Major Economic Terms related to Production and Supply
Business organizations require enough resources for producing a set of products. The resources are limited in nature and thereby affects the production cycle. The behavior of the production cycle will change accordingly with the availability of the resources.
In this context, we will discuss some major economic-production terms like Total Product, Average Product and Marginal Product. Understanding and analysis of these terms are important in a business, especially one which is engaged in the production line. Let us begin our content with the economic and production knowledge delight.
Production and Cost play a Vital Role in a Business
Macroeconomics depicts the large-scale operational procedure of a business or enterprise. Moreover, both production and cost are two indispensable parts of it. Production plays a vital role in the survival of a business amid a competitive market. On the other hand, cost determines the volume of production. At large, any business aims to achieve optimum production efficiency by reducing production costs.
However, for that, one needs to know some fundamental concepts like a definition of production, total product formula, and likewise.
What is Production?
Production is a process of converting resources into products or services.
Production Function: it studies the fundamental difference between physical input and output.
Below is its formula.
Y= F (L.K)
Here, Y= Production, L= Labour and K= Capital.
What is the Total Product?
It refers to the total amount of output that a firm produces within a given period, utilising given inputs.
Total Product Formula is
TP= AP*L
Where AP= product/ labour unit; L= Labour
Average Product
It is output per unit of inputs of variable factors.
Average Product (AP)= Total Product (TP)/ Labour (L).
Marginal Product
It denotes the addition of variable factors to the total product.
Thus, Marginal product= Changed output/ changed input.
In other ways, marginal product leads to an increase of total product with the help of additional workers or input.
Relationship between Total Product and Marginal Product
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In order to derive the relation, first students need to remember the total product formula. Moreover, the law of variable proportions explains the relationship between these two.
Marginal Product = ∑ Total Product
This law explains
TP increases at an increasing rate when MP increases. This pattern provides a Total Product Curve with a shape of convex. It then continues till MP reaches the maximum point of TP.
Where MP declines and stays positive, TP increases at a decreasing rate. This pattern provides a Total Product curve with a shape of concave after reaching a point of inflection. It continues till the TP curve reaches its maximum.
When MP is negative and declining, TP declines.
In case MP is zero, TP reaches its maximum.
Relationship between Marginal Product and Average Product
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Just like the relationship between marginal product and total product, the connection between this two is mentioned below.
The marginal product remains above an average product when AP rises.
Similarly, MP remains below AP, in case AP declines.
Average product and marginal product become equal at the maximum AP.
Discussion of Minor Economic Terms related to Production
Short Run
This refers to a period when a particular business can make alterations in variable factors to influence production. However, here the fixed factors remain the same.
Long Run
In the long run, an enterprise can make any changes in all factors to attain the desired production.
Now that you get an overall idea of what is a production and different usages of the total product formula let’s proceed towards the fundamental concept of Costs.
Cost Function
It explains the relationship between the quantity produced and cost.
Thus,
C= F (Qx)
Here, C= Production –Cost and Qx= Quantity of x goods produced.
Cost of Production Cost
It refers to the cost incurred to purchase various factor inputs like land and employ labourers. This also includes the expenses of non-factor inputs like fuel, raw material, etc.
Total Cost
It is a total of fixed and variable costs and can be expressed as -
‘I’C= TFC+TVC
Where TFC= Total Fixed Cost
TVC= Total Variable Cost
Implicit Cost
It covers the cost of inputs that are self-owned used in production.
Explicit Cost
It accounts for standard business costs and also directly influences the profitability of a business, for instance, lease payments, wages, etc.
These are some of the most crucial factors of this chapter that students need to learn to perform well in the examination. Understanding these concepts may seem difficult at the beginning, but with proper guidance, it will become easier to comprehend.
Thus, if you want to know more about how to derive the total product formula or any other concepts of production and costs, visit Vedantu’s website or download the app. They have some useful and informative study materials that you can consult to clear your basics.
FAQs on Product Analysis: Total, Average, and Marginal Product
1. What do Total Product (TP), Average Product (AP), and Marginal Product (MP) mean in the context of production?
In economics, these three concepts are used to analyse the relationship between inputs and outputs in the short run:
- Total Product (TP): This refers to the total quantity of goods or services produced by a firm with a given amount of inputs during a specific period.
- Average Product (AP): This is the output per unit of a variable input (like labour). It is calculated by dividing the Total Product by the number of units of the variable input used.
- Marginal Product (MP): This is the additional output produced by using one more unit of a variable input, while keeping all other inputs constant. It represents the change in Total Product resulting from an additional unit of input.
2. How are the formulas for Total Product, Average Product, and Marginal Product used in calculations?
These concepts are calculated using specific formulas based on production data:
- Average Product (AP): Calculated as Total Product divided by the units of the variable input (L, for labour). Formula: AP = TP / L.
- Marginal Product (MP): Calculated as the change in Total Product divided by the change in the variable input. Formula: MP = ΔTP / ΔL. It can also be found by subtracting the previous total product from the current total product: MPn = TPn - TPn-1.
- Total Product (TP): Can be calculated as the sum of all marginal products (TP = ΣMP) or by multiplying the Average Product by the units of the variable input (TP = AP × L).
3. What is a production function and how does it form the basis for understanding TP, AP, and MP?
A production function is a technical equation that shows the maximum quantity of output a firm can produce from any given combination of inputs (like labour and capital). It is expressed as Q = f(L, K), where Q is output, L is labour, and K is capital.
The concepts of TP, AP, and MP are derived directly from this function. They are used to analyse the production function in the short run, where one input (e.g., capital) is fixed, and another (e.g., labour) is varied. TP, AP, and MP describe how the output (Q) changes as we add more units of the variable input, which is the core of short-run production analysis.
4. Can you explain the relationship between TP, AP, and MP using a schedule (table)?
Certainly. The relationship is best understood through the Law of Variable Proportions, as shown in this example schedule:
- Stage 1 (Increasing Returns): As the first few workers are hired, TP increases at an increasing rate. Here, MP rises and is higher than AP.
- Stage 2 (Diminishing Returns): As more workers are added, TP increases but at a decreasing rate. Here, both MP and AP start to fall, and MP becomes less than AP after intersecting AP at its maximum point. A rational firm always operates in this stage.
- Stage 3 (Negative Returns): After a certain point, adding more workers leads to a fall in TP. Here, MP becomes negative.
For example: If hiring the 4th worker increases TP from 40 to 52, the MP is 12. If the 5th worker increases TP from 52 to 60, the MP is 8, showing diminishing returns.
5. What is the Law of Variable Proportions and how does it govern the behaviour of the product curves?
The Law of Variable Proportions is a fundamental principle in short-run production. It states that as we keep increasing the quantity of only one input while keeping other inputs fixed, the marginal product of that variable input will eventually decline. This law governs the shape of the product curves:
- The TP curve initially rises steeply (increasing returns), then becomes less steep (diminishing returns), reaches a maximum, and finally declines (negative returns).
- The MP curve first rises, reaches a maximum, then falls, becomes zero when TP is at its maximum, and finally turns negative.
- The AP curve also rises, reaches a maximum, and then falls, but it remains positive as long as TP is positive.
6. Why does the Marginal Product (MP) curve always cut the Average Product (AP) curve at its maximum point?
This is a mathematical and logical necessity. Think of your exam scores. If your score in the next exam (the marginal score) is higher than your average score so far, your average will go up. If it's lower, your average will go down.
- When MP > AP, the additional output from the new unit is higher than the average, so it pulls the average up. Thus, the AP curve is rising.
- When MP < AP, the additional output is lower than the average, so it pulls the average down. Thus, the AP curve is falling.
- Therefore, the MP curve must intersect the AP curve precisely at the point where AP is at its maximum, because at that specific point, the average is neither rising nor falling.
7. What is the significance of the distinction between 'short-run' and 'long-run' in production analysis?
The distinction is crucial for understanding how firms can adjust their production levels.
- The short run is a period where at least one factor of production is fixed (e.g., factory size, heavy machinery). Production can only be changed by altering the variable factors (e.g., labour, raw materials). The analysis of TP, AP, MP, and the Law of Variable Proportions applies specifically to the short run.
- The long run is a period long enough for a firm to change all its factors of production, including its scale of operation. In the long run, there are no fixed factors. Instead of studying the Law of Variable Proportions, economists analyse Returns to Scale.
8. How can a business use the analysis of TP, AP, and MP to make decisions about hiring more workers?
A business uses this analysis to find the optimal number of workers to hire for maximum efficiency. A rational producer will aim to operate in Stage 2 (Diminishing Returns) of production.
By analysing the marginal product, a manager can decide if hiring an additional worker is beneficial. They will continue to hire as long as the Marginal Product is positive and the value of that marginal product is greater than the cost of hiring the worker (the wage). The analysis helps a firm avoid entering Stage 3, where hiring more workers would actually cause a decrease in total output, leading to inefficiency and losses.
