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What product should the business produce (product-product)

A third decision for a manager is what should the business produce when it has several alternative products to consider.

The assumption is that the inputs can be used to produce several different products or output. The manager's decision then is which of these products should be produced with the variable input. Similar to the assumptions underlying the discussions of "how much to produce" and "how to produce," it is assumed the manager wants to produce a combination of outputs or products that maximizes profit.

Economic theory indicates that the business should produce the combination of products so

MPPy1/Py1 = MPPy2/Py2 or

MPPy1/MPPy2 = Py2/Py1

The assumptions underlying this economic rule include

• one input (X) can be used to produce more than one product (e.g., y1 and y2);
• there is a limited quantity of X available to the business;
• the quantity of each product that will be produced by using one more unit of input will differ (i.e., MPPy1 will not equal MPPy2),
• the market price of the outputs will differ (Py1 will not equal Py2), and
• the cost of one unit of X will be the same regardless of which product is being produced.

Accordingly, when the ratio between the amount of y1 that can be produced from a unit of X and the Py1 (MPPy1/Py1) is equal to the ratio between the amount of y2 that can be produced from a unit of X and the Py2 (MPPy2/Py2), the business is producing the combination of the two products that maximize profit.

• If the ratio for one product is greater than the ratio of the other product, the business would increase it profit by shifting more of the input to produce the product with the higher ratio. The manager would continue to shift the use of X between the two products unit the ratios are equal.

Managers also may want to consider the economic theory that explains deciding how much to produce and how to produce.

The next page provides a summary and suggests some implications for managers.

Last Updated October 22, 2009

Email: David.Saxowsky@ndsu.edu

This material is intended for educational purposes only. It is not a substitute for competent professional advice. Seek appropriate advice for answers to your specific questions.

E-Mail:sswandal@ndsuext.nodak.edu
Published by Agricusiness and Applied Economics
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