Concepts

Fixed & Variable Inputs Short-run & Long-run Production

PRODUCTION FUNCTION
A

production function is the functional relationship between inputs and output. It shows the maximum output which can be obtained for a given combination of inputs. It expresses the technological relationship between inputs and output of a product. In general, we can represent the production function for a firm as:

Where Q is the maximum quantity of output, x1, x2, .,xn are

the quantities of various inputs, and f stands for functional relationship between inputs and output.

PRODUCTION FUNCTION
For the sake of clarity, let us restrict our attention only one

product produced using either one input or two inputs. If there are only two inputs capital (K) and labour (L), we can write production function as:

This function defines the maximum rate of output (Q) obtainable

for a given rate of input.

PRODUCTION FUNCTION
Perfect divisibility of both input and output There are only two factors of production labour and capital. Limited substitution of one factor for the other.

A given technology
Inelastic supply of fixed factors in the short run.

Short-run Production

The Law of Diminishing Returns

The law of returns to a Variable input

The law of diminishing returns states that when more and more units of a variable input are applied to a given quantity of fixed inputs, the total output may initially increase at an increasing rate and then at a constant rate but it will eventually increase at diminishing rate.

Three Stages in Production

Three Stages

Factors behind Law of Return

The marginal productivity of workers increases in Stage I,

whereas it decreases in Stage II. In other words, in Stage I, Law of Increasing returns is in operation and in Stage II, the law of Diminishing returns is in application.
The reasons of laws of returns are as under:

Indivisibility of fixed factor. Division of labour.

Long-run Production
WITH TWO VARIABLES INPUT

Marginal Rate of Technical Substitution

The rate, at which one input can be substituted for

another input, if output remains constant, is called the marginal rate of technical substitution (MRTS). It is defined in case of two inputs, capital and labour, as the amount of capital that can be replaced by an extra unit of labour, without affecting total output.

Different forms of Isoquants

In panel I, the isoquants are right angles implying that the two inputs a and b must be used in fixed proportion and they are not at all substitutable. For instance, there is no substitution possible between the tyres and a battery in anautomobile production process.
The MRTS in all such cases would, therefore, be zero.

Different forms of Isoquants

The other extreme case would be where the inputs a and b are perfect substitutes as shown in panel II. The isoquants in this category will be a straight line with constant slope or MRTS. A good example of this type would be natural gas and fuel oil, which are close substitutes in energy production.

Different forms of Isoquants

The most common situation is presented in panel III.

The inputs are imperfect substitutes in this case and the rate at which input a can be given up in return for one more unit of input b keeping the output constant diminishes as the amount of input b increases.

Production Analysis: Long Run

Long-run Production Analysis

What are the optimum quantities of labour and capital that

manager should hire and employ? A manager might have a fixed production target and wish to find out least cost input combination for that level of output. Alternatively he could a fixed rupee budget for production and wish to determine that input combination which maximizes his output for a given cost.
What is expansion path? Are returns to scale increasing or

decreasing?

Isocost Lines
For determining the least-cost technology, one needs, besides the production function the factor prices. If PL and PK were the prices of labour and capital, respectively then the firms total cost equation would be the following:

C LPL KPK

Least-cost Input Combination

PL dK dL PK dK ( MPP K ) dL( MPP L) 0 MPP dK L dL MPP K MPP MPP L K PL PK

Economic Region of Production

Laws of Returns to Scale

1. Increasing Returns to Scale

2. Constant Returns to Scale

3. Diminishing Returns to Scale

Thank you..