The act of production involves the transformation of inputs into outputs. The word production in economics is not merely confined to effecting physical transformation in the matter, “It also covers the rendering of services such as transporting, financing, wholesaling and retailing. Laws of production, or in other words, the generalizations regarding relations between inputs and outputs developed in the chapter will apply to all these types of production.
The relation between inputs and output of a firm has been called the ‘Production Function’. Thus the theory of production is the study of the production function. The production function of a firm can be studied by holding the quantities of some factors fixed, while varying the amount of other factors. This is done when the law of variable proportions is derived. The production function of a firm can also be studied by varying the amounts of all factors. The behaviour of production when all factors are varied is the subject matter of the laws of returns to scale. Thus, in the theory of production, the study of (a) the law of variable proportions and (b) the laws of returns to scale is included.
IMPORTANCE OF THE THEORY OF PRODUCTION
The theory of production plays a double role in the price theory. Firstly, it provides a basis for the analysis of relation between costs and amount of output. Costs govern supply of a product which, together with demand, determines the price of a product. The prices of inputs or factors of production influence the costs of production and hence play a part in determining the prices of products. Secondly, the theory of production provides a basis for theory of firm’s demand for factors (inputs) of production. Demand for factors of production or inputs, together with the supply of them, determines their prices.
The theory of production is relevant to the macro-theory of distribution. The aggregate distributive shares of the various factors, for instance, aggregative shares of wages and profits in national income, depend upon the elasticity of substitution between factors which is an important concept of the theory of production. In fact, in the neo-classical macro-theory of -distribution, elasticity of substitution is the crucial factor which determines the aggregative shares of the various factors.
Before we take up the explanation of the theory of production in detail, we shall first explain the concept of ‘Equal-Product Curve’ which is the tool of analysis in the theory of production.
