The Neoclassical Theory of Production and Distribution

Assumptions:
1. The goal of every firm is to maximize profit ( maximize stock holders' equity ).
2. One variable input is applied to a given fixed input.

Definitions:

• Inputs- materials or factor services used in the process of production.
  • Fixed Input-cannot be varied in the short run. (Example: Size of the Factory)
  • Variable Input- amount used can be changed in the short run.
• Output- the commodity or service which is produced.
• Production Function - a schedule that shows the maximum amount of output that
  can be produced by applying various amounts of the variable input to a given fixed input.

  Q = f (inputs)

• Total product (TP) - the total quantity, or total output, of a particular good produced.

The production function is represented by the following data and can be graphed as shown.

 

 

 

 

 

 

 

 

 

Starting from the origin, as the number of units of input increases, output begins to expand at an
increasing rate. At the point of inflection it continues to increase at a decreasing rate. Finally, it
reaches a maximum and then becomes negative.

The curve tells us the quantity of output that results from applying various amounts of the variable
input to a given fixed input. For example, at 6 units of input the correspnding output is 2600.