
RETURNS
TotalProduct,TP
Quantity of Labor
AverageProduct,AP,and
MarginalProduct,MP
Quantity of Labor
Total Product
Marginal
Product
Average
Product
Diminishing
Marginal
Returns

17. 17
NEGATIVE MARGINAL
RETURNS
TotalProduct
Quantity of Labor
AverageProduct,and
MarginalProduct
Quantity of Labor
Total Product
Marginal
Product
Average
Product
Negative
Marginal
Returns

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