PRODUCTION, THEORY OF

in economics, an effort to explain the principles by which a business firm decides how much of each commodity that it sells (its outputs or products) it will produce, and how much of each kind of labour, raw material, fixed capital good, etc., that it employs (its inputs or factors of production) it will use. The theory involves some of the most fundamental principles of economics. These include the relationship between the prices of commodities and the prices (or wages or rents) of the productive factors used to produce them and also the relationships between the prices of commodities and productive factors, on the one hand, and the quantities of these commodities and productive factors that are produced or used, on the other. The various decisions a business enterprise makes about its productive activities can be classified into three layers of increasing complexity. The first layer includes decisions about methods of producing a given quantity of the output in a plant of given size and equipment. It involves the problem of what is called short-run cost minimization. The second layer, including the determination of the most profitable quantities of products to produce in any given plant, deals with what is called short-run profit maximization. The third layer, concerning the determination of the most profitable size and equipment of plant, relates to what is called long-run profit maximization. Additional reading Rolf Fre, Fundamentals of Production Theory (1988), contains an excellent introductory treatment. Authoritative intermediate-level discussions may be found in William J. Baumol, Economic Theory and Operations Analysis, 4th ed. (1977). Vernon L. Smith, Investment and Production (1961), especially emphasizes the relationship between long-run costs and investment. Probably the best technical presentation is Paul A. Samuelson, Foundations of Economic Analysis, enlarged ed. (1983). George J. Stigler, Production and Distribution Theories (1941, reissued 1994), provides a discussion of the evolution of the theory; while Gerhard Rosegger, The Economics of Production and Innovation: An Industrial Perspective, 2nd ed. (1986); and Finn R. Frsund (ed.), Topics in Production Theory (1984), discuss the relationship between theory and empirical data. J. Viner, Cost Curves and Supply Curves, Zeitschrift fr Nationalkonomie, 3:2346 (1931), remains a classic text. An interesting survey of recent work in this area is Fernando J. Cardim de Carvalho, Mr. Keynes and the Post Keynesians: Principles of Macroeconomics for a Monetary Production Economy (1992). Robert Dorfman The Editors of the Encyclopdia Britannica