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1. Production Theory

A Production Function describes the relationship between inputs (like labor, capital) and the maximum output that can be produced from them. It shows how efficiently inputs are converted into outputs.

Types of Inputs:

  • Fixed Inputs: Inputs that do not change with output (e.g., machinery).
  • Variable Inputs: Inputs that change with the level of output (e.g., labor).

Law of Diminishing Returns: As more units of a variable input (like labor) are added to a fixed input (like land), the additional output from each new unit of input will eventually decrease.

Real-Life Example:​

A farmer using fertilizer (variable input) on a fixed plot of land (fixed input) may initially see high increases in crop yield. However, after a certain point, adding more fertilizer results in diminishing returns, with smaller increases in yield.