Theory of Production Presented By: Pankaj Kumar RBS ; Meadows
Introduction Whatever be the objective of business firms, achieving optimum efficiency in production or minimizing the cost of production is one of the prime concerns of managers today. Infact, the very survival of the firms in a competitive market depend on their ability to produce at a competitive cost.
Short Run Production Function : The Law of Variable Proportions Statement of the law: “ The law of variable proportions states that when more and more units of the variable factor are added to a given quantity of fixed factors, the total product may initially increase at an increasing rate reach the maximum and then decline ”.
Tabular Presentation of Law of Variable Proportions 47 -25 470 10 55 -9 495 9 63 0 505 8 72 24 505 7 80 50 480 6 86 62 430 5 92 98 368 4 90 100 270 3 85 90 170 2 80 80 80 1 I Stage II Stage III Stage AP MP TP Units of Labour
Diagrammatical Presentation of Law of Variable Proportions Assumptions of the law: State of Technology remains the same. Input prices remain unchanged, Variable factors are homogeneous. AP MP AP MP
A Rational producer will never choose to produce in stage III where Marginal Productivity of variable factor is negative. It will stop at the end of the second stage where Marginal Productivity of the variable factor is Zero. At this point the producer is maximizing the total output and will thus be making the maximum use of the available variable factors.
A producer will also not choose to produce in Stage I where he will not be making full use of the available resources as the average product of the variable factor continues to increase in this stage.
A producer will like to produce in the second stage. At this stage Marginal and Average Product of the variable factor falls but the Total Product of the variable factor is maximum at the end of this stage. Thus stage II represents the stage of rational producer decision.
Law of Diminishing Returns and Business Decisions
Long Run Production Function: The Returns to scale
The long run production function is termed as returns to scale. In the long run, the output can be increased by increasing all the factors in the same proportions.
The laws of returns to scale is explained by the help of Isoquant curves. An Isoquant curve is the locus of points representing various combination of two inputs, Capital & Labour, yielding the same output.
There are three technical possibilities;
a) Total output may increase more than proportionately: Increasing returns to scale,
b) Total output may increase at a constant rate: Constant Returns to Scale,
c) Total output may increase less than proportionately: Diminishing returns to scale.
Three Stages of Law of Diminishing Returns Increasing Returns Increasing Returns Constant Returns Diminishing Returns Scale of Inputs Marginal Product
Small number of sellers : There is a small number of sellers under oligopoly. Conceptually, however, the number of sellers is so small and the market share of each firm is so large that a single firm can influence the market price and business strategy of the rival firms
Interdependence of decision making : The competition between the firms takes the form of action, reaction, and counteraction between them. Since the number of firms in the industry is small, the business strategy of each firm in respect of pricing, advertising, product modification is closely watched by the rival firms
In order to avoid uncertainty arising out of interdependence and to avoid price wars and cut throat competition, firms working under oligopolistic conditions often enter into an agreement regarding a uniform price – output policy to be pursued by them. The agreement may be either formal or secret. when the firms enter into such secret agreements, collusive oligopoly prevails.
Collusion is of two types:
b) Price Leadership.
In a cartel type of collusive oligopoly, firms jointly fix a price and output policy through agreements.
Under Price Leadership one firm sets the price and others follow it. The one which sets the price is a price leader and the one who follow him are his followers.
Price and output determination under cartel: - Joint profit maximization
Price and Output Determination Under Low-Cost Price Leadership.