UNIT 2: BASIC PRODUCTION ECONOMICS

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UNIT 2 BASIC PRODUCTION ECONOMICS

• Theme 5 Production function analysis
• Output/output relationships

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Output/Output relationships What to produce

• The question to ponder on how to use inputs
  between different options of output.
• One can use all the inputs to produce one output
  or can use them to produce more than one output.
• This gives you the production possibility curve

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Joint products
Y2
0
Y1
A fixed amount of Y2 will follow on the
production of Y1 at a certain input level (Beef
and hides)
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Supplementary products
Y2
Supplementary areas
0
Y1
If Y1 changes without changes in Y2 (Goats and
cattle grazing habits different)
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Complimentary products
Y2
Complementary area

0
Y1
Production of one is to the advantage of the
other one (Goats and cattle goats prevent bush
encroachment, more grass for cattle)
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Antagonistic products
Y2
0
Y1
Production of Y1 uses inputs of Y2 and also leads
to a decrease in the production of Y2 (Animals
carrying diseases which kill other animals)
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Competing products (NB)
Y2
Y1
0
Increase in production of Y1 lead to a decrease
in production of Y2 Decision rule Profit is
maximized where the physical substitution rate
between two products is equal to the inverse of
the price relationship of the product
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• Max profit combination
• ?Y2 PY1
• ?Y1 PY2

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Graphically
Product Y2
Iso-product curve
A
Production possibility curve
0
Product Y1
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The choice of the optimum profit combination of
products with fixed number of available inputs
Wheat price R0.42/kg Maize price R0.24/kg
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Conclusion

• The maximum profit combination for a number of
  products if inputs are limited
• ?Y1PY1 ?Y2PY2.?Yn.Pn

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Economies of scale

• Economies of scale is concerned with determining
  the most profitable size of a business
• Return to scale parameter
• Percentage change in cost (R)
• Percentage change in production value (R)

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Three general rations

• Decreasing cost or increasing returns-to-scale
  (rationlt1)
• Constant cost or constant returns-to-scale
  (ratio1)
• Increasing cost or decreasing return-to-scale
  (ratiogt1)

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Graphical illustration
Decreasing cost
Constant cost
Increasing cost
Cost (R)
Economies of scale
Diseconomies of scale
Long-term ATC
A
B
0
Size of business
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Note

• When the cost decreases, the average cost per
  unit of output will decrease, so that the
  average profit per unit of output increases
• Economies of scale occurs in an area where
  characterised by decreasing cost or increasing
  returns to scale
• As the size of the business increases in size,
  the long-term ATV reaches a minimum, where it
  temporarily stabilises