production function

• Factors of production


  • Land
  • Labour
  • Capital
  • Enterprise
• Demand for the factors is determined from the nature of business operation
• Many clothing items are produced in developing countries in South East Asia, North Africa and Central Europe
• Firms want to be as competitive as they can be, so they aim to keep production costs as low as possible
• The task of the firm is to find the least cost or most efficient combination of labour and capital for the production of a given quantity of output
• In the clothing industry

  Labour and capital are in direct competition with each other
• If labour costs are relatively cheap in developing countries


  The production process is more likely to use more labour than capital
• In developed countries


  The reverse is true regarding labour and capital usage
• Line A shows a method whereby labour and capital are used in the same proportion
• Line B uses twice as much capital to labour
• Line C shows that it uses twice as much labour to capital
• Points X, Y, Z show the respective amounts of labour and capital needed to produce 100 units of output
• Isoquant


  Joining three points gives us an isoquant
• The short run production function assumes that the size of the clothing factory is fixed
• The only way in which the units of clothing produced can be varied is through the varying input of labour
• Marginal product


  Shows the increase in production from every additional unit of labour employed
• As the number of workers increases but the number of machines remains fixed

  Marginal product declines
• Diminishing returns


  The phenomenon where marginal product declines as more labour is added
• The graph shows the relationship between factor inputs (labour) and the total product or output of clothing
• The firm has an objective of profit maximization
• The firm will have to consider all costs to remain profitable
• Short run costs


  • Fixed costs
  • Variable costs
  • Total costs
  • Average fixed costs
  • Average variable costs
  • Average total costs
• Fixed costs


  Costs that must be paid irrespective of the number of units produced
• Examples of fixed costs

  • Rent/mortgage
  • Insurance
  • Salaries
• Variable costs


  Costs that vary with output
• Total costs


  Fixed costs + Variable costs
• Average fixed costs


  Total fixed cost / Output
• Average variable costs


  Total variable cost / Output
• Average total costs


  Total cost / Output
• The most important cost curve for the firm is ATC
• If the firm increases output

  Total cost will rise
• Marginal cost


  The extra cost to produce the good as extra units are produced
• Firms will only increase output


  If sales revenue outweighs the extra cost of production
• As more variable cost (labour) are added to a fixed amount of machines, the extra contribution each new worker makes will begin to fall
• This is called diminishing returns
• As the firm's output rises, the average cost of producing the good will fall since fixed cost is spread over a number of units provided
• Average variable cost will be rising as we add more labour to a fixed amount of machines
• Eventually this will outweigh the effect of falling AFC, causing ATC to rise
• This will give ATC a U shape
• On the diagram MC cuts ATC at its lowest point