Introduction of Production & its Function


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Introduction of Production & its Function

  1. 1. Introduction to Production,Factors of Production andScalesNitish Kumar AryaM.A. EconomicsBanaras Hindu UniversityVaranasi – 221005
  2. 2. What is Production?• Production to an economist, is the creation of utilities tosatisfy wants; whether that means the creation of a gooditself in agriculture or industry; its transport from thepoint of production to the point of consumption(geographical distribution); its transport through timefrom the moment of production to the moment ofconsumption, in stock-piles, cold stores, warehouses orgranaries (distribution through time); or the provisionof personal services directly enjoyed by individuals orgroups such as health education, health andentertainment
  3. 3. Types of Production• Primary production - Man’s inheritance ofnatural wealth such as mining, agriculture,fishery, forestry etc• Secondary production - derived productionfrom natural primary products - industry forexample• Tertiary production– Commercial services - wholesale, banks,insurance, export house– Personal services - professor, doctor, advocates
  4. 4. Production Theory• In production resources used for the productionof a product or service are known as factors ofproduction (also known as inputs)– land– labour– capital– organization• Production Function– P = f(A,B,C,D)
  5. 5. Law of Variable Proportions• “as the quantity of a variable input is increasedby equal doses, keeping the quantities of otherinputs constant, the total product will increase,but after a point, at a diminishing rate”• In other words, when more and more units ofthe variable factor is used (holding thequantities of other factors constant), a point isreached beyond which the marginal product,then the average product and finally the totalproduct will diminish• This law is also known as law of diminishingreturns
  6. 6. Law of Diminishing Returns
  7. 7. -200204060800 5 10Total PdtAvge PdtMarginal PdtLaw of Diminishing Returns
  8. 8. Importance of Law• It applies to not only agriculture but alsoindustry - universal applicability• By substituting one factor in place of other,efficiency (or higher levels of productionand productivity) can be achieved• Remember the importance of capital andlabour as factors of production indeveloping nations
  9. 9. Law of Returns to Scale• What happens when all the inputs areincreased in the same proportion?• The scale of production will increase - buteffect on production shows three stages– Increasing Returns to Scale– Constant Returns to Scale– Diminishing Returns to Scale
  10. 10. Law of Returns to Scale
  11. 11. LawofReturnstoScale0510150 20 40 60 80ScaleReturns
  12. 12. Production FunctionIsoquant and Isocost Approach• An isoquant is a curve on which the variouscombinations of labor and capital show thesame output. This curve is also known asproduction indifference curve
  13. 13. Production FunctionIsocost Approach• Isocost curves are also known as outlay lines,price lines, input-price lines, factor-cost lines,constant-outlay lines etc. Each isocost linerepresents the different combinations of twoinputs that a firm can buy for a given sum ofmoney at the given price of each point.
  14. 14. Isocost - Diagram• The point where the isocost line tangent to an isoquant curverepresent the least-cost combination of the two factorscapitallabour
  15. 15. Equilibrium of a Firm -What isequilibrium?• Firms will produce in such a way that the profit ismaximized• Firms will not change the production function atequilibrium output• Profit = TR-TC• TR = P x Q (price x quantity)• AR = TR/Q = (P x Q)/Q = P– therefore, AR curve showing different values of AR atvarious levels of output is same as the demand curvefaced by an individual firm (latter shows quantities)
  16. 16. Shape of Demand Curve• Relationship between AR and Q is shown by theshape of the demand or AR curve– AR upward sloping or rising left to right– AR downward sloping– AR horizontal to X axis• First possibility is unlikely - a firm may not beable to sell larger and larger output by charginghigher and higher price• The second and third depends on the type ofmarket
  17. 17. Marginal Revenue• MR= TR (N+1) - TR (N) or change in totalrevenue upon change in quantity• Therefore, MR is equal to the slope of TR curve• Relation between AR and MR– MR = change TR/change Q• MR = change (PxQ)/change Q• = change (ARxQ)change Q• =AR(change Q/change Q) + Q (change AR/change Q)– MR=AR+Q(change AR/change Q)– therefore (MR-AR) = Qx(slope of AR curve)• MR = AR when AR is horizontal and MR is <AR whenAR is downward sloping