Production Theory-Roles, Objectives and basic analysis

Production Theory:

How to define a ‘Firm’? – Roles, Objectives, and more:

a) Specialization in production.

b) Team production is more proficient than individual production in many aspects.

  • Less transaction costs however more monitoring costs in firm.

c) Internal control than external market transactions with a lots of transaction cost.

  • Opportunistic behaviours because of asset specificity.
  • However is internal control always reasonable? Not really. Why?
  • Example: Vehicle brand owner

d) Profit-maximizers?

e) Ownership as well as management are separated.

Production Technology: Basic Analysis

a) Time periods: SR with at least one fixed input/LR with all variable inputs

b) Production function (total product curve)

Q = f (L, K) ...............(1)

Q: is maximum amount of output a firm could obtain from a given combination of inputs. Therefore inefficient management could reduce output from what is technologically possible. If we invert the equation (1) to get L = g(Q), which tells us the minimum amount of labor L required to produce a given amount of output Q, this function is labor requirement function.


APL = Q/L                       

MPL= dQ/dL

Up to I (inflection point), MPL is increasing (increasing marginal returns to labor), and after that MPL starts diminishing.

Up to S, APL is increasing, so APL < MPL .

After S, APL is decreasing,


Law of Diminishing Marginal Returns: Principle that as the usage of one input raises the quantities of other inputs being held fixed a point will be reached beyond which the marginal product of the variable input will decrease.

574_diminishing marginal returns.jpg

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