Theory of Production

Production

The transformation of physical inputs into physical outputs.

Production Function

The technological relationship between physical inputs and physical outputs.

Total Product (TP)

The total quantity of output produced with a given amount of inputs.

Average Product (AP)

The amount of output produced per unit of variable factor.

Marginal Product (MP)

The additional output produced by an additional unit of variable factor.

Law of Diminishing Marginal Productivity

As the number of variable factors increases, the marginal product of the factor initially increases and then declines.

Stages of Production

Stages in short run including Stage I where marginal product rises, Stage II where it falls but total product increases, and Stage III where marginal product becomes negative.

Increasing Returns to Scale (IRS)

When output increases by more than the proportion of input increase.

Constant Returns to Scale (CRS)

When output increases by the same proportion as input increase.

Decreasing Returns to Scale (DRS)

When output increases by less than the proportion of input increase.

Isoquant

A curve that represents different combinations of two inputs that yield the same level of output.

Marginal Rate of Technical Substitution (MRTS)

The rate at which one factor can be substituted for another without changing the output.

Isocost Line

A line representing different combinations of labor and capital that can be purchased with a fixed budget.

Properties of Isoquant

Isoquants are negatively sloped and convex to the origin, indicating diminishing marginal returns.

No Isoquants Can Touch Either Axis

It is impossible for production to occur using only one factor, hence no isoquant can touch either axis.