Production II

This second Learning Path on production will draw on the basics we saw in Production I and add several extra factors to our analysis. We will basically introduce three new parameters to our possibilities: we will add a time frame and see how this shapes our choices, we will introduce the ability to produce more than one good or service, and we will also take a first look at prices, production costs and competition as a whole market dynamic.

Under perfect competition, prices are determined by market forces. If the price of a specific type of bog standard, hexagonal, 15mm screw, for example, is  0.01€, there is nothing stopping you from trying to sell it at ten times the price, but you probably won’t last very long. You’re better off deciding whether you can make a profit selling at that price before you start producing at all. In terms of labour and capital, we suppose they are interchangeable, as we saw when we looked at the MRTS. Depending on the going price of labour (wages) and capital (machinery and interest rates), you will choose one or the other or a combination of both: whatever is most productive per euro spent.

All we can now do is set our level of production. We know that marginal productivity drops with each added unit of labour (or capital), under the law of diminishing returns. When, therefore, should we stop? We could try cramming our screw factory with workers until they begin getting in each others’ way and start having negative productivity (the equivalent of getting them to work 20 hour days until they are tired enough to start doing more harm than good), but not only is this not health and safety compliant, it is also much too late. The simple answer is that we stop when it is not worth hiring any more workers. This idea of ‘worth’ will depend on various factors, and is the subject of our analysis in this second LP.

So, let’s define these factors and get started. We will begin by looking at the concept of

• Static period analysis, introducing one of the main factors we will have to juggle.

This will lead us onto our first scenario, the short run, where we will look at:

• Production functions and
• Production analysis in the Short Run

In the next section we will cover the long run, with:

• Analysis in the Long Run and
• Returns to scale

Before an entry on

• Production analysis in the Very Long Run

In the final section of this LP, we will introduce another factor, multi-product analysis, in two entries on:

• Production possibility frontier and
• Multi-product function.