1.4 PRODUCTION, COSTS AND REVENUE
What is production?
Production is the process by which various inputs are transformed into outputs
The inputs are the factors of production
The outputs are economic goods, i.e. products and services
The process of production is carried out by firms
What is productivity?
Productivity is measured by the output per unit of input
Productivity can be measured from a microeconomic level (industrial, firm, industry)
to a macroeconomic level (country)
Labour productivity- output per worker
Capital productivity- output per unit of capital
Firm- a productive organisation which sells its output of goods and/ or services
commercially
Productivity indicates the level of efficiency of production
Measuring output (numerator)
Output is measured either by the
quantity produced or by the value
of the output
Measuring inputs (denominator)
For labour, the input factor is
usually the number of workers or the number of worker time periods e.g. the
number of workers multiplied with the number of hours worked in a week or day
Importance of labour productivity
Labour productivity is important because it can have significant implications for
firms
Workers must be paid so a firm with low labour productivity will have to employ
fewer workers (at a greater cost) than a competitor with high labour productivity
Firms may also compare labour and capital productivity when considering which
would be more effective and productive (humans or machines)
, If the costs (per unit of output) can be reduced, a firm will be able to lower its prices
without reducing its profit on each unit of output and this may lead to higher sales
(demand), making the firm more competitive.
This can lead to higher revenue
Improving labour productivity
To improve labour productivity, a firm will
o Increase output i.e. the number of units produced by each worker
(numerator)
It seems intuitive that one way to increase a workers output is by
paying them more. After all higher wages tend to motivate people
However increasing wages will increase the input costs which will
reduce profits
Consequently, firms will seek ways to increase output without adding
to wage and other labour costs
o Reduce the input i.e. the number of workers (denominator)
Is the total output remains constant, then reducing the number of
workers (denominator) will increase productivity
While increasing labour and capital productivity may help to reduce costs and
increase productivity, it is worth considering that quality is an important factor in
output and in marketing, selling products and services
By implication, higher quality products will require a higher level of skilled labour
and specialised machines
Capital productivity
Capital productivity is difficult to measure, particularly across different industries,
producing different products with different types of capital goods
The level of labour and capital will vary depending on the type of industry in which
the firm operates
Industries which are capital intensive use a higher proportion of capital than labour
o E.g. oil refining
o Car manufacture
Industries which are labour intensive use a higher proportion of labour than capital
o E.g. farming
o Food production
1.4.2 Specialisation, division of labour and exchange
Specialisation
Where a worker performs one task (or a limited range and number of tasks)
This can also apply to a firm specialising in production of one or limited range of
related goods (products and services
This can apply to whole countries who specialise in a particular area of expertise e.g.
, o Switzerland- pharmaceuticals
o Guatemala- coffee
Advantages of specialisation
Main benefit of workers specialising is that it substantially increases the efficiency,
speed and quantity of output
Workers do not need to switch between tasks, saving time
Each worker becomes an expert and increasingly more skilled at their job
Specific and specialised machinery (capital) can be produced (capital WIDENING)
Trade and growth- more will be exported as they decide to specialise in something,
economy will grow which leads to living standards to improve
Reduces the problem of scarcity- specific products can be imported
It could also have the opposite effect
Workers may become bored of their role as they do the same job every day
When a worker wishes to leave the firm must find someone who can match the
exact skillset the worker who is leaving has
Division of labour
Where a number of specialised workers will perform tasks as part of the production process
Capital widening- where labour uses more of the same type of machinery or tools
Capital deepening- where labour uses new and different technology and/or more efficient
capital, also known as capital intensity
Trade- the buying and selling of goods and/or services
Exchange- to give something in return for something else received. Money is a medium of
exchange
Barter
In theory, individuals (and firms and communities) could specialise and exchange the
surplus of their production with the surplus of another individual’s output.
This is barter.
However, a major drawback of barter is that it requires a double coincidence of
wants, e.g. the farmer exchanges the amount of corn wanted by the fisherman
when the fisherman exchanges the amount of fish wanted by the farmer
Money
As an alternative to barter, individuals, firms communities and countries use money
to exchange goods and services
Money can be notes and coins but it can also be any item that:
o Provides a common means of exchange
o Is a store of value
Law of diminishing returns and returns to scale
What is production?
Production is the process by which various inputs are transformed into outputs
The inputs are the factors of production
The outputs are economic goods, i.e. products and services
The process of production is carried out by firms
What is productivity?
Productivity is measured by the output per unit of input
Productivity can be measured from a microeconomic level (industrial, firm, industry)
to a macroeconomic level (country)
Labour productivity- output per worker
Capital productivity- output per unit of capital
Firm- a productive organisation which sells its output of goods and/ or services
commercially
Productivity indicates the level of efficiency of production
Measuring output (numerator)
Output is measured either by the
quantity produced or by the value
of the output
Measuring inputs (denominator)
For labour, the input factor is
usually the number of workers or the number of worker time periods e.g. the
number of workers multiplied with the number of hours worked in a week or day
Importance of labour productivity
Labour productivity is important because it can have significant implications for
firms
Workers must be paid so a firm with low labour productivity will have to employ
fewer workers (at a greater cost) than a competitor with high labour productivity
Firms may also compare labour and capital productivity when considering which
would be more effective and productive (humans or machines)
, If the costs (per unit of output) can be reduced, a firm will be able to lower its prices
without reducing its profit on each unit of output and this may lead to higher sales
(demand), making the firm more competitive.
This can lead to higher revenue
Improving labour productivity
To improve labour productivity, a firm will
o Increase output i.e. the number of units produced by each worker
(numerator)
It seems intuitive that one way to increase a workers output is by
paying them more. After all higher wages tend to motivate people
However increasing wages will increase the input costs which will
reduce profits
Consequently, firms will seek ways to increase output without adding
to wage and other labour costs
o Reduce the input i.e. the number of workers (denominator)
Is the total output remains constant, then reducing the number of
workers (denominator) will increase productivity
While increasing labour and capital productivity may help to reduce costs and
increase productivity, it is worth considering that quality is an important factor in
output and in marketing, selling products and services
By implication, higher quality products will require a higher level of skilled labour
and specialised machines
Capital productivity
Capital productivity is difficult to measure, particularly across different industries,
producing different products with different types of capital goods
The level of labour and capital will vary depending on the type of industry in which
the firm operates
Industries which are capital intensive use a higher proportion of capital than labour
o E.g. oil refining
o Car manufacture
Industries which are labour intensive use a higher proportion of labour than capital
o E.g. farming
o Food production
1.4.2 Specialisation, division of labour and exchange
Specialisation
Where a worker performs one task (or a limited range and number of tasks)
This can also apply to a firm specialising in production of one or limited range of
related goods (products and services
This can apply to whole countries who specialise in a particular area of expertise e.g.
, o Switzerland- pharmaceuticals
o Guatemala- coffee
Advantages of specialisation
Main benefit of workers specialising is that it substantially increases the efficiency,
speed and quantity of output
Workers do not need to switch between tasks, saving time
Each worker becomes an expert and increasingly more skilled at their job
Specific and specialised machinery (capital) can be produced (capital WIDENING)
Trade and growth- more will be exported as they decide to specialise in something,
economy will grow which leads to living standards to improve
Reduces the problem of scarcity- specific products can be imported
It could also have the opposite effect
Workers may become bored of their role as they do the same job every day
When a worker wishes to leave the firm must find someone who can match the
exact skillset the worker who is leaving has
Division of labour
Where a number of specialised workers will perform tasks as part of the production process
Capital widening- where labour uses more of the same type of machinery or tools
Capital deepening- where labour uses new and different technology and/or more efficient
capital, also known as capital intensity
Trade- the buying and selling of goods and/or services
Exchange- to give something in return for something else received. Money is a medium of
exchange
Barter
In theory, individuals (and firms and communities) could specialise and exchange the
surplus of their production with the surplus of another individual’s output.
This is barter.
However, a major drawback of barter is that it requires a double coincidence of
wants, e.g. the farmer exchanges the amount of corn wanted by the fisherman
when the fisherman exchanges the amount of fish wanted by the farmer
Money
As an alternative to barter, individuals, firms communities and countries use money
to exchange goods and services
Money can be notes and coins but it can also be any item that:
o Provides a common means of exchange
o Is a store of value
Law of diminishing returns and returns to scale
