<Last updated 11.04.2020>
Hi! If you are interested in Economics, I’ve prepared the below short explanation. You should take a look at this short article, in which I show the Production Function model of an individual entity, a business.
We have already mentioned that Production is the process in which producers/businesses use the factors of production (i.e. land, buildings, machinery, workers etc.) in order to produce goods and services that human beings use to satisfy needs and wants. To produce a product, or good, the factors of production (human capital, natural resources, physical capital) must be combined efficiently in the production process.
The quantities of factors of production used are called inputs and, after they are processed and converted to goods, they become output.
A business wants to achieve the Optimum Production Level. Which combination of quantities of factors of production must the business choose >The one that minimizes the cost of production per unit of output and so maximizes the profit per unit of output.
There are two important considerations:
a) How the amount of output changes when the quantity of factors of production changes and the effect of technology used in the production process.
b) The change in the cost of production when the amount of output changes.
> In this model we have the following Production Function: I.e. Q = f(K, N, L) > K= Capital, N= Natural Resources, L= Labor
This is the function that describes the relationship between the quantity that can be produced, within a specific period of time, with the quantity of factors of production.
> Economic Science distinguishes between two periods of production. The short-run and the long-run.
There are both fixed and variable factors in the short run. In the long-run though, the business can change the quantities used of all factors of production (i.e. Fixed factors are buildings, machinery, technology etc.).
Now we are showing an example of a production function with only one variable, Labor (L). Q= Output quantity
With fixed amount of factors of production, except labor, the quantity produced can only be increased by increasing the amount of labor. The Law of Diminishing Returns exists in this model. This law holds for the variable factor of production when other factors are fixed. It describes that the increase in output will not be analogous to the increase in input. In fact the increase in output amount will be lower. i.e. 20% extra workers won’t produce 20% extra amount of output after a point (i.e. other factors are fixed and limit worker’s ability).
Total Output (TP) is the output that is produced by all workers/labor (L) for a period of time (there are no other factors). After the second worker, more input of labor increases output but increases it less than before (showed by the Marginal Product curve (MP)). After the seventh worker, more input (8 workers now) reduces output.
Average Product is the amount of output that is produced per worker for a period of time. > AP = Total Product / Number of Workers
When MP is higher than the AP, the AP increases. When MP is lower than the AP, the AP decreases. When MP equals the AP, the AP is maximized.
MP = Change in Total Product (Output) / Change in number of workers = ΔTP / ΔL
You can see from the graph that there are three stages of the production process in this model (concerning the particular function). Firstly, marginal product increases (efficient use of workers with other factors), then decreases (more workers increase output but less for each worker – inefficient use) and eventually goes negative. (More workers are used than the ones needed, results in an inefficient use of variable L with fixed factors of production)
What is the optimum level of output? We have to compare marginal product with marginal revenue to answer this question.
How can a business use resources more efficiently? It has to seek to implement new technologies. New improved methods of production, of combining resources, leading to an increase in production even if we have fixed factors of production. Technological progress is the target of many societies since it plays an important role in countering the economic problem and the law of diminishing returns. For example, wagons with horses versus trains.
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