Economics of Production

Production economics considers the aspects of macroeconomics that relate to firm outputs and, fundamentally, the optimisation of production.

An important representation of this production is found in the Production Possibility Frontier diagram. This shows the different possible combinations of goods that the firm can produce given limited capacity and two productions options. Maximum efficiency is found along the curve, with production at any point within the curve (downward left, in graphical terms) being under-utilisation of capacity. The larger aim is to expand the production frontier to allow greater combinations which result in higher overall production and an increase in firm revenue. 

Another key area of production economics is related to analysis of the cost function and the maximisation of profit. We can analyse this by producing the equations that determine cost and revenue. From this we can determine average, total and marginal values.
The curves resulting from these functions will be affected by factors such as economies of scale and diminishing returns and thus the functions  result in curves which will intersect at points. These intersections show important points for the firms to consider.
The profit maximising point can subsequently be found by identifying where marginal cost is equal to marginal revenue - i.e. where they intersect. This represents the point where further production will simply lead to losses, as cost would exceed the profit generated.

Distinction must be made between the short run situation and the long run situation. The long run must account for changes in capacity and productivity efficiency arising from effects such as improved technology and expansion of facilities. As such, multiple short run average cost curves can be mapped to an overall long run average cost curve. The typical scenario is that the long run curve is u shaped, becoming more efficient and then eventually less efficient again. This reflects the difficulty that comes with higher production as matters such as supply chain become more complex.

Within the chapter, further matters are detailed, including the relevance of opportunity cost and elasticity of demand. Examples are also given to illustrate the cost and revenue functions within an organisational setting. Air carrier Ryanair is one such example.

Understanding this topic can give a firm a new perspective on their overall management and planning, meanwhile observers can gain an understanding of firm motivations and growth patterns. Hence, there is clear value in understanding these fundamental firm-level matters to be able to understand wider macroeconomic systems and phenomena.


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