Production—the relationship between inputs and outputs— is most often associated with images of ASSEMBLY LINEs and manufacturing, but production concepts apply to SERVICES, RETAILING businesses, households, and government. In production, inputs—RESOURCES such as labor, materials, energy, and equipment (often referred to as factors of production or land, labor, CAPITAL, and ENTREPRENEURSHIP in economics textbooks)—are combined to produce outputs. For example, to produce this entry in the encyclopedia required labor (the author), materials (printing materials), and capital (the computer and printing system). Logically, more inputs results in more outputs most of the time. Whether or not more inputs result in more outputs depends on whether all inputs are variable (changing with the level of output) or fixed (not changing within a range of output). Often a businessperson is confronted with a situation in which some resources are variable and some are fixed. A typical example is found in the operations of a typical fast-food restaurant. When planning a day’s output, a manager is aware of fixed inputs, including the size of the building and equipment inside; and variable inputs, including labor, energy, and ingredients. As more variable inputs are added to the fixed-production process, total output initially increases. If this restaurant had only one worker, he or she would have to take orders, prepare and assemble meals, take payment, and clean up after customers. Running around the building doing all these tasks would involve a lot of wasted motion and time, and total output (meals) would be small. With the addition of a second, third, and fourth worker, however, total output would increase rapidly. Through specialization, total production would likely be greater than what each worker could have produced individually. Adding a fifth, sixth, or seventh worker would probably result in an increase in total meal production, but it would not be not as rapid, and the fast-food restaurant would experience diminishing marginal returns. The law of diminishing marginal returns states that as equal successive amounts of a variable resource are combined with a fixed amount of another resource, marginal increases in output will eventually decline and can even become negative. Using the fast-food restaurant example, at some point added workers doing specialized parts of the meal-production process are not fully utilized. If a worker is assigned to the french-fry machine and customers aren’t ordering many french fries, that worker’s contribution to total product will be minimal. In addition, more workers trying to produce meals in a confined space would result in disrupted production as they constantly bumped into each other. In this situation, added units of a variable resource would create declining total production (negative marginal returns). Production analysts carefully evaluate COSTS, including total cost, average cost, and marginal cost. Fixed costs occur in any production process where some resource is fixed. As output increases, the cost of the fixed resource is spread over a larger quantity of production, and average fixed cost declines as production increases. Declining fixed costs per unit of output and increased productivity through specialization lead to ECONOMIES OF SCALE (declining average costs). When larger quantities of output result in higher average costs, the firm faces diseconomies of scale. One of the critical decisions managers must make is the size of the operation to establish. Whether a fast-food restaurant, assembly line, or other venue, the size of the operation and fixed inputs associated with its range of production determine the range of economies and diseconomies of scale within which the firm can operate.
See also MARGINAL ANALYSIS.