PRODUCTION FUNCTION

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 What is Production Function?
• It is a functional specification that provides
the combination of inputs with which a
chosen target level of output can be
produced.
• The graphical representation of long run
production function is termed as an
Isoquant.

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From Production Function to Cost
Function : Long Run Total Cost

• Tangent point between an isoquant and an

isocost line gives the least combination of
inputs with which the output level
corresponding to the isoquant can be
produced.

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 A
INPUT Y

TH
PA
N
S IO
A N
X P
E Q3
3 Q2

2
Q1
1

O C1 C2 C3 INPUT X

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IMPLICATION OF THE GRAPH

• It shows the level of output at one least cost

combination.
• It also shows the total cost of production of
output.
• OA represents the lowest cost level in
which output can be expanded.

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 RESULTS OF OA
• OA represents :
– The cost of most efficient combination of
input and
– The corresponding level of output.
•
• These two items of data characterizes the
cost function. Hence the cost function can
be derived from the expansion path.

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• Cost is dependent on :
– The level of output and
– The level of price of the input


• As the price of the input is not under the

control of the producer this factor is not
explicitly considered and the active
determinants of cost turns out to be only
the level of output.

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 Thus in most general form

C = f (Q)

•
•
 Where,
 C represents Cost
 Q represents Output

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The combinations given in the
graph correspond to the long run
or the short run?
• There is no fixed input
• Expansion path starts from the origin indicating
that costs vary with output and
• It also depicts that if output is zero cost is zero
•
 Hence the cost function derived from the
expansion path is long run in nature.

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COST

LRTC
C3

C2

C1

OUTPUT
O Q1 Q2 Q3

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 STEPS TO DERIVE LRTC SCHEDULE

• Step 1 :
– Select the level of output (effectively using
the isoquant)
• Step 2 :
– Find the optimal (least cost) combination of
inputs which correspond to the point of
tangency between the isoquant selected in
step 1 and the isocost line.

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• Step 3 :
– The point of tangency gives the physical
quantity of inputs to be employed.
Multiply these with their prices and sum
up to get the cost.
• Step 4 :
– This combination of output and cost gives
one point on the LRTC curve.
• Step 5 :
– Repeat the above steps for different levels of
output.

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