Production and Supply

In investigating the foundations of supply and demand, we will look at demand and supply as separate headings. It doesn't matter much, logically, which we take first. Historically, the first stages of the economists' Reasonable Dialog were focused more on supply. In investigating the foundations of supply, we are investigating the economics of production, and that was the central topic for the classical economists.

Adam Smith, we recall, had been very optimistic about the future economic development of the industrializing countries. With increased division of labor leading to higher wages and growing demand, he felt, production could continue to grow. However, Thomas Malthus criticized Smith's optimism. Malthus spoke for the pessimistic view, and, of course, Malthus is best known for his claim that increasing population would lead to poverty. In supporting this idea, Malthus began to study the limits on production. It was this study that has made his work important particularly for Neoclassical economics.

Limits on production stem from limited resources with a given technology. With a given technology, limited quantities of inputs will yield only limited quantities of outputs. The relationship between the quantities of inputs and the maximum quantities of outputs produced is called the "production function."

The "production function." is a relationship between quantities of input and quantities of output that tells us, for each quantity of input, the greatest output that can be produced with those inputs. Malthus didn't work out the details, but he clearly had this idea in mind as he originated the key concept of Diminishing Returns.