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Production Theory

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  • Pages: 4
  • Word count: 898
  • Category: Economics

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Production refers to the creation of wealth for the sole purpose of utility in order to improve the welfare of people. It is creation of goods and provision of services to satisfy human wants.

Forms of production
a) Direct production.
Also known subsistence production and it refers to production of Goods for own consumption. It s output is normally low. b) Indirect production.
It is production for sale. It is also known as market economy. It uses modern production methods / technology.

Levels of production
There are three levels of production.
a) Primary level.
This is the basic level where production starts. It’s sometimes known as extraction level and involves production of raw materials. E.g. mining

b) Secondary level.
This is also known as transformation / manufacturing level. In this level output from primary level is used to produce finished goods or services. E.g. engineering, carpentry
c) Tertiary level.
This summarizes the production process. It involves the supply of finished goods and services to the final consumer. E.g. transport, banking

Types of goods produced
1) Consumer goods.
These are goods which satisfy human wants directly. They are categorized into durable and non-durable goods.
2) Producer goods.
This refers to categories of goods which give indirect utility to the consumer.
3) Services.
These are intangible economic goods. E.g. teaching, insurance

Factors of production
These are also known as inputs or factors of production or economic sources. They are those things necessary for production to take place.

1) Land
It represents all natural resources that help in the production process. It provides space for the activity of the other factors of production. It differs in fertility and its both mobile and immobile. It provides raw materials such as water minerals. For production purposes, land is subjected to the law of diminishing marginal returns.

2) Capital

Refers to a manmade resources used for further production. It deals with the manufacturing aid to production by making them efficient. It a manmade resource. It includes: Plants and machinery, buildings, tools and other equipments, e.t.c Capital can be owned by individuals as private capital or the government as social capital. It can also be mobile or non mobile.

3) Labor

It’s a human resource and can be mental or physical. It can also be skilled, semiskilled or unskilled. It is rewarded inform of wages / salaries.

Demand for labor

It refers to number of laborers/employees which a firm is willing and able to hire at given wage rate over a specified period of time. It’s a derived demand since it arises from the demand of goods and services

Determinants of demand for labor

• Demand for goods and services the firm is producing. As demand for goods increase, demand for labor increases. • Productivity of labor. If labor is more productive compared to other factors, the demand for labor increases. • Changes in the prices of other factors of production. Comparing price of labor and capital, if price of capital increases relative to that of labor, then the demand for labor increases. • The wage rate. The higher the wage rate the lower the demand

Supply of labor

This refers to the number of workers willing and able to work (or man-hours available for work) at a given wage rate and over given period of time.

Factors effecting labor supply
1. Wage rate. The higher the wage rate the greater the supply 2. Level of education and training.
3. Retirement age policy of the government.
4. Population size and composition.
5. Technology – means of production

4) Entrepreneurship / organization
It is the ability to organize other factors of production in effective proportions for production. It is concerned with the overall production by organization of all other factors of production.

The scales of production
This refers to the extent of complexity of business organizations. It means the potential or capacity of a business firm to produce output. The size of any business organization depends on:
1. Capital employed.
2. Quality of capital employed.
3. The number of workers employed.
4. The amount of raw material employed.
5. The number of departments it has.
6. The amount and quality of energy employed.

The production functions.
This refers to the technical relationship between input requirements and
output of a firm. If a firm requires land, labor and capital the firms production function is:

Qx = f (N, K, L)

Where Qx = Output, L= labor, K = capital and N = land.

In the short run some of these factors are fixed and labor in most cases is a more variable factor. Short run effects of changes in a variable input are given by the returns to scale in production.

Graphical representation of production labor

Assuming labor is the only variable factor, it is possible to describe the average product of labor and marginal product of labor.

Average product of labor (APL) = Total product per unit of labor

APL = TPL /L e.g. 200 / 10 = 20.

This defines the level of efficiency of labor.

Marginal product of labor (MPL)

Refers to change in the total product due to change in labor.


Suppose a firm uses labor in the production of its output, the table below gives the total products of the corresponding labor units. Use the table to establish the relationship between total product, average products and marginal products.

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