Micro CHAPTER 3.1:

CHAPTER SUMMARY

The production function is a model that explains how businesses decide how much output (products) to produce and how much input (the things you need to use to produce - workers, materials, etc.) to use to produce it. We use the term product to describe the amount produced.

When learning about the production function, we usually imagine a business that uses human workers as its only input - this keeps things simple. For each worker we add, we want to know their marginal product - the amount of additional stuff that we can now make because we hired them. If we can produce 15 units with 1 worker, or 34 units with 2 workers, then the marginal product of the second worker is 19 units (34 - 15 = 19).

Initially, many businesses have increasing marginal returns, meaning that adding worker #2 adds more to our total product than adding worker #1 did. Eventually, we reach the point of diminishing marginal returns, where adding more workers does increase our total product, but not as much as the earlier workers did. Lastly, at some point, we may reach negative marginal returns, where adding more workers actually reduces our total product. This all reflects the law of diminishing marginal returns, which states that adding more and more input eventually results in lower and lower marginal returns.

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