CHAPTER 5 : THEORY OF PRODUCTION

1. CLASSIFICATION OF FACTORS OF
PRODUCTION FROM CONVENTIONAL AND
ISLAMIC PERSPECTIVE
Definition of production theory
Production
- Can be defined as a process of transforming
the inputs to output
- @ Referring to the process of using the
services of labor and equipment together with
natural resources and materials to make goods
and services
Inut
- Refer to the productive services of labor,
capital, natural resources and entrepreneur
Outut
- Refer to goods and services
F!ctor o" roduction
- Refer to the resources that can be used to
produce goods or services such as land,
minerals, forest, human resources both mental
and physical; and production aids such as
machinery, tools, warehouse and buildings

!actor of production from the conventional

perspective
- "nder conventional perspective, an economy resources
comprise of natural endowments called factor of
production as follow#
F!ctor o"
PRODUCTION
D#"inition
LAND
Refer to all natural resources
or gifts of nature that is
usable in the production
process, i$e$ land, forest,
minerals, oil, gold, water
resources etc$
LA$OR
Refer to all the physical and
mental talents of men and
women which are available
and usable in producing
goods and services, i$e$
doctor, lecturer, nurse, clerk
etc$
CAPITAL
Refer to the production aids
such as machinery,
equipment and factory
which are usable in
producing goods and
services
ENTERPRENUER
Refer to the human ability
and talent for people who
are initiative, innovative,
risk bearer and busindss
policy decision to seek
profits by combining
resources to produce
products
%
!actor of production from the &slamic perspective
- "nder &slamic perspective there are % source for the 'uslim
to attain vealth that(s owning and earning
- )arning is said to satis*y the need through physical labor
individually or in con+ulction with the other factors of
earning, so the factor of earning are as follo,#
F!cdor% o" EARNIN& D#"inition
LAND
Refer to wherever 'an can
work on this globe such as the
seas, valleys, water sources, etc
LA$OR
'eans to e-tract most of the
goods of earth$ & t also refers to
getting wealth through ways
such as employment and trade$
.he prerequisites are mental
sanity and physical health
CAPITAL
Refers to the continuation of
work for obtaining wealth$ &t is
money or wealth saved for
spending later in ways that
would accrue profits
ENTERPRENUER
/ man who make the decision
and has ability and capability
to produce with &slamic value
0
'. PRODUCTION FUNCTION ( SHORT RUN ) LON&
RUN
1roduction function
- Refer to the relationship between input and the ma-imum
attainable output that a firm can produce and various
quantities of output
- &t also refers to the relationship between the inputs 2factor of
production3 and outputs 2good and services3
- Can be written as
* + " ,-. L. M. E/
4here 5 6 amount of output depends on the quantity of
inputs
76 Capital
8 6 8abor
' 6 land and raw materials
) 6 )ntrepreneur
- the production function e-plains that the number of output
253 depends on the quantity of inputs where the larger the
number of input, the larger the number of outputs will be
- here we assume that the level of technology is fi-ed and
quality of input is identical9homogenous 2to ensure that differ
only quantity not quality3
1roduction period
- can be divided into % periods#
i$ short-run
:
ii$ long-run
SHORT0RUN
- Refer to the time period over which there at
least only one fi-ed input in the production
- !i-ed input, is an input that the quantity
cannot change during the period of time under
consideration
- &n the short-run, the firm cannot increase its
level of production by altering his fi-ed
factors such as factory or machinery e-cept on
his variable factors such as labor and raw
materials
LON&0RUN
- can be defined as the time period over which
all factors are variable
- variable input, is any resources for which the
quantity can change during the period of time
under consideration
- in the long-run there is no fi-ed factor and
technology is assumed to be constant
;hort-run production function# 2.1, '1 * /13
&n the short-run production, there is at least one factor, which is
fi-ed while the other factors are variable
we assume that only % factors of production are used in a
production process 2labor * capital3
8abor 283 is assumed to be the variable input where as capital
273 is kept fi-ed in amount as follow#
<
=
*+ " ,L. -/
TOTAL PRODUCT OF A VARIABLE INPUT (TP)

.he amount of output produced when a given amount of that
input is used along with a fi-ed input
AVERAGE PRODUCT OF A VARIABLE INPUT (AP)
.he average amount produced by each unit of a variable input,
formula#
MARGINAL PRODUCT (MP)
Can be defined as the change in total output produced by adding
one unit of a variable input, with all other inputs used being held
constant
/lso called the relationship between changes in total output and
changes in labor, formula#
THE LAW OF DIMINISHING MARGINAL
RETURN(LDMR)
>??? Applicable in the short-run where there must be at
least one fixed factor ???@
A
AVERA&E PRODUCT + TOTAL PRODUCT
TOTAL LA$OR
+ TCUDORP LANI&RAM TCUDORP LATOT E&NAHC
RO$AL LATOT E&NAHC
T1# LDMR %t!t#% t1!t !"t#r ! c#rt!in oint. 21#n t1#
!ddition!3 unit% o" ! 4!ri!53# inut !r# !dd#d to "i6#d
inut%. t1# 7!r8in!3 roduct o" t1# 4!ri!53# inut
d#c3in#%
sometimes called the law of variable proportions because it
shows how output varies when the proportion of a variable
inputs used in production varies
D&'&B&;C&BD R)."RB; determined the shaped of the
marginal product curve
1E&B. E! D&'&B&;C&BD R)."RB; is the level of use
of a variable input at which its '1 begins to decline
the '1 of the variable input will therefore become smaller
and smaller till approaches Fero as more of the variable
input is employed in the short run
e-ample#
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.1

,
/1
'1 units of variable factor
28/IER3
;./D) 2increasing returns to a factor3
- ;tage begins from point K to the point of
intersection of '1 and /1 curves$ Bote that at this
stage, there is a sharp increase of .1 as we increase
the units of labor employed$
- .his also means that each additional increase in labor
units will result in greater increases of the .1$ /
rational producer will continue to produce goods at
this stage as .1 increases by increasing more labor
;./D) % 2decreasing returns to a factor3
- .his stage begins from the intersection point of '1
and /1 curves 2end of stage 3 until '1 curve
touches the horiFontal or G-a-is$
- /t this stage, the values of /1 and '1 are
decreasing$ Bote that the /1 curve is always higher
than the '1 curve, and when the '1 curve touches
the horiFontal G-a-is, the .1 reaches its ma-imum
point$
- .his the most efficient stage of production because
the combinations of variable and fi-ed input are used
efficiently$
- / rational producer will want to produce at this stage
of production as the .1 has already achieved its
ma-imum point$ Cowever, if he continues to produce
beyond this stage, the .1 will start to decline$
;./D) 0 2negative returns to a factor3
- .his stage begins when '1 equals to Fero and
continues to decline thereafter$
J
- / rational producer should not be producing at this
stage of production because an increase in labor
leads to a decline in the total product$
RELATIONSHIP BETWEEN TP AND MP
Iased on the graph of 8D'R
4hen '1 is increasing .1 will increase at a increasing
rate
4hen '1 is decreasing .1 will increase at a decreasing
rate
4hen '1 is zero .1 at a maximum
4hen '1 is negative .1 declines
RELATIONSHIP BETWEEN 'P AND /P
Iased on the graph of 8D'R
4hen '1 exceeds /1, /1 is increasing
4hen '1 less than /1, /1 is decreasing
4hen '1 equals to /1, /1 is maximum
8ong run production function
&n the long run production, all factors of production are assumed
to be variable, so the production function in the long run period
will then be#
* + " ,L!nd. L!5or. C!it!3. Entr#r#n#ur/
Change in the scale operation is referring to the change in the
level of operation that occurs when an organiFation use all of its
input is varied in the same proportion
L
.here are 0 possibilities of return to scale
i$ &ncreasing return to scale
ii$ Constant returns to scale
iii$ Decreasing returns to scale
INCREASING RETURNS TO SCALE
Refer to increase in output by a proportion that e-ceeds the
portion by which all the inputs increases
i$e$ an increase of <KM of input will bring about an increase of
more than <KM in the amount of output
Dou53in8 !33 inut% 9 dou53in8 outut%
'achinery
8abor
CONSTANT RETURNS TO SCALE
Refer to increase in output by the same portion by which all the
inputs increase
i$e$ an increase in the amount of input by <KM will lead to
increase in output by <KM also
Doubling all input 6 doubling all output
'achinery
K
8abor
DECREASING RETURNS TO SCALE
Refer to output increases by a proportion that less than the
portion by which all the inputs increase
i$e$ an increase of <KM in the amount of input will lead to
increase in the 0KM in the amount of output
Dou53in8 !33 inut : dou53in8 outut
'achinery
8abor