Market Theory and the Price System

8. Production Theory

153 8 production theory Thus far, our analysis of individual economic activity and of the interaction in the market of the economic activity of numerous individuals has been confined to a world where no production was considered possible . The market process we were able to analyze was a process where all participants participated directly as consumers. Our principal purpose in this book, however, is to analyze a market process where the wants of participants in their role of consumers may be met not only through exchange but also by acts of production from resources. In the pure exchange economy of the preceding chapter, a participant could improve his position (from that he finds himself placed in by natural endowment at the start of each day) only through acts of exchange. In the full market process, which we wish to investigate, a participant may improve his position not only by direct exchange of endowed consumer good for endowed consumer good but also by acts of production and of exchanges of resources and products for the resources and products of others. In this and the following chapter we take up the analysis of the activity of the individual participant in his role of producer. In Chapters 10 and 11 we will examine the market process forged out of the interactions of numerous individuals acting in their capacities of resource owner, producer , and consumer. The economic analysis of production affects the analysis of the market process, of course, through the supply side. In this chapter and the next we inquire into the way the quantity of product that will be offered to the market at a given product price depends upon the pattern of production costs. In this chapter we lay the groundwork by setting up the problem of production in its proper economic framework, indicating the kinds of alternatives a would-be producer is free to choose among, and showing especially how this range of alternatives is circumscribed by what we will discover to be the Laws of Variable Proportions. In Chapter 9 we will proceed to show how the principles of production theory, developed in the present chapter, can be applied to the analysis of production costs and upon the way these costs affect supply. the economic aspect of production The economist examines production from a very special point of view. From a purely physical perspective, of course, production is simply the process where quantities of raw materials and labor are transformed into 154 production theory quantities of product, the quantities being rigidly determined by the laws of physical science. For the technologist the interest lies wholly in these physical laws, describing the various results that can be expected to follow on different patterns of resource combination. The economist’s perspective on production, however, is a quite different one. Production is a process not of physical nature but of human action. In seeking to improve their positions, men find it worthwhile to act as producers as well as consumers. As consumers they act to spend their incomes on the goods and services they consider most important. In exactly the same way they may seek to improve their positions by producing goods and services—either those they consider most important for themselves or those that can be sold to command the goods they consider most important. The very same categories, such as purpose, means, ends, and cost, which make possible the analysis of consumer demand, reappear unchanged in connection with the actions of men engaged in production. And the economist analyzes production with these categories making up the focus of his attention, rather than the physical laws within whose framework productive activity is carried on. The essence of the economist’s outlook is thus that he sees the producer as a man making choices among alternatives of a certain order of complexity. By considering the range of possible alternatives, the economist is able to analyze the way these choices are made and the way action will change in response to changes in the range of alternatives that choice is made from. production by the isolated individual Production would take place of course, even in the absence of a market. Robinson Crusoe and his production plans are accorded frequent attention in economic treatises. An isolated individual finds himself with a severely limited stock of goods ready for immediate consumption. These may not be sufficient to satisfy even his immediate subsistence needs and fall very short of satisfying all his “wants.” On the other...