Magsaysay Memorial High School Inc.

, Villaluz, Delfin Junior High School: Week

7
Albano, Isabela
APPLIED ECONOMICS- GRADE 12 ABM

Socioeconomic Factors Affecting Business and

Industry: Production Theory
LEARNING OBJECTIVES:

At the end of the chapter, the students must be able to:

 understand the production theory;
 identify the various socioeconomic factors affecting business
and industry in terms of production; and
 explain the importance of production theory in business.

Production is a process of combining various inputs to produce an

output for consumption. It is the act of creating output in the form of a
commodity or a service that contributes to the utility of individuals. The
term input refers to the resources used to produce goods and services.
Output refers to the product created as a result of the combination of
input in the production process.

Production Theory
In economics, production theory explains the principles in which the
business has to take decisions on how much of each commodity it sells,
how much it produces, and how much of raw material ie., fixed capital
and labor it employs. It defines the relationships between the price of the
commodities and productive factors on one hand, and the quantities of
these commodities and productive factors that are produced on the other
hand.

The Production Function is an equation showing the maximum

output of a commodity that a firm can produce per time with each set of
inputs.
Q = f (i)
Where: Q = output and i = input

To be more specific, output depends on the quantity of land, labor, and

capital available. Thus, Q = f(Ld,Lb,C).

Basically, production analysis is concerned with the analysis in

which resources such as land, labor, and capital are employed to
produce a firm’s final product. To produce goods, the basic inputs are
classified into two divisions: fixed inputs and variable inputs. Fixed
inputs are resources that remain constant in the short-run. Variable
inputs are resources which can be changed in the short-run or long-run.

The short-run is the period in which at least one factor of

production is considered fixed. Usually, the capital is considered
constant in the short-run. In the long-run, all factors of production are
variable, while in the very long-run all factors of production are variable

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 Magsaysay Memorial High School Inc., Villaluz, Delfin Junior High School: Week
7
Albano, Isabela
APPLIED ECONOMICS- GRADE 12 ABM

and research and development are possible. Economic models and

theories are not dynamic, but they are fixed to a period. So, economists
based their models on the short-run or long-run. The difference in these
periods is the ability to change the factors of production given the time.
For example, in the short run, it is impossible to set up a new factory,
but more plausible to hire new workers. It shows that in a period, the
current output can change with one factor, while in the long run, you
can make any changes.

Law of Diminishing Marginal Returns

If more variable factors of production are used in a combination
with a fixed factor of production, the marginal product, and then the
average product will eventually decline. The law of diminishing marginal
returns determines the behavior of output in the short-run.

The law of diminishing marginal returns is a theory in

economics that predicts when the optimal level of capacity is reached,
adding a factor of production will actually result in a smaller increase in
output.

OUTPUT PRODUCED IS MEASURED IN THREE FORMS:

1. Total Product (TP)

 is the combined production of several units of a given
input. Think of a pizza restaurant, with tables, chairs, and
ovens (fixed factor of production). With no workers, the
output is zero, with one worker the output is ‘x’ units. The
worker takes orders, makes pizzas, cleans tables, and
serves the bill. If there are two workers, the second worker
can do the same work as the first, and the output will be
2x units. They can specialize and further increase the
outputs.

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 Magsaysay Memorial High School Inc., Villaluz, Delfin Junior High School: Week
7
Albano, Isabela
APPLIED ECONOMICS- GRADE 12 ABM

2. Marginal Product
 is the additional output produced by an additional unit of the input and
is equal to change in total product/change in input.

For example, when one more chef has added the production increases to
x units, and when the second worker has hired the output increases by
more than 2x units. In the above figure, the output will increase at an
increasing rate till L1, hence the marginal product is rising till L1. Given
a fixed input, as the manager of the pizza restaurant adds extra workers,
the total output increases however at a decreasing rate. When the
manager of the store hires more workers, each new worker adding less to
the output, and the marginal product begins to fall from L1 to L2. After
the L2, the contribution of newly hired workers is negative. If a fixed
capital, which has a limited capacity, can cater up to 5 workers, hiring
more than 5 workers will be useless. No firms will hire beyond L2, where
there is too much of labor to a fixed capital.

3. Average Product
 refers to the average contribution per unit of input and is equal to TP/i.

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 Magsaysay Memorial High School Inc., Villaluz, Delfin Junior High School: Week
7
Albano, Isabela
APPLIED ECONOMICS- GRADE 12 ABM

Take note take that if the marginal product is greater than the
average product, then the average product will rise. If the marginal
product is less than the average product, then the average product
will drop. If the marginal product is equal to the average product,
then the average product will be at its maximum.

Significance of Production Theory in Business

As we already learned, a business is engaged in providing goods and

services to customers to make profits. Although some businesses are
engaged in retailing goods that they bought from producers, many
businesses produce the goods that they sell. It is therefore important for
the business proprietors to be aware of the production behavior that will
maximize output within limited quantities of inputs available. This in
turn will help maximize profits for the enterprise.

ACTIVITY:
MY PRODUCTION!
A. Production Function Directions: Below is the production schedule
for Output X with variable labor input. Compute the marginal
product and average product in each labor input.

Production Schedule for Output X with Variable Labor Input

Quantity of total Product Marginal Average
Labor Input Product Product
1 10
2 22
3 37
4 55
5 69
6 77
7 80
8 81

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 Magsaysay Memorial High School Inc., Villaluz, Delfin Junior High School: Week
7
Albano, Isabela
APPLIED ECONOMICS- GRADE 12 ABM

9 81
10 80

B. Application of the Law of Diminishing Marginal Returns Directions:

Discuss the above production schedule using the concept of Law of
Diminishing Marginal Returns.

C. Directions: Read each statement carefully. Write T if the statement

is correct, otherwise write F.
____________1. Marginal Product is the change in the total product as
a result of changing the variable factor of production by
1 unit.
____________2. If the marginal product is less than the average
product, then the average product will rise.
____________3. In the long-run, all factors of production are fixed.
____________4. The theory of production explains the principles by
which a business firm decides how much of each
commodity that it will produce.
____________5. The average product refers to the average contribution
per unit of input.

D. Choose the letter of the best answer and write it on a separate

sheet of paper.
1. It is a process of combining various inputs to produce an output
for consumption.
A. Production B. Consumption C. Product D.
Consume

2. It refers to the product created as a result of the combination of

input in the production process.
A. input B. output C. material D. none of
the above

3. It is an equation that shows the maximum output of a

commodity that a firm can produce per time with each set of
inputs.
A. Production Schedule B. Production Function

C. Production Utility D. Production Mode

4. It is a period in which at least one factor of production is

considered fixed.
A. short-run B. medium-run C. long-run
D. infinity-run

5. It is a theory in economics that predicts when the optimal level of

capacity is reached, adding a factor of production will actually
result a smaller increase in output.

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 Magsaysay Memorial High School Inc., Villaluz, Delfin Junior High School: Week
7
Albano, Isabela
APPLIED ECONOMICS- GRADE 12 ABM

A. Law of Production B. Law of Diminishing

Production
C. Law of Diminishing Marginal Utility D. Law of Diminishing
Marginal Returns

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