Production Economics: A Dual Approach to Theory and Applications. Volume 1: The Theory of Production

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Because the output per unit of the variable input is improving throughout stage 1, a price-taking firm will always operate beyond this stage. In Stage 2, output increases at a decreasing rate, and the average and marginal physical product both decline. However, the average product of fixed inputs not shown is still rising, because output is rising while fixed input usage is constant. In this stage, the employment of additional variable inputs increases the output per unit of fixed input but decreases the output per unit of the variable input.

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In Stage 3, too much variable input is being used relative to the available fixed inputs: variable inputs are over-utilized in the sense that their presence on the margin obstructs the production process rather than enhancing it. The output per unit of both the fixed and the variable input declines throughout this stage.

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At the boundary between stage 2 and stage 3, the highest possible output is being obtained from the fixed input. By definition, in the long run the firm can change its scale of operations by adjusting the level of inputs that are fixed in the short run, thereby shifting the production function upward as plotted against the variable input. If fixed inputs are lumpy, adjustments to the scale of operations may be more significant than what is required to merely balance production capacity with demand.

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For example, you may only need to increase production by million units per year to keep up with demand, but the production equipment upgrades that are available may involve increasing productive capacity by 2 million units per year. If a firm is operating at a profit-maximizing level in stage one, it might, in the long run, choose to reduce its scale of operations by selling capital equipment. By reducing the amount of fixed capital inputs, the production function will shift down. The beginning of stage 2 shifts from B1 to B2.

The unchanged profit-maximizing output level will now be in stage 2. There are two special classes of production functions that are often analyzed. The presence of increasing returns means that a one percent increase in the usage levels of all inputs would result in a greater than one percent increase in output; the presence of decreasing returns means that it would result in a less than one percent increase in output. Constant returns to scale is the in-between case. If a production function is homogeneous of degree one, it is sometimes called "linearly homogeneous".

A linearly homogeneous production function with inputs capital and labour has the properties that the marginal and average physical products of both capital and labour can be expressed as functions of the capital-labour ratio alone.

The production function

Moreover, in this case if each input is paid at a rate equal to its marginal product, the firm's revenues will be exactly exhausted and there will be no excess economic profit. Homothetic functions are functions whose marginal technical rate of substitution the slope of the isoquant , a curve drawn through the set of points in say labour-capital space at which the same quantity of output is produced for varying combinations of the inputs is homogeneous of degree zero.

Due to this, along rays coming from the origin, the slopes of the isoquants will be the same. In macroeconomics , aggregate production functions for whole nations are sometimes constructed. In theory they are the summation of all the production functions of individual producers; however there are methodological problems associated with aggregate production functions, and economists have debated extensively whether the concept is valid.

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There are two major criticisms [ which? During the s, '60s, and '70s there was a lively debate about the theoretical soundness of production functions see the Capital controversy. Although the criticism was directed primarily at aggregate production functions, microeconomic production functions were also put under scrutiny.

The debate began in when Joan Robinson criticized the way the factor input capital was measured and how the notion of factor proportions had distracted economists. She wrote:. Before [they] ever do ask, [they] have become a professor, and so sloppy habits of thought are handed on from one generation to the next".

According to the argument, it is impossible to conceive of capital in such a way that its quantity is independent of the rates of interest and wages. The problem is that this independence is a precondition of constructing an isoquant. Further, the slope of the isoquant helps determine relative factor prices, but the curve cannot be constructed and its slope measured unless the prices are known beforehand. As a result of the criticism on their weak theoretical grounds, it has been claimed that empirical results firmly support the use of neoclassical well behaved aggregate production functions.

Natural resources are usually absent in production functions. When Robert Solow and Joseph Stiglitz attempted to develop a more realistic production function by including natural resources, they did it in a manner economist Nicholas Georgescu-Roegen criticized as a "conjuring trick": Solow and Stiglitz had failed to take into account the laws of thermodynamics , since their variant allowed man-made capital to be a complete substitute for natural resources.

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Neither Solow nor Stiglitz reacted to Georgescu-Roegen's criticism, despite an invitation to do so in the September issue of the journal Ecological Economics. The theory of the production function depicts the relation between physical outputs of a production process and physical inputs, i. The practical application of production functions is obtained by valuing the physical outputs and inputs by their prices.

The economic value of physical outputs minus the economic value of physical inputs is the income generated by the production process. By keeping the prices fixed between two periods under review we get the income change generated by a change of the production function.

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  7. This is the principle how the production function is made a practical concept, i. From Wikipedia, the free encyclopedia. Quadratic production function. Shifting a production function. See also: Cambridge capital controversy. Main article: Production economics. Assembly line Computer-aided manufacturing Distribution economics Division of labour Industrial Revolution Mass production Production Production theory basics Production, costs, and pricing Production possibility frontier Productive forces Productive and unproductive labour Productivity Productivity improving technologies historical Productivity model Second Industrial Revolution.

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    The production function

    Cambridge: Cambridge University Press. Ecological Economics. Journal of Economic Perspectives. For Smith, the development and expansion of the division of labour is key to the creation and accumulation of wealth. The level of wealth is increased by expanding the division of labour within society as a whole, and within specific industries. Society's labour as a whole is exercised within this division of labour, and each worker's claim on society's wealth is in proportion to that worker's position within the division of labour.

    The view that the division of labour is a cooperative aspect of the structure and development of socity may have inspired Durkheim, whose first major work was The Division of Labour. Smith did not have what Marx considered to be a systematic labour theory of value that would explain exchange in modern capitalism. For earlier societies, Smith claimed that products exchanged more or less in proportion to the amount of labour embodied in them.

    However, in capitalism, each of land, capital and labour had a return to them, so that the labour theory of value no longer explained prices. While Marx was quite critical of Smith, he did adopt some of his ideas, although he changed or developed them in a somewhat different way than Smith. The notion of value emerging in production, and on the basis of labour, became a key aspect of Marx's model of society. The notion of the division of labour is also important for Marx and other sociologists. Marx thought Smith too uncritical in his acceptance of the division of labour. While Marx recognized the cooperative character of the division of labour under capitalism, and on the other hand he viewed it as a source of alienation and argued that a social system eliminating much of the division of labour would ultimately develop.

    Marx was also critical of Smith's invisible hand, the unseen force that Smith claims guides individual self interest to promote the general good of society. The invisible hand might be considered an economic counterpart of Durkheim's solidarity and order. David Ricardo was an English stockbroker who made a fortune in the stock market as a young man, and then became a political economist. His Principles of Political Economy and Taxation was published in , and it became the model for much of the abstract economic theorizing which has followed. While Ricardo was interested in current economic issues, his main contribution was his incisive analytical ability.

    Ricardo developed a more complete labour theory of value than did Smith, so that some writers consider Marx's political economic writings as merely a minor development of Ricardo's ideas. Ricardo's economic analysis did not the use value of a commodity, but was concerned with its exchange value. Further, he was mostly interested in commodities which can be produced in large numbers in agriculture or industry reproducible commodities -- as opposed to works of art, specialized talents, etc.

    For Ricardo, the value of these commodities, in exchange, was the amount of labour embodied in them.

    Theory of production

    This was the current labour required to produce them, plus the past labour embodied in tools, building, implements, and equipment i. For Ricardo, profit emerged based on the amount of capital employed. While Smith also had this view, Ricardo stated this more clearly, and removed any confusion concerning where profit came from, that is, in production, by employing living labour along with capital past labour. Ricardo had a dismal view of the future, looking on the supply of land as very limited. He argued that there were limited prospects for technical improvements to expand employment.

    Ricardo noted a declining rate of profit, and predicted future declines as well. Some have called economics the dismal science because of his grim outlook. Ricardo's labour theory of value began to be used by trade unionists and early socialists, the "Ricardian socialists," who said that labour deserved all the product of its own labour.

    In addition, Marx took over Ricardo's labour theory, solving some of the problems raised by Ricardo, but putting the theory to new uses as well. Perhaps because of these radical implications, political economy generally abandoned the labour theory of value after Ricardo, preferring to adopt some cost of production theory. Marx begins Capital by analyzing the commodity, the relationship of commodities with each other, and the implications of this for social relationships.

    From the analysis of the commodity, Marx builds a labour theory of value which he uses to explain not only exchange relationships in capitalism, but the economic and social structures of capitalism, and their development.