• Refers to the transformation of resources into
output of goods and services
• Short Run
– Fixed Inputs
– Variable Inputs
• Production Function (refers to relation b/w
firm’s input of resources and output of goods)
– Q = Q(L, K), where L is Labour and K is capital
• Cobb-Douglas Production Function
– Q = ALµ K1-µ
• Total Product
– It is the output that can be produced using
various levels of inputs
• Average Product
– It is the total production divided by the number
of variable input employed
• Marginal Product
– change in output resulting from a change in
factor of production
Law of Diminishing Marginal Product
• It postulates that as more units of a variable
input are used with a fixed amount of other
inputs, after a point, a smaller and smaller return
will accrue to
• each additional unit of the variable unit. In other
words, the marginal product of the variable input
• This occurs because each additional unit of the
variable input has less and less of the fixed
inputs with which to work.
• TPL, APL and MPL – all are rising. This
implies that as more and more input
• TPL increasing at increasing rate
• (Labour) is used in the production
process, the output due to labour in a
given situation increases.
• When APL is maximum, is equal to MPL.
• This stage II begins where stage I ends
and continues up until stage III begins.
• In this stage, TPL is rising but at a falling
rate, such that both APL are MPL are
• Till MPL becomes zero corresponding to
TPL reaching maximum.
• It shows that both TPL and APL are
declining, so does MPL at a faster rate
• Such that it is negative (both in terms of
absolute level of output and relative rate of
• If the firm intends to maximise production, it should employ O-L2
• If the firm intends to maximise production per unit of labour, it should
• If it wants to maximise additional output (production) per unit of
additional labour, it should employ O-L0.
• Under no circumstances it should employ any labour beyond O-L2,
because then the (marginal) productivity of labour is zero or negative.
PRODUCTION IN LONG RUN
• Increasing returns to scale occurs when the
percentage change in output is greater than the
percentage change in inputs.
• Decreasing returns to scale occurs when the
percentage change in input is greater than the
percentage change in output.
• Constant returns to scale occurs when the
percentage change in output is equal to
percentage change in input.
Marginal rate of technical substitution
• Measures how one factor of production is
substituted for another while keeping the
The marginal rate of technical substitution of
labour for capital K can be determined as:
• Represents Marginal Rate of Technical Substitution between factors K and L (ML
Isoquant - Features
• Negative slope
• Upper Isoquants represent higher level
• Do not intersect each other