For example, given the lower gasoline prices, the company can now serve a greater area and increase its supply.Ĭonversely, if a firm faces higher costs of production, then it will earn lower profits at any given selling price for its products. Since lower costs correspond to higher profits, the messenger company may now supply more of its services at any given price. If the price of gasoline falls, then the company will find it can deliver messages more cheaply than before. The company may find that buying gasoline is one of its main costs. Take, for example, a messenger company that delivers packages around a city. This can be shown by the supply curve shifting to the right.
So, when costs of production fall, a firm will tend to supply a larger quantity at any given price for its output. When a firm’s profits increase, it is more motivated to produce output, since the more it produces the more profit it will earn. If a firm faces lower costs of production while the prices for the good or service the firm produces remain unchanged, a firm’s profits go up. Goods and services are produced using combinations of labor, materials, and machinery, or what we call inputs or factors of production. In thinking about the factors that affect supply, remember what motivates firms: profits, which are the difference between revenues and costs. Just as a shift in demand is represented by a change in the quantity demanded at every price, a shift in supply means a change in the quantity supplied at every price. If other factors relevant to supply do change, then the entire supply curve will shift. The stages of production analyze the increasing returns, diminishing returns, and the negative returns, to calculate the best use of resources and inputs to produce at an optimal level.Ī supply curve shows how quantity supplied will change as the price rises and falls, assuming ceteris paribus so that no other economically relevant factors are changing. In order to determine the optimal input used in production, the changes in marginal product are examined in the various stages of production. Marginal product is the extra output or change in the total product caused by the addition of one more unit of variable input, in this case, the number of workers. Once the output has been calculated the measure is known as "marginal product".
4 factors of production law how to#
If the cost is high, the factory will need to consider how to produce the highest output amount in Stage 2 for the least amount of money. If the cost is low, then more workers can be hired. The exact number of workers needed by a company can only be ascertained when the cost of adding each new worker is calculated. By Stage 3 the marginal output becomes negative and the total factory output decreases. Too many workers get in each other's way and do not produce as much as in Stage 1 or even Stage 2. The total production is slowing down so this stage is no longer producing increasing returns, but now it is diminishing returns.Īt Stage 3 the company has hired too many workers and now the output is considered producing in negative returns. Soon additional workers hired may be needed to do things other than produce, like stock shelves or answer phones. By Stage 2 production output continues to rise, but at small and smaller increments. Unfortunately, a company cannot continue in Stage 1 because as soon as it is discovered that adding additional workers increases output, the company continues to hire additional employees. As long as each new worker contributes to the total output than the worker before, total output rises faster and faster.
Until the company hires enough workers to run all of the machinery, this stage results in increasing returns.
Stage 1 begins when the first worker is hired, but there are not enough workers to produce efficiently enough to create a positive return. Generally, there are three stages of production. In this scenario, the company can calculate the total product, or total output, that the firm will produce. The basic model used by economists is the hypothetical production schedule to determine output when the number of workers changes. This concept helps a producer determine the best use of resources to effect output. The Law of Variable Proportion can be best illustrated by using the "production function" for the concept that describes the relationship between changes in output to different amounts of a single input while all other inputs are held constant.
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