1.

THE PRODUCTION FUNCTION

The production function shows the existing relationship between the obtained product and the
combination of factors that are used in its obtaining, that is to say, it is the mathematical expression
that relates the amounts of factors used with the quantity of product obtained according to
a specific technique. It is given by the expression:
Q f(T,L,K,E) where:
Q = Maximum quantity of product obtained
Earth
K = Capital
E = Business Initiative

It can be clearly understood through an example: let’s suppose that a farmer is dedicated
to the cultivation of wheat. It uses the land it has, the seeds, the fertilizers, the fertilizers,
the workers, the tractors, the harvesting machines, etc. The production function indicates
to the farmer what is the level of production (amount of wheat) that he will achieve through the
combination of all the productive factors available at that moment. The
temporal dimension is of vital importance here, as the production function makes
reference to a moment in time when technology is given, since if it occurs
a technological change (which can be a change in the way resources are combined
productive until a technical advance) the production function will vary.

Therefore, when studying the company as a unit producing goods and services
we must take into account the period of time considered by this to adopt its
decisions. In this sense, considering its temporal dimension, we can differentiate two
production perspectives:
Short-term productionIt is the one that occurs over a period of time during the
which can only vary the amount of certain factors.
Long-term productionIt is obtained in a period of time during the
all production factors can vary.

A. THE SHORT-TERM PRODUCTION

To analyze short-term production, let's use an example. Let's suppose that a

A group of friends decides to start a bakery. The necessary productive factors for the
cake production is the work (number of workers to hire), the capital (a premises,
ovens, utensils for making cakes, furniture, and raw materials) and entrepreneurial initiative
necessary to carry out the project.

To simplify the analysis, we will assume that only two productive factors are used: capital and
work. Specifically, the friends have rented a commercial space of 200m2 and two ovens

which will constitute the capital factor, in the short term fixed or invariable. On the other hand, the variable factor
it will be the labor force, that is, the number of workers or hours of work to be hired. If
If we want to increase cake production, we will need to increase the amount of factors.
variable (the work).

Thus, the short-term production function is given by the expression:

Q f(L,K) where:
output level (cakes) to produce
L = work or variable factor in the short term
K = capital or fixed factor in the short term
The weekly production that the bakery would reach as the variable factor increases,
that is, as workers are incorporated, it is graphically represented as follows: they are positioned
the values collected in the table, placing the dependent variable on the vertical axis
(total cake production) and on the x-axis the independent variable (number of workers).

Number of workers Total product

(Constant capital) Cakes
0 0 Short-term production function
1 100
1600
2 300
1400
3 540 1200
4 800 1000
5 1050 800
600
6 1260 400
7 1400 200
8 1400
0 1 2 3 4 5 6 7 8 9
9 1350
Number of workers

This graph shows that when there are no workers, production is zero and that, as it
by incorporating work units, the production of cakes increases until
a point where it not only does not increase, but even decreases.

This phenomenon is due to theLaw of decreasing returnswhich affirms that if it increases

the amount of one of the production factors (labor), but the rest remains the same
constant (the capital), total production will increase at an increasingly slower pace until it stops.
to decrease, even being able to diminish.

Explanation of the law: in our example, the physical capital (the premises and the two ovens) has a
limited usability and although when incorporating the first workers the increases of
production is important because tasks can be shared among them (kneading,
bake, attend to the public, etc.) and specialize, starting from a certain number of
workers the possibilities of dividing the work among themselves will be smaller, which will cause
the emergence of downtime and even that some workers hinder others,
leading to a decline in performance and, possibly, production
total.

This law is only enforced in the short term, as there are fixed factors and the technology is given.
It wouldn't be like this if we had the possibility of increasing the productive factors that we have.
considered fixed (increase the number of ovens and/or rent another place) or improve the technology,
What happens in the long term.

B. LONG-TERM PRODUCTION

In terms of production, the long term is considered the period of time in which the company
It can vary all the factors it uses, so no factor is fixed. In the example
From the bakery, in the long term there would be no fixed factors: we could rent a larger place.
and other establishments, use ovens with greater capacity or a larger number, resort to ways
alternatives for organizing production and even introducing technological improvements.

Ultimately, in the long term, the range of options available to any company to...
Carrying out the production process is much greater, as all factors can vary.
In this way, if we wanted to continue progressively increasing the production of the
pastry shop or any company, we would have to do it by increasing both the work and
the capital and that, as we have seen, we could only do it in the long term, for which
we would have to vary the scale at which we use the productive factors.

If we vary all the factors used in the same proportion, we will obtain an amount of
product referred to as economies of scale. Therefore, thereturns to scale
they measure the variation of the total product when all the inputs are proportionally increased
factors. Hence, we can find:
Increasing returns to scale or economies of scaleWhen varying the
amount used of all factors in a certain proportion, the amount
obtained from the product varies in a greater proportion.
Constant returns to scaleWhen the amount used of all the factors
and the amount of product obtained varies in the same proportion.
Decreasing returns to scale or diseconomies of scale. When varying the
amount used of all factors in a given proportion, the amount
obtained from the product varies in a lesser proportion.

To illustrate these concepts, we will once again use the example of the bakery. We start from a
initial situation in which a production was achieved with two furnaces and four workers
of 800 cakes. Let's assume now that the bakery increases its productive factors in
100%, in such a way that it has 4 ovens and 8 workers. Therefore, depending on the
the level of production that we reach in this new situation, we will be able to determine if the bakery
presents constant, increasing or decreasing returns to scale:

Work Production
Capital Yields of
Situation (units cakes
(physical units) scale
physics)
Initial 2 4 800 -
A 4 8 1600 Constants
New B 4 8 1200 Decreasing
C 4 8 2000 Growing

2. THE ECONOMIC CALCULATIONS OF COMPANIES

A. THE INCOME

The revenues of a company are the money it receives from the sale of its
products. Thetotal incomethey are obtained by multiplying the price of the
products by the number of units produced and sold of the same.

It is also possible to calculate what is known as average income and income IT

Me
[Link] incomethe result of dividing the total income Q
between the number of units produced.

Themarginal incomeit is the increase in total revenue when sold IT

one more unit of product. As this unit is sold at the price of IMg
market, for a company in free competition, the marginal income is equal
to the price.
[Link] PRODUCTION COSTS
The production costs of a company can be defined as the monetary value of the
quantities consumed of productive factors. We differentiate several types:
Total cost (TC).It is the monetary value of all the factors used to produce a
good or a service. In the short term, just as we have seen in production (in which
some factors remained fixed and others varied), there are fixed costs and variable costs,
whereas in the long term all costs, just like the factors, are variable.
- Fixed costs (FC).They are those that do not depend on the volume of production, they
incurs in them even if the company produces nothing. Applied to the example of the
Pastry shop, it would be the rent of the premises and the ovens and the fixed fee for supplies:
light, phone, gas, etc.
- Variable costs (VC).They are those that depend on the volume of production of the
company, that is, these costs do not appear if there is no production. For example:
raw materials, labor, etc.

Unit variable cost

Q = Production

Average or unit cost (CMe).Represents the cost of each unit CT

CMe
produced.

Marginal cost (MC)Donkey cost increment that originates as CMg

result of producing an additional unit. CT

Graphic representation:

Fixed costs are graphically represented by a straight line starting from the
the y-axis based on the amount of these costs runs parallel to the x-axis, which
it indicates that they will always be the same, regardless of the amount produced.

Variable costs start from the origin of coordinates, since if there is no production, the costs
variables do not exist. As production increases, it also increases
the amount of them.

Finally, the total costs are based on

from the y-axis at the height of the
costs fixed passing
parallel to variable costs,
since the slope of both curves
it is the same, given that the costs
totals are nothing more than the costs
variables plus fixed costs, which is
a constant amount.
C. THE BENEFIT

ThebenefitIt is obtained as the difference between income and total costs.

Bº IT CT

As we have seen with the previous concepts, we can calculate theaverage benefit
the marginal benefit.
Bº Bº
BMe BMg IMg CMg

[Link] illustrate the concepts we have just analyzed, we will make use of again
from the example of the bakery. Our entrepreneur friends have these related data
to the daily cost structure of the pastry shop: fixed costs (rent of the premises and ovens,
fixed supply fees, etc.) amount to €60 and variable costs (raw materials,
labor, consumption of supplies, etc.) shows the following evolution regarding the
cake production measured in kilograms:

Production 1 2 3 4 5 6 7 8 9 10 11
(Kg.)
Variable cost 20 35 48 60 70 78 87 100 120 150 193

On the other hand, the selling price of each kilogram of pastries is 30 €.

Q
CFCV CT CMe CMg IT IMe IMg Bº BMe BMg
(Kg.)
0 60 0 60 - - 0 - - -60 - -
1 60 20 80 80 20 30 30 30 -50 -50 10
2 60 35 95 47.5 15 60 30 30 -35-17'5 15
3 60 48 108 36 13 90 30 30 -18 -6 17
4 60 60 120 30 12 120 30 30 0 0 18
5 60 70 130 26 10 150 30 30 20 4 20
6 60 78 138 23 8 180 30 30 42 7 22
7 60 87 147 21 9 210 30 30 63 9 21
8 60 100 160 20 13 240 30 30 80 10 17
9 60 120 180 20 20 270 30 30 90 10 10
10 60 150 210 21 30 300 30 30 90 9 0
11 60 193 253 23 43 330 30 30 77 7 -7

D. THE BREAK-EVEN POINT

From the table, we can draw very interesting conclusions about the functioning.
from the bakery. Thus, if less than a certain amount of cakes are sold daily, the company
will incur losses. In this regard, it is of particular interest to any entity
business to know its so-called break-even point, which is the amount
the product that a company has to produce and sell to obtain zero profit, that is,
the level of income necessary to cover all of their costs, both fixed and variable. In
In our example, the break-even point of the bakery is set at 4 Kg., since for that level
from production and sale, the profit is zero. Therefore, if the entrepreneurial friends want
to know on a specific day if they have obtained profits or losses, this variable is highly
clarifying, since if they do not reach sales of 4 kg. of cakes, they will know that they have incurred
in losses and if, on the contrary, they exceed this threshold, they will have obtained profits.
 Analytical determination of the point
Break-even point or profitability threshold of the company
dead
350 In the deadlock 0, for the
300 queIT CT
250
CT
200
Losses IT P Q
150
Benefits CT CF CV
100
50 Resume CVu Q
0
0 1 2 3 4 5 6 7 8 9 10 11 Therefore:
Production (Q)

IT CT P Q CF CVu Q

Factoring out Q leaves us with: Q(P CVu) CF from where it is obtained that:

What is the expression of the break-even point or threshold of profitability.

In this way:
If Q > Q* The company makes profits

If Q < Q* The company incurs losses

E. When does the company maximize its profits?

The company maximizes its profits when Marginal Revenue equals Marginal [Link]
this situation, the company
the income from the sale of the last unit is identical to its cost. If IMg > CMg for the company
he would be interested in increasing production, since for each new unit sold he will earn more than
what it costs to obtain it, as they will increase their profits.

On the contrary, if IMg < CMg, the company will choose to reduce production, since for each
a new unit that sells will generate an amount lower than its acquisition cost, so
benefits will be reduced.

In our example, the company will maximize profits when it produces and sells 10 Kg.
cakes, obtaining a profit of 90 €.