Production

Lesson 11
Meaning
• Production is the process of making or manufacturing goods
and products from raw materials or components.
• In other words, production takes inputs and uses them to
create an output which is fit for consumption – a good or
product which has value to an end-user or customer.
Factors of production
1. Land: It is a free gift of nature and it is called as a natural, original or
primary factor of production.

2. Labour: Person or people engaged in some physical work form the

labour force which is a factor of production.

3. Capital: It means wealth, money or income which is invested in a

business to boost production. Includes buildings, machinery.

4. Entrepreneur: It is the work of an entrepreneur to bring the required

factors together and make them work harmoniously.
Factors of production and their rewards
• The remuneration to them are as follows:

• 1. Land: Rent is a reward for the use of land.

• 2. Labour: Wages are the reward for labour.

• 3. Capital: Interest is the reward for capital.

• 4. Entrepreneur: Profit is the reward for an entrepreneur.

The Production Possibilities Curve
• The production possibilities curve (PPC) is a graph that shows
all of the different combinations of output that can be produced
given current resources and technology.
• The PPC is also referred to as the production possibility frontier
(PPF).
• PPC can be used to illustrate the concepts of scarcity,
opportunity cost, efficiency, inefficiency, economic growth, and
contractions.
Assumptions of PPC
Production Possibility Curve is based on the following assumptions:

1. Fixed Resources: The quantity and quality of resources available in the economy is
assumed to be fixed. This includes factors of production such as labor, capital, land, and
technology. However, one can transfer the resources from one use to another.
2. Fixed Technology: The PPC assumes that the level of technology available for
production remains constant. This means that the methods, processes, and efficiency of
production do not change.
3. Full Employment of Resources: The PPC assumes that all available resources in the
economy are fully employed and utilized efficiently.
5. Two Goods: The PPC assumes that with the given resources, only two goods can be
produced.
5. Unequal Efficiency in Production: Under PPC, it is assumed that the resources are not
equally efficient in the production of all goods. Therefore, when the resources are
transferred from one use to another (production of one good to another), the productivity
declines.
Example of PPC
• Marginal Opportunity Cost (MOC): is the number of
units of a commodity sacrificed to gain one more unit of
another commodity. Under PPC, MOC is always
increasing. It means that more units of a commodity
have to be sacrificed in order to gain one more unit of
another commodity.
• Marginal Rate of Transformation (MRT): the ratio of
number of units of a commodity sacrificed to gain one
more unit of another commodity.
� 푈푛� 퐺푎�푛 
� 푈푛� 푆푎푐푟� �푐 
• MRT=
• MRT = 2A:1O, means the economy has decided to
produce i more unit of orange by reducing (sacrificing) 2
units of apple.
• ​
•
Properties of PPC
The two properties of Production Possibility Curve (PPC) are as follows:
1. PPC slopes Downward: A PPC curve shows all the possible combinations of two goods that can be
produced with the given resources and technology.
Here, one can produce more of one commodity only by taking away resources from the production of
another commodity.
Due to this there is inverse relationship between the change in quantity of one commodity and change
quantity of another commodity, resulting in downward slope of PPF curve from left to right.

2. PPC is Concave Shaped: Increasing Marginal Rate of Transformation (MRT) is the reason behind
concave shape of a PPC curve.
Increasing MRT means that more units of one commodity are sacrificed to gain one more unit of another
commodity.
The reason behind increasing MRT is the assumption that any resource is never equally efficient to
produce all goods.
Thus, as the resources are transferred from one good to another, less and less efficient resources are
employed; increasing cost and MRT.
PPC and Scarcity
• As the resources available
around us are scarce, we
cannot satisfy all of our needs
and wants.
• And even if all the resources
in the economy are utilized in
the best possible manner,
their capabilities are
restricted due to scarce
resources.
PPC and Choice
• Since, we are forced to make
economic decisions and
choose among alternate
goods and services to satisfy
our wants in the best possible
manner.
• Hence, society has to decide
what to produce out of the
infinite possibilities.
 PPC and Opportunity Cost
• Opportunity Cost of a product is the alternate
option that must be given up in order to
produce the given product.
• The concept of opportunity cost can be seen
in PPC. I
• In the example, the opportunity cost of
producing more Oranges is less Apples.
• As we move from points D to E, the
production of Orange increases from 3 units
to 4 units, but the production of Apples
decreases from 9 units to 5 units.
• It means that the opportunity cost of the 4th
unit of Orage is sacrifice of 4 units of Apples.
PPC and Efficiency
• The points on the interior of
the PPC are inefficient, points
on the PPC are efficient, and
points beyond the PPC are
unattainable.
• The opportunity cost of
moving from one efficient
combination of production to
another efficient combination
of production is how much of
one good is given up in order
to get more of the other good.
PPC and Economic Growth
• Economic growth is usually associated to higher incomes and
higher standards of living.
• In Economics, we make the distinction between an increase in
the output of a country (actual economic growth) and an
increase in the productive capacity (potential economic growth).

• Economic growth can arise due to:

a) Increased employment
b) Advencement in technology
c) Increased exports
Change in PPC
• One of the assumptions under PPC is fixed resources.
• However, if we consider the today’s changing environment,
due to the increase or decrease in resources, the production
capacity of an economy keeps on changing constantly.
• These changes results in a change in [Link] change in PPF
curve shows either increase or decrease in the productive
capacity of the economy.
• The PPC can change in two ways; Shift in PPC and Rotation in
PPC .
Shift in the PPC
• A shift in PPC represents a change in productive capacity with
respect to both goods.
• The PPC curve can shift either rightwards or leftwards.
Rightward shift in the PPC
• A shift to the right of the PPC
is associated with economic
growth.
• Economic growth is usually
associated to higher incomes
and higher standards of living.
• Economic growth can arise
due to: Increased
employment of resources and
advencement in technology
• The existing curve (PP) shifts
to the right (P1P1).
Leftward Shift in PPC:
• When there is a degradation
in technology or a decrease
in resources, in respect to
both goods, the PPC will shift
in left direction.
• For example, if there is
destruction of resources due
to floods, the production of
Apples and Oranges will
reduce.
• In such case, the existing
curve (PP) will shift to the left
(P1P1).
Rotation of PPC
• When there is a change in resources or technology with
respect to only one good, the PPC curve will rotate either for
the commodity on X-axis or the commodity on Y-axis.
Rotation for commodity on X-axis
• When there is advancement
in technology or growth in
resources for the production
of the commodity on X-axis
(say orange), then the PPC
will rotate from AB to AC; i.e.,
rightwards rotation.
• However, if there is
degradation in technology or
reduction in resources, the
PPC will rotate from AB to
AD; i.e., leftwards rotation.
Rotation for commodity on Y-axis
• When there is advancement
in technology or growth in
resources for the production
of the commodity on Y-axis
(say, Apple), then the PPC will
rotate from AB to CB; i.e.,
rightwards rotation.
• However, if there is
degradation in technology or
reduction in resources, the
PPC will rotate from AB to
DB; i.e., leftwards rotation.
Production Period
Production Period
• Short-Run: a time period in which at least one factor of
production/ input is fixed (cannot be changed), while others are
variable.
• Long-Run: a time period in which all factors of production can
be varied
Short-Run Production
Relationship
The production function
• A firm is an organization that produces goods or services for sale. To do this, it
must transform inputs into output.
• The quantity of output a firm produces depends on the quantity of inputs; this
relationship is known as the firm’s production function.
• A firm’s production function underlies its cost curves. As a first step, let’s look at
the characteristics of a hypothetical production
• function.
• A firm’s production function is represened as �=�(�,�) which means, the
quantity of output (Q) is some function of capital (K) and labor (L).
• A simple production function: �=�+�, means a firm can produce one unit of
output using one unit of capital or one unit of labour.
Inputs
• A fixed input is an input whose quantity is fixed for a period of
time and cannot be varied. Example, land.
• A variable input is an input whose quantity the firm can vary at
any time. Example, labour.
Outputs
• The total product is the total volume or amount of final output produced by a
firm given inputs in a given period of time.
• The total product curve shows how the quantity of output depends on the
quantity of the variable input, for a given quantity of the fixed input.
• The total product curve shows the production function graphically.
• It slopes upward because production increases as input is increased.
• It also becomes flatter because the marginal product of the input declines as
more and more is added.
• The marginal product of an input is the additional quantity of output that is
produced by using one more unit of that input.
Outputs
• Example, marginal product of labour:

• Average product: The output per unit of factor inputs or the

average of the total product per unit of input.
• AP = Total Product / Variable Inputs
Total Product Curve
The production function
The Law of Diminishing Returns
• The law of diminishing returns to an input states that,
increasing the quantity of an input, while holding the levels of
all other inputs fixed, leads to a decline in the marginal product
of that input.
• In other words, as more units of a variable are added to a
quantity of fixed factors, there may be increasing or constant
returns and then diminishing returns will eventually set in.
• It also called the law of varying proportions.
The Law of Diminishing Returns
Three Stages of Production
• Overall, the law of diminishing returns highlights the importance
of balancing inputs and outputs to maximize total utility in
production.
• By identifying which stage they are in, producers can determine
how much input to add and when to stop adding more.
• Understanding the stages of production is crucial for producers
to optimize their production process and avoid inefficiencies.
• There are three stages of production which are characterized
by increasing marginal returns, decreasing marginal returns,
and negative marginal returns.
Increasing returns stage
• During this stage, the producer experiences an increase in
output as they add more units of input.
• This is because the producer is underutilizing their inputs, and
as they add more, they are able to achieve economies of scale.
• For example, a pizza shop may need one chef to produce 50
pizzas a day, but as they add 2 more chefs, they can produce
100 pizzas a day with the same amount of fixed resources.
Diminishing returns stage
• During this stage, the producer experiences a decrease in
output as they add more units of input.
• This is because the producer is utilizing their inputs efficiently,
but there comes a point where adding more inputs does not
yield the same level of output.
• For example, a pizza shop may need five chefs to produce 500
(AP=100) pizzas a day, but adding a sixth chef may only
increase output to 525 (MP=25) pizzas a day.
Negative returns stage
• During this stage, the producer experiences a further decrease
in output as they add more units of input.
• This is because the producer is overusing their inputs, and
adding more only leads to inefficiencies and waste.
• For example, a pizza shop may need five chefs to produce 500
pizzas a day, but adding a seventh chef may decrease output
to 475 pizzas a day due to overcrowding in the kitchen.
Stages of production and the Law of Diminishing Returns
Short-Run Production Curves
Average product and marginal product curves
• The average product curve, representing the output per unit of
input, also reflects the Law of Diminishing Returns.
• It usually rises at first, reaches a maximum, and then begins to
fall. The point where the average product is at its highest
coincides with the point where it intersects with the marginal
product curve.
Thank you