VProduction

Function
 Y



V "Production is the process that transforms

inputs into output.´

V "Production is the process by which the

resources (input) are transformed into a
different and more useful commodity.
Various inputs are combined in different
quantities to produce various levels of
output.´
 ›


Production:

V Production means transforming inputs ( Labour,

Machines, Raw materials etc.) into an output.

Jnput and Output:

V xn input is a good or service that goes into the

process of production. Land, Labour, Capital,
Management, Entrepreneur and Technology are
classified as inputs.
V xn output is any good or service that comes out of
the production process.
|ixed Jnputs & Variable Jnputs:

V Fixed inputs remains fixed (constant) up to certain

level of output.
V Variable inputs change with the change in output.

› ort Run and Long Run©

V ›hort run refers to a period of time in which supply of

certain inputs i.e., plant, building and machinery etc.
is fixed or inelastic.
V Long run refers to a time period in which the supply
of all the inputs is elastic or variable.
 Production Function

V Production function is defined as "t e functional

relations ip between p
sical inputs ( i.e., factors of
production ) and p
sical outputs, i.e., t e quantit

of goods produced´.

V Production function may be expressed as under©

ë = f ( K,L)
Yhere ;
ë = Output of commodity per
unit of time.
K = Capital.
L = Labour.
f = Functional Relationship.
V Production function depends on :

Ô uantities of recourses used.

Ô ›tate of technical knowledge.
Ô Possible process.
Ô ›ize of firms.
Ô Relative prices of factors of production.
Ô Combination of factors.
V Production decisions of a firm are similar
to consumer decisions
Can also be broken down into three steps

Production Technology

Cost Constraints

Input Choices
Production Decisions of a Firm

Œ. Production Technology
º ½escribe how Ú
 can be transformed
into 

Ô Inputs© land, labor, capital and raw
materials
Ô Outputs© cars, desks, books, etc.
º Firms can produce different amounts of
outputs using different combinations of
inputs
Production Decisions of a Firm
£. Cost Constraints
º Firms must consider
Ú of labor,
capital and other inputs
º Firms want to minimize total production
costs partly determined by input prices
º xs consumers must consider budget
constraints, firms must be concerned
about costs of production
Production Decisions of a Firm

Ñ. Input Choices
èiven input prices and production
technology, the firm must choose p

p

 p
Ú
 to use in producing
output
èiven prices of different inputs, the firm
may choose different combinations of
inputs to minimize costs
Ô If labor is cheap, firm may choose to
produce with more labor and less capital
 n
eri  uses of production
function
ÿLeastÿCostÿFactors combination
ÿOptimum level of output
ÿProgramming technique in production
planning
ÿEquilibrium level of output
ÿReturns to scale
u› ort run© ›hort run refers to a period of time in
which supply of certain factor inputs is fixed or
inelastic.

uîon
run: Long run refers to a period of time in

which the supply of all the inputs is elastic, but not
enough to permit a change in technology.

u 6ery on
period© Very long period refers to a

period of time in which along with all other factor
inputs,the technology of production can also be
changed.
›hort run analysis of production function

î   

D Laws of production are of two t
pes:

The law of variable proportions.

Laws of returns to scale.
›





  






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 xssumptions

Œ. The law applies only in the short run.

£. One factor of production is variable & others

are fixed.

Ñ. xll units of variable factor are homogeneous.

4. ›tate of technology is given & remains the

same.

5. Factor proportions can he changed.


 





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¦ot  product / ¦ot  p ysic  product :- It
is defined as the total quantity & services
produced by a firm with the given inputs
during a specified period of time or total
product is sum total of output of each unit of
variable factor used in the process of
production. Thus

TP = ›um of MPs
TP = xP X n
 r
in  Product :- is net ddition to tot  product when
one more unit of variable factors employed
MP = TPnÿ TPnÿŒ
MP = ǻTP/ ǻ L

Aver
e. product :- is t e per unit production of t e

variable factors i.e. xP = TP/ L

Re tions ip between ¦P & P

Œ. Yhen TP increases at increasing rate, MP also increases.

£. Yhen TP starts increasing at decreasing rate, MP
decreases but remains positive
Ñ. Yhen TP is maximum & constant MP is O (zero)
4. Yhen TP begins to fall, MP is negative
arginal and Average Product

V Yhen marginal product is greater than the

average product, the average product is
increasing
V Yhen marginal product is less than the
average product, the average product is
decreasing
V Yhen marginal product is zero, total
product (output) is at its maximum
V Marginal product crosses average product
at its maximum
 Re tions ip between AP & P

Œ. Both xP & MP cures are derived from TP since, xP =

TP/ L & MP = ǻTP/ǻL

£. Yhen MP is greater than xP, xP rises but MP rises at

faster pace.

Ñ. Yhen MP equals to xP, xP is constant

4. Yhen MP is less than xP, xP falls but MP falls at higher

rate.
uThree stages of production

ÿ›tage I© Increasing Returns ± TP increases at

increasing rate, indicated by increasing MP.
ÿThere is intermediary constant stage between
stage I & stage II. TP increases at a constant rate
indicated by constant MP

ÿ›tage II© ½iminishing Returns ± TP continues to

increase but at diminishing rates, indicated by
declining MP

ÿ›tage III© Negative Returns ± TP begins to decline,

indicated by negative MP
  








 

 



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 ¦ ree Stages of Production in S ort Run


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Œ. Incre sin
return to f ctor:-

(i) Fuer utiiz tion of fixed f ctor : In t e initi 

st
es Fixed factor remain under utilized its fuller
utilization starts with the more application of
variable factor, hence, initially additional unit of
variable factors add more to the total output

(ii) ›peci iz tion of î bour :- Addition 

ppic tion of Variable factor causes process based
division of Labour that raises the efficiency of factors.
xccordingly marginal productivity tends to rise.
£. Diminis in
return to f ctor:-

(i) Imperfect f ctor substitut biity :- F ctors of

production are imperfect substitutes of each other.
More & more of Labour, for eg. Cannot be continuously
used in place of additional capital. xccordingly
diminishing returns to variable factor becomes
inevitable.

(ii) Disturbin
t e optimum proportion :-

Continuous increase in application of variable factor
along with fixed factors beyond a point crosses the limit
of ideal factor ratio. This results
in poor coÿordination between the fixed & variable
factors which causes diminishing return to a factor.
Ñ. Ne
tive returns to f ctor :-

(i) Overcrowdin
:- W en more & more v ri be

f ctors re dded to a given quantity of fixed
factor it will lead to over crowding & due to this
MP of the Labours decreases & it goes into
negative

(ii)  n
ement Probems :- W en t ere re too

m ny workers they may shift the responsibility to
others & it becomes difficult for the management to
coordinate with them. The Labours avoid doing
work. xll these things lead to decrease in efficiency
of Laboures. Thus the output also decreases.
Production: One Variable Input
Production: One Variable Input

V Observations©
Œ. Yhen labor is zero, output is zero as well
£. Yith additional workers, output (M)
increases up to 8 units of labor
Ñ. Beyond this point, output declines
Ô Increasing labor can make better use of
existing capital initially
Ô xfter a point, more labor is not useful and
can be counterproductive
Production: One Variable Input

V xverage product of Labor ÿ Output per

unit of a particular product
V Measures the productivity of a firm¶s
labor in terms of how much, on
average, each worker can produce

 
 X  X
  J î
Production: One Variable Input

V Marginal Product of Labor ± additional

output produced when labor increases
by one unit
V Change in output divided by the change
in labor

ñ  ñ
 X X
ñ J ñî
Production: One Variable Input
Production: One Variable Input

V Ye can graph the information in Table to

show
How output varies with changes in labor
Ô Output is maximized at ŒŒ£ units
xverage and Marginal Products
Ô Marginal Product is positive as long as
total output is increasing
Ô Marginal Product crosses xverage Product
at its maximum
Production: One Variable Input

Output
per
Month 
ŒŒ£

Total Product

xt point ½, output is
60 maximized.

0 Œ £ Ñ 4 5 6 7 8 9 Œ0 Labor per Month

 Production: One Variable Input

‡Left of E© MP > xP & xP is increasing

Output ‡Right of E© MP < xP & xP is decreasing
per ‡xt E© MP = xP & xP is at its maximum
Yorker
‡xt 8 units, MP is zero and output is at max
Ñ0
Marginal Product

 xverage Product
£0

Œ0

0 Œ £ Ñ 4 5 6 7 8 9 Œ0 Labor per Month

 îaw of Diminis ing arginal Returns

V Yhen the use of labor input is small and

capital is fixed, output increases considerably
since workers can begin to specialize and MP
of labor increases

V Yhen the use of labor input is large, some

workers become less efficient and MP of labor
decreases
îaw of Diminis ing arginal
Returns
V Typically applies only for the short run
when one variable input is fixed
V Can be used for longÿrun decisions to
evaluate the tradeÿoffs of different plant
configurations
V xssumes the quality of the variable
input is constant
îaw of Diminis ing arginal
Returns
V Easily confused with negative returns ±
decreases in output
V Explains a ëÚ Ú  marginal product,
not necessarily a negative one
xëëÚÚ  output can be declining while
  output is increasing
îaw of Diminis ing arginal
Returns
V xssumes a constant technology
Changes in technology will cause shifts in
the total product curve
More output can be produced with same
inputs
Labor productivity can increase if there are
improvements in technology, even though
any given production process exhibits
diminishing returns to labor
¦ e Effect of ¦ec nological
Improvement Moving from x to B to C, labor
Output

productivity is increasing over time

Œ00 

x

50



Labor per
time period
0 Œ £ Ñ 4 5 6 7 8 9 Œ0
Production: ¦wo Variable
Inputs

V Firm can produce output by combining

different amounts of labor and capital

V In the long run, capital and labor are

both variable
Production© Two Variable Inputs
V The information can be represented
graphically using isoqu nts
Curves showing all possible combinations of
inputs that yield the same output

V Curves are smooth to allow for use of

fractional inputs
Curve Πshows all possible combinations of
labor and capital that will produce 55 units of
output
 Isoquant ap
Capital 5 
Ex© 55 units of output
per year can be produced with
Ñ & ŒL (pt. x)
4 OR
Œ & ÑL (pt. ½)
Ñ
x

£
M

90
 M

75
Œ
M

55
Œ £ Ñ 4 5 Labor per year
Production: ¦wo Variable Inputs

V ½iminishing Returns to Labor with

Isoquants
V Holding capital at Ñ and increasing
labor from 0 to Œ to £ to Ñ
Output increases at a decreasing rate (0,
55, £0, Œ5) illustrating diminishing marginal
returns from labor in the short run and long
run
V ½iminishing Returns to Capital with
Isoquants
V Holding labor constant at Ñ increasing
capital from 0 to Œ to £ to Ñ

Output increases at a decreasing rate (0,

55, £0, Œ5) due to diminishing returns from
capital in short run and long run
 Diminis ing Returns
Capital 5 Increasing labor holding
per year capital constant (x, B,
C)
4 OR
Increasing capital
holding labor constant
Ñ (E, ½, C
x


£
M

90

Œ  M

75
M

55
Œ £ Ñ 4 5 Labor per year
V ›ubstituting xmong Inputs

Companies must decide what combination

of inputs to use to produce a certain
quantity of output

There is a tradeÿoff between inputs,

allowing them to use more of one input and
less of another for the same level of output
V ›ubstituting xmong Inputs

›lope of the isoquant shows how one input

can be substituted for the other and keep
the level of output the same

The negative of the slope is the m r
in 

r te of tec nic  substitution (R¦›)

Ô xmount by which the quantity of one input

can be reduced when one extra unit of
another input is used, so that output remains
constant
V The marginal rate of technical
substitution equals©


  

 
› X

  î
  
› X ñ
for a fixed level of 
ñî
V xs labor increases to replace capital
Labor becomes relatively less productive
Capital becomes relatively more productive
Need less capital to keep output constant
Isoquant becomes flatter
 arginal Rate of ¦ec nical Substitution

Capital
5
per year
Negative ›lope measures MRT›;
£ MRT› decreases as move down
4 the indifference curve

Œ
Ñ
Œ
Œ
£
£/Ñ Œ

90
Œ/Ñ 
75
Œ Œ

55

Œ £ Ñ 4 5 î
 
Isoquants: Special Cases

V Two extreme cases show the possible

range of input substitution in
production
Œ. Perfect substitutes
MRT› is constant at all points on isoquant
›ame output can be produced with a lot
of capital or a lot of labor or a balanced
mix
Perfect Substitutes
Capital
per x
›ame output can be
month reached with mostly
capital or mostly labor (x
or C) or with equal
amount of both (B)

  
Labor
per month
£. Perfect Complements

Fixed proportions production function

There is no substitution available between
inputs
The output can be made with only a specific
proportion of capital and labor
Cannot increase output unless increase both
capital and labor in that specific proportion
Fixed-Proportions Production Function

Capital
per ›ame output can
month only be produced
with one set of
inputs.






 
x

Labor
per month
î
 Production Function in Long Run
uî
 
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Returns to Scale

V Incre sin
returns to sc e© output

more than doubles when all inputs are
doubled
Larger output associated with lower cost
(cars)
One firm is more efficient than many
(utilities)
The isoquants get closer together
 Increasing Returns to Scale
Capital
(machine The isoquants
hours) x
move closer
together

Ñ0

£ £0
Œ0
Labor (hours)
5 Œ0
Returns to Scale

V Const nt returns to sc e© output

doubles when all inputs are doubled
›ize does not affect productivity
May have a large number of producers
Isoquants are equidistant apart
 Returns to Scale
Capital
(machine
x
hours)
6
Ñ0

4 Constant Returns©
Isoquants are
£ equally spaced
0
£

Œ0
Labor (hours)
5 Œ0 Œ5
Returns to Scale

V Decre sin
returns to sc e© output

less than doubles when all inputs are
doubled
½ecreasing efficiency with large size
Reduction of entrepreneurial abilities
Isoquants become farther apart
 Returns to Scale
Capital
(machine x
hours)

½ecreasing Returns©
Isoquants get further
4 apart

Ñ0
£
£0
Œ0

5 Œ0 Labor (hours)