Firm is a unit that produces products using economic resources
Technological relationship between inputs and outputs is described by the production function
Production function is summarized by the following equation
Q = F ( L, K)
Q = output
F = Function
L = Labour ( Variable factor inputs)
K = Capital (Fixed factor inputs)
Variable factor inputs and fixed factor inputs exist in the short run production
All factor inputs are variable in the long run.
Short run and long run are determined by the nature of production
Short run production behaviour is characterized by the law of diminishing marginal returns
Short run production is governed by the law of diminishing marginal returns
Diminishing marginal returns states that when production is increased by increasing variable
factor input for a given amount of fixed factor input, the average and marginal product of
the variable factor will diminish after a point
The table below illustrates the law of diminishing marginal returns
Marginal product is zero when the total product is maximized
Marginal product curve slopes downward through the maximum point of the
average product curve
Returns to scale explains long run production behaviour when all factors are
variable
There are three types of returns to scale
Increasing returns to scale
Decreasing returns to scale
Constant returns to scale
Increasing returns to scale prevails when output is increased by a greater
percentage than the increase in all inputs in the long run production
Decreasing returns to scale exists when output is increased by a less percentage
than the increase in all inputs in the long run production
Constant returns to scale exists when output is increased by the same percentage
to the increase in all inputs in the long run production
Increasing returns are the result of economies of scale
Increasing returns are caused by the geometric nature of certain inputs, indivisibility
of factors of production, use of machinery, division of labour and specialization
of labour, and one time payment
Diseconomies of scale causes decreasing returns to scale
Decreasing returns to scale are caused by depletion of resources, stress and,
problems of management and coordination
