The theory of production in business economics can be explained as those guiding principles which a business has to follow through which it conducts essential decisions regarding buying, distribution, and selling of a product or service. In the theory of production, those items which are being sold are classified as ‘products’ or ‘outputs’. Theory of production also talks about the factors which determine the quantity and quality of the product or output produced and sold, the number of raw materials needed, the conditions and relationships between labour, fixed capital, and prices of the products. It focuses on the production factors.
Theory of Production
Concepts such as marginal productivity theory of distribution, marginal productivity theory of wages, and product life cycle theory of international trade are also included within its scope. The theory of production focuses on some key factors which are:
- Factors of Production
- Production Function
- Production Analysis
- Cost Function
- Law of Variable Proportions
Production function
Production function represents a technical link between physical inputs as well as outputs of a business and is mathematically represented as:
Q= f (a,b,c,…….z)
From there the following can be reduced to:
Q= f (L,K)
Where L is the labour involved and K is the capital involved.
Production Analysis
Production Analysis in the theory of production can be defined as the analysis of the four resources available to the business. It is analysed through variable inputs, fixed inputs, and cost functions.
Cost Function
The cost function is the link between the price of the product and the output, mathematically represented by:
C= F[Q]
Then there are two types of Cost functions which are Short Run Cost and Long-Run Cost.
- Short Run Cost analyses those factors which are constant
| Short Run Fixed | Variable Cost | Short Run Total |
| These costs don’t change | These costs are likely to change | This is the total incurred cost of output |
| Insurance charge and rent | Raw materials and electricity | Total Cost= Total Fixed Cost + Total Variable Cost |
Table 1 shows three types of short-run cost
Long Run Cost analyses variable factors so that proper adjustments can be made to operational costs. Mathematically, it is represented as
Long run cost= Long run variable cost
Law of Variable Proportions
It depends on three distinct phases:
- Returns to a factor
- Returns to a scale
- Isoquants
Theory of Production studies the utilisation and impact of these forces which can be then applied to businesses.
Marginal Productivity Theory of Distribution
As a part of business economics at large and theory of production specifically, the marginal productivity theory of distribution (MTPD) is dependent on the assumption that in an economy where there is a free market, the particular demand for any given factor of production will depend on the marginal product. The marginal product in the theory of production is a distinct chance that is evident in the total product. MTPD has been seen as beneficial for the following reasons:
- Brings distributive justice
- Determines fairness in profits, rents, wages, and interest
Marginal Productivity Theory of Wages
The marginal productivity theory of wages explains that there is a specific trend and type in the hiring process of employers involved in the overarching theory of production.
Product Life cycle Theory of International Trade
This theory was developed by Raymond Vernon. The product life cycle theory of international trade is a principle and a theory that is economical. It was formulated as a reply to the Heckscher-Ohlin model. It can be applied in these dimensions:
- Labour-saving products
- Capital saving products
- For high-income groups
Importance of Theory of Production
Theory of production is helpful in the following ways:
- Advertisements of commodities and services
- Determination of rewards
- Marketing decisions
Conclusion
Therefore, the theory of production offers an in-depth look at the various market factors and forces which influence the various decision-making processes of a firm. The forces of demand and supply are controlled by market conditions. Understanding how these factors are affected by internal and external conditions can reveal important patterns and observations about the entire commercial and trading process. Production theory is also instrumental in gauging employment and the unemployment rate in the industry.