Short run production theory

What is production?F

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It is easiest to imagine the production process as a factory which turns inputs (the factors of production) into outputs (a product).

However, the theory of production also includes businesses which simply trade (i.e. buy and sell) without actually making anything, and businesses which deliver a service as well as those which sell a tangible product. All these businesses use land, labour and capital, with a dash of entrepreneurial-ism, to meet a defined need, hopefully at a profit!

Further more, these business enterprises can be privately or state owned. So although we often use factory examples, remember how broad the theory actually is.

The importance of time

7. Short-run

Revenue and costs in the short run are influenced by the factors of production available. 'Short-run' is defined as a period within which at least one factor of production is fixed.

And...

8. Long-run

Revenue and costs are not restricted by factors of production in the long run. 'Long run' is defined as a period over which all the factors of production can change.

If we run a factory (or coffee shop, hospital, airline, etc.) time makes a big difference to how we think about production. In the short-run, we are limited in what we produce by the size of our factory and the equipment we own. We can employ new workers fairly easily, and buy more materials, but there is only so much we can produce every day. The question is “What is the optimal level of production?”

In the long-run anything is possible. We can raise finance and buy more factories, as well as employing more workers and buying more materials. The question then becomes “What is the optimal scale of production?”

The optimal level of production

When one person makes a product they have to do everything, from start to finish. When two people share the work they can divide up the tasks and begin to specialise in certain aspects of production. As more people are employed in production the job of making the product can be broken down into more and more specialised tasks. You may be surprised just how many stages there are to the production of even the simplest of products.

Adam Smith's pin factory

Over 200 years ago, Adam Smith argued that the production of a simple pin could be shared amongst many workers.

“One man draws out the wire, another straights it, a third cuts it, a fourth points it, a fifth grinds it at the top for receiving the pin head. The business of making a pin is divided into about eighteen distinct operations.”

How does specialisation improve productivity?

How significant is the division of labour?

“A workman not educated in the business of pin making could scarce, perhaps, with his utmost industry, make one pin in a day... Ten persons could make among them upwards of forty-eight thousand pins in a day. Each person, therefore, making a tenth part of forty-eight thousand pins, might be considered as making four thousand eight hundred pins in a day.”

The division of labour, as Adam Smith called it, could significantly increase the output of a firm in three ways:

I. The increase in 'dexterity' of each worker

II. The saved time by avoiding moving from one job to another

III.The invention of machines which could perform the simple tasks in place of workers

The application of these ideas has revolutionised production and dramatically increased our wealth and standard of living.

Toasters and the modern economyHow far has the concept of division

of labour taken us? Thomas Thwaites has the answer.

Thomas asked himself, how hard could it be for one man to build a toaster, from scratch? One factory can turn out hundreds, if not thousands, of toasters every day. How much greater is this than what one man could do alone, without the benefit of the division of labour?

http://www.ted.com/talks/thomas_thwaites_how_i_built_a_toaster_from_scratch.html

Strawberry’s and specialisation If you have ever been strawberry picking you will know that you need

one field of strawberries, one basket and a lot of effort.

How many 'distinct operations' can the process of picking strawberries be divided into?

Include everything from finding the ripe strawberries through to weighing and packing them

Think about what equipment you could use

Handling production data

No. of workers(fixed capital)

0 1 2 3 4 5 6 7 8 9

Total output, product or returns

0 1 4 9 16 25 32 35 36 34

Average output, product or returns

- 1

Marginal output, product or returns

1 3

Here we have some data which shows the total output of a firm in the short run as it employs more labour to work in its factory. By calculating the average output per worker we can see the effects of increased productivity due to specialisation. The marginal output is the amount added to total output as each additional worker is added.

Fill in the missing data for average and marginal output.

Short-run production theory

No. of workers(fixed capital)

0 1 2 3 4 5 6 7 8 9

Total output, product or returns

0 1 4 9 16 25 32 35 36 34

Average output, product or returns

- 1 2 3 4 5 5.3 5 4.5 3.8

Marginal output, product or returns

1 3 5 7 9 7 3 1 -2

What happens to average and marginal output as more workers are employed?

Why?

Plot the total output on one graph and the average and marginal output on another graph.

Product curvesWe can see the effect of the

division of labour in these curves as total, average and marginal product rises.

However, we also see something strange happening. As more workers are employed the increase in total product begins to slow, then actually falls as the ninth worker is employed. The marginal product curve shows that the ninth worker has a negative marginal output... by increasing workers to this level the firm actually produces less.

What is going on?

The law of diminishing marginal returns

This law states that as a variable factor of production is added to fixed factors, eventually the marginal returns (or marginal product) of the variable factor will begin to fall.

Imagine our strawberry pickers. As more workers are employed the total output (no. of strawberries picked) increases, but so does the marginal output as each worker makes the operation more productive.

However, the filed is only so big and can only yield so many strawberries. As the number of workers increases further the marginal product falls. Workers get in each others way and reduce each others' productivity.

Drawing the marginal and average product curves

Note the relationship between the marginal and average product curves:

When marginal > average product the average rises

When marginal < average product the average falls

When marginal = average the average is constant

In other words, the marginal product curve crosses the average product curve at its highest point.

Summary

Short-run production theory attempts to explain what happens to output as a variable factor is added to fixed factor/s of production

As a variable factor of production is added to fixed factor/s the marginal output increases at first due to the effects of specialisation and the division of labour

As the variable factor continues to be added the marginal product eventually falls due to diminishing marginal returns