Theory of Production

Production refers to the various economic activities involved in creating goods and services and making them available to final consumers for the satisfaction of human wants. All goods and services produced must possess utility, meaning they must be capable of satisfying human needs.

Production is regarded as complete only when the goods and services produced reach the final users or consumers.

Types of Production

Production can be classified into two major categories:

Direct Production

Direct production is a type of production in which an individual produces goods and services solely for personal or family consumption. The goods produced are usually small in quantity and are not meant for sale.

Indirect Production

Indirect production involves the large-scale production of goods and services mainly for sale or exchange. It requires the use of modern equipment and skilled labour.

Indirect production is further divided into three main categories:

  1. Primary Production
  2. Secondary Production
  3. Tertiary Production

Primary Production

Primary production involves the extraction of raw materials directly from nature. It focuses on obtaining natural resources from land, water, and air. Examples include agriculture, mining, fishing, lumbering, and hunting.

Secondary Production

Secondary production involves the processing and transformation of raw materials obtained from primary production into finished or semi-finished goods that are acceptable to consumers. It includes manufacturing and construction activities such as making clothes, processed food, houses, vehicles, and machinery.

Tertiary Production

Tertiary production is concerned with the provision of services that assist in the distribution of goods produced at the primary and secondary levels. It also includes professional services. Examples include wholesalers, retailers, transporters, as well as professionals such as doctors, teachers, lawyers, police officers, soldiers, musicians, and others.

Types of Goods

Economists classify goods and services that satisfy human wants into three main groups:

Consumer Goods and Services

These are goods and services that directly satisfy consumers’ immediate needs and wants. They are classified into:

Capital or Producer Goods

Capital goods are man-made goods used in the production of other goods and services. They are demanded not for direct consumption, but for their contribution to further production. The purchase of capital goods is referred to as investment. Examples include machines, tools, factories, vehicles, and buildings.

Public Goods

Public goods are goods and services provided by the government for the benefit of all members of society without exclusion. Examples include national defence, police services, street lighting, roads, and environmental protection.

Economies of Scale (Scale of Production)

Economies of scale refer to the expansion of a firm as a result of increasing the capital employed in order to increase output and reduce the cost per unit of production. An increase in output implies an increase in the scale of production.

Capital employed refers to the purchase of fixed assets such as machinery, plants, and equipment by a firm.

Types of Economies of Scale

Economies of scale are broadly classified into:

Internal Economies and Internal Diseconomies of Scale

Internal Economies of Scale

Internal economies of scale are the advantages a firm enjoys as a result of an increase in its size and output. These advantages lead to a reduction in the average cost of production as output increases. Internal economies are also known as the economies of large-scale production.

Types of Internal Economies of Scale

Internal Diseconomies of Scale

Internal diseconomies of scale arise when a firm becomes too large or expands too rapidly, leading to inefficiency. As a result, productivity may decline and the cost per unit of output may increase.

External Economies and External Diseconomies of Scale

External economies of scale are the benefits a firm enjoys as a result of the concentration of many firms or industries in a particular location.

Examples of External Economies

Law of Diminishing Returns (Law of Variable Proportions)

The Law of Diminishing Returns, also known as the Law of Variable Proportions, states that when additional units of a variable factor of production (such as labour) are continuously applied to one or more fixed factors (such as land), total output may increase rapidly at first. However, beyond a certain point, the additional output obtained from each extra unit of the variable factor will begin to decrease, and eventually total output may decline.

This law is particularly applicable to both the agricultural and industrial sectors of the economy.

Merits of the Law of Diminishing Returns

Division of Labour

Division of labour refers to the process of breaking down a production activity into several distinct operations, with each operation performed by a different worker or group of workers.

For example, in the publishing industry, division of labour exists where different workers are responsible for writing manuscripts, editing, filming and plating, printing, folding, collating, sewing, binding, and finally trimming.

Specialisation

Specialisation is the concentration of the productive efforts of an individual, firm, or country on a particular economic activity in which it has the greatest advantage.

Division of labour is a form of specialisation. In fact, specialisation results from division of labour.

Advantages of Division of Labour and Specialisation

Disadvantages of Division of Labour and Specialisation

Limitations to Division of Labour