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# C H A P T E R 6 M I C R O P R O D U C T I O N T H E O R Y

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### C H A P T E R 6 M I C R O P R O D U C T I O N T H E O R Y

1. 1. Zulkhairi Nisa-Sg Petani Campus 1 Production Theory
2. 2. FACTORS OF PRODUCTION  Production or supply represents the sellers or supplier’s side and their willingness and Zulkhairi Nisa-Sg Petani Campus ability to produce and sell goods and services (output) Input Processing Output  Production involves the using of inputs  Inputscan be categorized into 4 types which are land, labor, capital and entrepreneur 2
3. 3.  Labour Labor comprises all the human resources in the form of workers, employees, professionals, self-employed who produce goods and services  Capital Capital can be defined as the funds or finance which can be used Zulkhairi Nisa-Sg Petani Campus to acquire equipment, machine, infrastructure and other physical resources required to produce goods and services  Land Land is natural resources used to produce goods and services including land itself and natural resources such as vegetables and crops, mineral and oils  Entrepreneur Entrepreneur is the person who has the ability to take risk, to turn new ideas and innovations into profitable undertakings to produce goods and services. 3
4. 4. PRODUCTION FUNCTION  The technological relationship expressing the maximum amount of a product attainable from Zulkhairi Nisa-Sg Petani Campus different combinations of factor inputs or it shows units of total output (Q) as a function of units of inputs  Mathematically it can be expressed by  Q=f(labor, land, capital, entrepreneur) 4
5. 5. Production Time Range Zulkhairi Nisa-Sg Petani Campus Short run Long run Production Production  At least one fixed input + variable  No fixed input inputs  Law of Return to Scale  Law Diminishing Marginal Return 5
6. 6. SHORT RUN PRODUCTION FUNCTION  A short run can be defined as the production period in which at least one of the inputs is fixed  A fixed input is an input which the quantity does not vary according to the amount of output Zulkhairi Nisa-Sg Petani Campus A fixed input is one which is permanent and stays in the production by the same quantity regardless of whether there is output or not Examples a machine, building and equipment  A variable input is an input which the quantity varies according to the amount of output. More output means more variable inputs needed Examples are labor, raw material 6
7. 7.  Ingeneral, short run production function can be written as: Q = f(variable inputs, fixed inputs)  The short run period is a time period during which at least one input is fixed and its quantity cannot be varied Zulkhairi Nisa-Sg Petani Campus  The production is subjected to the law of diminishing marginal returns  The law states that when the more and more of variable input is combined with a fixed input, beyond some point of production, the additional output from each additional unit of variable input will diminish 7
8. 8. IMPORTANT CONCEPTS  Total physical product / total product (TPP/TP) The total output or production that results from the combining or transformation of factors of production Zulkhairi Nisa-Sg Petani Campus  Average physical product / average product (APP/AP) The output per unit of variable input or total physical product divided by the quantity of variable factor APP = TP/QL ; where QL is the amount of variable factor  Marginal physical product / marginal product (MPP/MP) The additional output that can be produced by hiring one more unit of variable factor; holding all other factors constant MPP = TP/  QL 8
9. 9. APL MPL The Law of Stage of Land Labour TPL (TP/L) (TP/L) Marginal Returns Production 1 1 3 3 - The Law of 1 2 7 3.5 < 4 Increasing Marginal Returns 1 3 33 11 < 26 Stage 1 1 4 50 12.5 < 17 1 5 65 13 < 15 The Law of Diminishing 1 6 75 12.5 > 10 Marginal Returns 1 7 80 11.43 5 Stage 2 1 8 80 10 0 1 9 78 8.67 –2 Negative Stage 3 Marginal Returns 1 10 72 7.2 –6 Zulkhairi Nisa-Sg Petani Campus 9
10. 10. TP(Q) d Stage 1 Stage 2 Stage 3 Zulkhairi Nisa-Sg Petani Campus c b MPP/APP b’ c’ APP d’ 10 0 L1 L2 L3 L MPP
11. 11. RELATIONSHIP BETWEEN APPL AND MPPL  MPPL between two points is equal to the slope of TP between these two points  MPPL rises at first as the slope of TP gets steeper  MPPL reaches its maximum at point b where the slope of TPPL is the steepest Zulkhairi Nisa-Sg Petani Campus  After b’ or b, the diminishing marginal returns set in and MPPL falls as TP becomes less steeper  APPL at first rises and continues to rise as long as MPPL is greater than APPL and APPL rises up to point c’  Beyond c’ MPPL is below APPL. By adding more labors, output will increase at decreasing rate which pulls the APPL down or the APPL fall  Maximum TP is at point d where the slope of TP is zero or when MPPL is zero  Beyond d or d’, TP fall and MPPL is negative, APPL continues to fall but with positive values. 11
12. 12. STAGES OF PRODUCTION  There are three stages of production; stage 1, stage 2 and stage 3  Stage 1 Zulkhairi Nisa-Sg Petani Campus Stage 1 begins from point 0 to the point of intersection of MP (marginal product) and AP (average product) curves.  At this stage, there is sharp increase of total product (TP) as we increase the units of labor employed.  This is also means that each additional increase in labor units will result in a greater increase of the TP. A rational producer will continue to produce goods at this stage as TP increase by increasing more labor 12 BACK
13. 13.  Stage 2 This stage begins from the intersection point of MP and AP curves ( end of stage 1) until MP curve touches the horizontal or x-axis. At this stage, the values of AP and MP are decreasing. Note that the AP curve is always higher than the MP curve, and when the MP curve touches the horizontal or x- axis, the TP reaches its maximum point Zulkhairi Nisa-Sg Petani Campus  This is the most efficient stage of production because the combinations of variables and fixed inputs are used efficiently.  A rational producer will want to produce at this stage of production as the TP has already achieved its maximum point.  However if he continues to produces beyond this stage, the TP will start to decline. 13 BACK
14. 14.  Stage 3  This stage begins when MP equals to zero and continues to decline thereafter.  A rational producer should not be producing at this stage Zulkhairi Nisa-Sg Petani Campus of production because an increase in labor leads to decline in the total product. 14 BACK
15. 15. Zulkhairi Nisa-Sg Petani Campus 15
16. 16.  Defined as the period where all inputs used are variable inputs  Firms use this period to plan their production by Zulkhairi Nisa-Sg Petani Campus varying their inputs  There are no fixed inputs in this period of production  All input used are variables inputs  Thus, in long run: Q = f (Variable Inputs: land, labor, capital, entrepreneur) 16
17. 17.  There are 4 factors of production in Islamic perspectives 1. Land Land is God’s gift which is invaluable to the life of mankind. Land is being used Zulkhairi Nisa-Sg Petani Campus to exploit’s all the goods’ produce essential to man. Allah SWT created land to remind mankind to protect and to make full use of it. 2. Labor labor is an abstract effort and services sells to an employer for production purposes. There are moral and ethic relationship between employee (labor) and employer. This relationship is based on syariah. Reward to a labor is not only in the form of wages but also a better return in the ‘Akhirat’ or hereafter. 3. Capital The Islamic economic system is free from Riba due to the fact that it will cause inflation, exploitation and so on. 4. Entrepreneur 17 An entrepreneur is a person who plans the way and nature of work which is able to come up with maximum productivity using the least cost possible approach without neglecting the Islamic values and quality of production.
18. 18. i) Producer’s objective is to attain maximum profit Zulkhairi Nisa-Sg Petani Campus ii) Producer’s responsibility is to make all the decisions about the organization like: a. deciding what goods are going to be produced, b. the best and the most efficient method of production c. return from his efforts in the form of profit 18
19. 19. i) Among the producer objectives are: a) To attain God’s pleasure b) To bring peace to the Ummah c) To attain maximum possible profit based on (a) and (b) Zulkhairi Nisa-Sg Petani Campus ii) Producer’s responsibility are: a) To combine all inputs with the lowest cost combination and increase productivity to the maximum level b) To ensure that any economic problem either internal or external of a firm can be solved c) To have sufficient market and to ensure stable price for all products d) Understanding current economic situation e) Ensure that all his industrial activities are not against the syariah f) Thinking about the balance between material profit and society’s welfare 19