Chapter 5: The Production Process and Costs
Technology summarizes the feasible means of converting raw inputs into an output. Most
production processes involve capital (machinery) and labor (people).
Increasing marginal returns – Range of input usage over which marginal product increases.
E.g. in the first hours you study for an exam you can concentrate very well and you increase your
knowledge rapidly.
Decreasing (diminishing) marginal returns – Range of input usage over which marginal
product declines. E.g. the longer you study the less you remember but still you gain more
knowledge. You increase total knowledge, but at a decreasing rate. Marginal product declines
but it is still positive.
Negative marginal returns – Range of input usage over which marginal product is negative.
E.g. if you study too long you get tired and too much information is in your head in too little
time. You get confused and reduce the total knowledge.
Phases of Marginal Returns – When there is an increase in the use of input, Marginal product
changes from increasing to decreasing and further to negative.
The manager’s role in the production process:
1. Produce on the production function
It describes the maximum possible output that can be produced with given inputs. In case of
labor, the manager has to think of an incentive system to ensure that employees are working at
full potential.
2. Use the Right level of inputs
The manager has to determine how many units of input are needed to maximize total output.
When a manager decides on how many employees that his/her firm needs to employ, he/she has
to consider marginal returns. The value marginal product describes the value of the output
produced by the last unit of an input.
Profit-Maximizing Input Usage – To maximize profits, a manager should use inputs at levels at
which the marginal benefit equals the marginal cost. More specifically, when the cost of each
additional unit of labor is w, the manager should continue to employ labor up to the point where
in the range of the diminishing marginal product. E.g. it is profitable to hire additional units of
labor as long as his/her contribution (value marginal product) is greater than his/her hiring costs.
Technology summarizes the feasible means of converting raw inputs into an output. Most
production processes involve capital (machinery) and labor (people).
Increasing marginal returns – Range of input usage over which marginal product increases.
E.g. in the first hours you study for an exam you can concentrate very well and you increase your
knowledge rapidly.
Decreasing (diminishing) marginal returns – Range of input usage over which marginal
product declines. E.g. the longer you study the less you remember but still you gain more
knowledge. You increase total knowledge, but at a decreasing rate. Marginal product declines
but it is still positive.
Negative marginal returns – Range of input usage over which marginal product is negative.
E.g. if you study too long you get tired and too much information is in your head in too little
time. You get confused and reduce the total knowledge.
Phases of Marginal Returns – When there is an increase in the use of input, Marginal product
changes from increasing to decreasing and further to negative.
The manager’s role in the production process:
1. Produce on the production function
It describes the maximum possible output that can be produced with given inputs. In case of
labor, the manager has to think of an incentive system to ensure that employees are working at
full potential.
2. Use the Right level of inputs
The manager has to determine how many units of input are needed to maximize total output.
When a manager decides on how many employees that his/her firm needs to employ, he/she has
to consider marginal returns. The value marginal product describes the value of the output
produced by the last unit of an input.
Profit-Maximizing Input Usage – To maximize profits, a manager should use inputs at levels at
which the marginal benefit equals the marginal cost. More specifically, when the cost of each
additional unit of labor is w, the manager should continue to employ labor up to the point where
in the range of the diminishing marginal product. E.g. it is profitable to hire additional units of
labor as long as his/her contribution (value marginal product) is greater than his/her hiring costs.
