THE THEORY OF PRODUCTION Chapter 5 Section 2

The Theory of Production What are the four Factors of Production? 1. L-Land 2. L-Labor 3. C-Capital 4. E-Entrepreneurship The Theory of Production = the relationship between the factors of production (inputs) and the output of goods and services. It examines how output changes when inputs change.

The Theory of Production Con’t The short run = short period of time during which producers can change variable (change-able) inputs. Most often, LABOR is the input producers change in the short run. The long run = longer period of time, where producers can adjust all inputs, like land, capital and labor.

Law of Variable Proportions The law of variable proportions states that in the short run, output (what you make) will change as one input (like labor) is varied while the others are held constant. In our lemonade example water stayed the same and we change the input of lemonade powder. The book discusses the addition of chili powder to chili. How can the input of one resource change the final product?

Rules of Activity One book in your hands at a time. Must pass the book to person next to you Must remain still No throwing the books or hitting people with the book (NO Exceptions!!!!) Stack books in pile(s) on the empty chair and floor next to chair.

Three Stages of Production Stage I – Increasing Returns = Adding one more input increases production and increases the total output. In this stage, marginal product is increasing. Stage II – Diminishing Returns = Adding one more input still continues to make output greater, but the increase becomes smaller and smaller, so the benefit is not as much as in Stage 1. Stage III – Negative returns = Adding one more input makes marginal product decrease; there is no added benefit.

Workers (Input) Total Product (Output) Marginal Product (what you get for each additional worker) Stage of Production 375 Stage – 75 = 37Increasing Returns – 112 = – 150 = 30Stage II – 180 = 23Diminishing Returns – 203 = – 217 = -9Stage III – 207 = -17Negative Returns