The Production Function
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bidders are entrepreneurs. An individual may, of course, be both a laborer and entrepreneur in the same production process. Nevertheless, the entrepreneur is unique in that it is through his or her initiative and enterprise that the other factors of production are organized in the first place. The entrepreneur is distinguished from the “hired hand” in a number of other ways. The entrepreneur, for example, makes the nonroutine decisions for the firm. The entrepreneur determines the firm’s organizational objectives. The entrepreneur is an innovator, constantly on the alert for the best (least expensive) production techniques. The entrepreneur also endeavors to ascertain the wants and needs of the public to be able to introduce new and better products, and to discontinue production of goods and services that are no longer in demand. The entrepreneur is a risk taker in the expectation of earning a profit. It should be pointed out once again that it is assumed that the expectation of earning profit is the motivating incentive for all commercial activities in a free economy. Without the profit motive, it is assumed that entrepreneurs would not incur risk the financial risks associated with combining productive resources to produce final goods and services for sale in the market. In the absence of the profit motive, the production of goods and services in quantities that are most in demand by society would not occur. Moreover, whenever the profit incentive is diluted—say, through a tax on profits—fewer goods and services will be produced by the private sector in exchange for an increase in goods and services produced by the public sector. Whether society is better off or worse off will ultimately depend on which sector is most responsive to society’s needs and preferences and which sector is most efficient in the utilization of productive resources in the delivery of those goods and services.The disappointing economic experiences of centrally planned economies in the communist countries of eastern Europe and Asia in the latter half of the twentieth century, compared with that of the essentially free market economies of western Europe, North America, and Japan often convincing testimony to the power of the profit motive in promoting the general economic well-being of society at large. To quote from Adam Smith: “By pursuing his own interest he (the entrepreneur) frequently promotes that of society more effectively than when he really intends to promote it.”1
THE PRODUCTION FUNCTION The technological relationship that describes the process whereby factors of production are efficiently transformed into goods and services is 1 Adam Smith, The Wealth of Nations. (New York: Modern Library, 1937) p. 423. (Originally published in 1776.)
