MODULE 10: THEORY OF PRODUCTION (CONTINUATION)

C. Production Function
 The Short-Run and the Long-Run
 Boundary Between Short-Run and Long-Run
D. Basic Concepts
 Total Product (TP)
 Average Product (AP)
 Marginal Product (MP)
 Relationship between AP and MP

WEEK: 10

TIME ALLOTMENT: 3 Hours

OBJECTIVES/ LEARNING OUTCOMES:

At the end of this module, the students are expected to understand the concept of production
function, distinction between the short-run and the long- run and the basic concepts for the production
analysis.

LEARNING CONTENT:

THEORY OF PRODUCTION (CONTINUATION)

Introduction

The theory of production is an analysis of output-input relationship. As such, discussions touch

on the relation of output to the size, combination, and efficiency of resources. In turn, this output
function serves as a tool in analyzing cost-output relationship in the next chapter.

Discussion

C. Production Function
Plant size and the efficiency of its resources (land, labor, and capital) determine plant capacity
(maximum output). Resources are fixed in the short-run which is generally described as a period
when conditions have not changed yet. But as plant size and resources efficiency change in the
long-rum, so is production capacity. In addition, material inputs change with output regardless of
the time frame i.e., within fixed or changing plant capacity.

The production function shows the relation between input changes and output changes. It
also shows the maximum amount of output that can be obtained by the firm from a fixed quantity
of resources.
The production function is expressed as:

Q = f (K, L, etc.)

Where Q is output (which is the dependent variable) and K and L are capital and labour inputs,
respectively. We can think of other inputs as well, such as land. For the sake of convenience we
assume here that the firm employs only two factors of production— labour and capital. The firm’s
output is treated as a flow, i.e., so many units per period of time. The volume of output of the firm’s
product, per period of time, depends on the quantities of these factors that are used by the firm.
Let us now suppose that the firm wishes to increase its volume (rate) of output. This can be
achieved by increasing the inputs of one or both factors of production. However, it is very easy to
vary the quantity of labour in the production process. It can be done very quickly (in a week or a
month). On the other hand, a fairly long period of time is required to vary the quantity of other
factors, for example, change the quantity (or usage) of capital, e.g. to install a new machine.

The speed with which different kinds of factors can be varied largely depends on the time period
under consideration. Here we assume that the firm is making decisions within two time periods —
the short-run and the long-run.

 The Short-Run and the Long-Run

The distinction between the short-run and the long-run is based on the difference
between fixed and variable factors. A factor of production is treated as a fixed factor if it
cannot easily be varied over the time period under consideration. On the other hand, a
variable factor is one which can be varied over the time period under consideration.

1. Short-Run
The short-run refers to the period of time over which one (or more) factor(s) of
production is (are) fixed.
In the real world, land and capital (such as plant and equipment) are usually
treated as fixed factors. Here we are considering a simple production process with only
two factors. We treat capital as the fixed factor and labour as the variable factor.
Thus, output becomes a function of (i.e., output depends on the usage of) the
variable factor labour working on a fixed quantity of capital. In other words, if the firm
wishes to vary its production in the short-run, it can do so only by changing the
quantity of labour. With a fixed quantity of capital, this necessitates changing the
proportions in which labour and capital are combined in the production process.

2. Long-Run
On the other hand the long- run is defined as the period over which all factors of
production can be varied, within the confines of existing technology. In the long-run
all factors are variable. Moreover the long-run also permits factor substitution. More
capital and less labour or more labour and less capital can be used to produce a fixed
amount of output.
“The long-run is the period that is relevant when a firm is either planning to go
into business or to expand, or contract, its entire scale of operation. The firm can then
choose those quantities of all factors of production that seem most suitable. In
particular, it can opt for a new factory of any technologically feasible size. However,
once the planning decision has been carried out— the plant built, machines purchased
 and installed, and so on—the firm acquires fixed factors and it is operating in the short
run.”

 Boundary Between the Short-Run and Long-Run

The boundary between the short-run and the long- run is not defined by reference
to any calendar—a year, or a month or a quarter. It varies from industry to industry and
from time to time within the same industry. In most plantation industries the long-run is
15-20 years. For example, rubber trees require a very long time to grow. On the other
hand, in a barber’s shop it may be just a week.
A barber may require only a few days to make all types of changes in his small
shop. In fact, the boundary between the two runs is defined only in terms of the fixity of
one factor of production. The length of the short-run is influenced by two sets of
considerations technological (such as how quickly equip-ment can be manufactured or
installed) and economic (such as the price the firm is willing to pay for equipment).
We may now turn to a consideration of how output varies in response to input
changes in the short run as also in the long run. It may be noted, at the outset, that
short-run output changes reflect changes in the proportions in which factors are
combined.
On the other hand, long-run changes in output reflect changes in the entire scale
of operation. In other words, in short-run we study the returns to a variable factor (such
as labour) and in the long-run we study the return to scale. It is, of course, possible to
study the nature of return to a variable factor in the long-run, as we shall see later in this
article.

D. Basic Concepts

 Total Product (TP)

- It is the total output resulting from the efforts of all the factors of production combined
together at any time.
- One factor kept constant, total product will vary with the quantity used of the variable
factor.
- Total product rises as more and more units of variable input is employed.
 Average Product (AP)
- It is the total product per unit of the variable factor.

 Marginal Product (MP)

- It is the change in total product per unit change in the quantity of variable factor.
  Relationship Between AP and MP
- Derived from the total product.
- MP > AP, when AP rises as a result of an increase in quantity of variable input.
- MP = AP, when AP is maximum. i.e. MP curve cuts the AP curve at its maximum.
- MP < AP, when AP falls as a result of a decrease in quantity of variable input.

Product Schedule

Summary

This module elaborated the production analysis in two different periods: the short-run and the
long-run. We shall take into consideration that output varies in response to input changes in the short
run and long run. The short-run output changes reflect changes in the proportions in which factors are
combined while long-run changes in output reflect changes in the entire scale of operation. The basic
concepts was also introduced as we proceed to understand production in the next chapter.

REFERENCES:

1. Pagoso, C., Dinio, R., Villasis, G. (2006). Introductory Microeconomics (Third Edition). Rex Book
Store, Manila, Philippines.
2. Kapoor, K.C., Soni J.C., Achrya, P.K., Riba, M., Riddi, A. (2016). Economic Theory. Vikas
Publishing House PVT.LTD

Congratulations on finishing Module 10! Keep up the good work.

Prepared: Reviewed/Approved:

JUVIELYN R. RAMOS AIZA P. RUMAUAC, CPA

Instructor Program Head, Accountancy and Business Administration