PRODUCTION Microeconomics Made Easy by William Yacovissi Mansfield University © William Yacovissi All Rights Reserved

PRODUCTION l The process of transforming inputs into a product for sale is called production l A company incurs costs in the production process. l The primary determinant of a company’s cost is the relationship between inputs and output.

PRODUCTION l This relationship is called productivity. l The more productive an input is, the more valuable it is to a firm l The average productivity of an input is the output per unit of input.

PRODUCTION l For example, if 100 workers produced 500 units of some good, the average productivity of each worker is 5. APl = Q/L or 500/100 = 5. l Inputs can be divided into fixed inputs and variable inputs.

PRODUCTION l Fixed inputs are things that can in specific sizes and last a long time, such as a truck. l Variable inputs are inputs that can be purchased in any amount and are short term. Labor is the most important variable input in most production processes.

PRODUCTION l When variable inputs are combined with fixed inputs, the productivity of the variable inputs often change dramatically, as the production process becomes more then less efficient.

PRODUCTION l For example, suppose you have purchased a franchise for a new fast food. As part of the franchise fee you will get plans that show you how to build the kitchen and attached dining area. Suppose you try to run the whole operation yourself. You will be very inefficient as you try to take orders, cook, clean up, order new supplies, etc.

PRODUCTION l You don’t have to be very smart to know you have to hire someone else to help you out. Hiring that second person will make your operation more efficient. l A production process is more efficient when the average productivity of a variable input goes up when more of the variable input is employed.

PRODUCTION l Naturally, as average productivity increases, average cost decreases. l Therefore,it is more profitable to continue to hire variable inputs as long as productivity is going up and cost per unit is going down.

PRODUCTION l Unfortunately, there comes a point when additional variable inputs causes the production process to become less efficient. For example, if you continued to hire people for your fast food restaurant, you will eventually employ too many people, so the average productivity of your workers will decline, and your average costs will begin to increase.

PRODUCTION l The question is when to stop hiring variable inputs. l The answer is it depends on the price customers are willing to pay for your product.