Types of production
- Primary: extracting resources from nature (farming, fishing, mining).
- Secondary: turning materials into goods (manufacturing, construction).
- Tertiary: providing services (retailing, banking, transport).
Whether a good is a consumer good or a capital good depends on its use: a smartphone used for leisure is a consumer good; the same phone used by a delivery rider to take orders is a capital good.
Factors of production and their returns
| Factor | Meaning | Return |
|---|---|---|
| Land | Natural resources, gifts of nature | Rent |
| Labour | Human effort used in production | Wage |
| Capital | Man-made goods used in production | Interest |
| Entrepreneurship | Bears business risks and makes business decisions | Profit (can be negative) |
Labour productivity and division of labour
Average labour productivity = output per unit of labour, e.g. output per man-hour.
It can rise with more or better capital, better technology, more education and training, better management (division of labour), better working conditions, and incentive schemes such as piece rate.
Division of labour raises productivity because workers can be chosen for jobs they are best at, practice makes perfect, and less time is spent on training and switching between tasks.
The law of diminishing marginal returns (short run)
Holding technology constant, when more and more units of a variable factor are added to a given quantity of fixed factors, the marginal product of the variable factor will eventually diminish.
- Marginal product (MP) = the change in total product from one more unit of the variable factor.
- Average product (AP) = total product ÷ units of the variable factor.
The law applies only in the short run, when there is a fixed factor. If all factors are variable (long run), the law does not apply.
Costs
- Fixed cost: does not vary with output (e.g. rent, licence fee).
- Variable cost: varies with output (e.g. raw materials, part-time wages, fuel).
Economies of scale (long run)
When the scale of production increases, average cost may fall:
- Internal economies of scale come from the firm's own expansion: technical, marketing (bulk purchase), financial, managerial, risk-bearing.
- External economies of scale come from the growth of the industry or its location, e.g. shops clustered in Mong Kok attract more customers and share supporting services.
Beyond some scale, diseconomies of scale (coordination problems) raise average cost.
Forms of business ownership
| Sole proprietorship | Partnership | Limited company | |
|---|---|---|---|
| Liability | Unlimited | Unlimited (general partners) | Limited |
| Legal entity | No | No | Yes |
| Number of owners | 1 | 2 to 20 | Shareholders |
| Transfer of ownership | Needs no one's consent | Needs consent of other partners | Shares transferable (freely, if listed) |
| Raising capital | Owner's savings and loans | Partners' capital | Shares; a public limited company can issue shares to the public |
A public corporation (e.g. the former MTRC) is owned by the government but run on commercial lines.
Shares versus debentures: shareholders are owners who receive dividends at the directors' discretion; debenture holders are creditors who receive fixed interest and are repaid before shareholders if the company is wound up.
Expansion of firms
- Horizontal integration: firms at the same stage of production.
- Vertical integration: firms at different stages of the same product (backward towards raw materials, forward towards consumers).
- Conglomerate integration: firms in unrelated lines of business.
Common mistake: diminishing marginal returns is a short-run idea; economies and diseconomies of scale are long-run ideas.