2.
Concept of Production
• In General Terms– Production means transforming inputs (labour, machines,
raw materials, time, etc.) into an output. This concept of production is
however limited to only ‘manufacturing’.
• In Managerial Terms – Creation of utility in a commodity is production.
• In Economical Terms – Production means a process by which resources
(men, material, time, etc.) are transformed into a different and more useful
commodity or service.
Where;
Input – It is a good or service that goes into the process of production.
Output – It is any good or service that comes out production process.
3.
The Production Function
• A Production Function is a tool of analysis used to explain the inputoutput relationship. It expresses physical relationship between production
inputs and the resultant output. It tells us that how much maximum output
can be obtained in the specified set of inputs and in the given state of
technology.
• Mathematically, the production function can be expressed as
Q=f(K, L)
Q is the level of output
K = units of capital
L = units of labour
•
f=
represents the production technology
4.
The Production Function(cont’d…)
• When discussing production function, it is important to distinguish between two time frames.
The shortrun production function which may also be termed as ‘single variable production
function’ describes the maximum quantity of good or service that can be produced by a set of
inputs, assuming that at least one of the inputs is fixed at some level which means that the
production can be increased by increasing the variable inputs only. It can be expressed as;
Q = f(L)
The longrun production function which may also be termed as ‘returns to scale’ describes the
maximum quantity of good or service that can be produced by a set of inputs, assuming that
the firm is free to adjust the level of all inputs. It can be expressed as;
Q = f(K, L)
5.
Production Function in the Long Run
• Long run production function shows relationship between inputs and
outputs under the condition that both the inputs, capital and labour, are
variable factors.
• In the long run, supply of both the inputs is supposed to be elastic and
firms can hire larger quantities of both labour and capital. With large
employment of capital and labour, the scale of production increases.
6.
Isoquant Curve
• The term ‘isoquant’ has been derived from the Greek word iso meaning ‘equal’ and
Latin word quantus meaning ‘quantity’. The ‘isoquant curve’ is, therefore, also
known as ‘Equal Product Curve’.
• An isoquant curve is locus of points representing various combinations of two
inputs  capital and labour  yielding the same output ,i.e., the factors combinations
are so formed that the substitution of one factor for the other leaves the output
unaffected.
• It is drawn on the basis of the assumption that there are only two inputs, i.e.,
labour(L) and capital(K), to produce a commodity X.
7.
Isoquant Schedule
A schedule showing various combinations of two inputs (say labour and
capital) at which a producer gets equal output is known as isoquant
schedule. The table depicts that all combinations A,B,C,D and E of
labour and capital give 2000 units of output to a producer. Hence, the
producer remains neutral.
Combination
Labour
(L)
Capital
(K)
Output
(Q,Units)
A
1
15
2000
B
2
10
2000
C
3
6
2000
D
4
3
2000
E
5
1
2000
8.
Isoquant Curve Diagrammatic Presentation
Y
Capital
A
K2
B
K1
0
L1
L2
Labour
IP
(2000 units)
X
9.
Characteristics of Isoquant Curve
• They slope downward to the right : They slope downward to the right because if one of the inputs
is reduced, the other input has to be so increased that the total output remains unaffected.
• They are convex to the origin : They are convex to the origin because of Marginal Rate of
Technical Substitution of labour for capital. (MRTSLK) is diminishing. MRTSLK is the slope of an
isoquant curve. Isoquant curves are negatively sloped.
• Two isoquant curves do not intersect each other : Two isoquant curves do not intersect each
other as it is against the fundamental condition that a producer gets equal output along an isoquant
curve.
• Higher the isoquant curve higher the output : A producer gets equal output along an isoquant
curve but he does not get equal output among the isoquant curves. A higher isoquant curve yields
higher level of output.
10.
Marginal Rate of Technical
Substitution (MRTS)
The MRTSlk is the amount of capital forgone for employing an
additional amount of labour. Hence, it is a rate of change in factor K in
relation to one unit change in factor L. This rate of change is
diminishing. So the slope of isoproduct curve is diminishing.
Slope = dK/dL = change in capital/change in labour = MRTSlk
Combination
Labour
(L)
Capital
(K)
MRTSlk
A
1
15

B
2
10
5/1
C
3
6
4/1
D
4
3
3/1
E
5
1
2/1
(dk/dl)
12.
Isoquant Curve
Y
E
5
4
Capital
3
A
B
C
2
D
1
1
2
3
Labour
Q3 =90
Q2 =75
Q1 =55
4
5
X
13.
Isocost Curves
An Isocost curve on the one hand shows the resources of producer and on the other hand it
shows relative factor price ratio. It shows various combinations of two factors (say labour
and capital) that can be employed by the producer in the given producer’s resources.
Y K
Slope = w/r
Capital
Cost Region
0
Labour
L
X
Its slope is given by relative factor prices i.e. w/r where w is wage rate (price of labour) and r is
rate of interest (price of capital). The area under an isocost line is known as cost region. In order
to obtain least cost combination, cost region is super imposed over production region.
14.
Increasing
returns to scale
Total output may increase
more than proportionately
Constant
returns to scale
Total output may
Increase proportionately
Diminishing
returns to scale
Total output may increase
Less than proportionately
15.
Increasing Returns to Scale
When a certain proportionate change in both the inputs, K and L, leads to a more
than proportionate change in output, it exhibits increasing returns to scale. For
example, if quantities of both the inputs, K and L, are successively doubled and
the corresponding output is more than doubled, the returns to scale is said to be
increasing.
Labour and
Capital
Output
ScheduleProportional
(TP)
change in
labour and
capital
Proportional
change in
output
1+1
10


2+2
22
100
120
4+4
50
100
127.2
8+8
125
100
150
16.
Increasing Returns to ScaleDiagrammatic Presentation
Y
Scale Line
A
OP>PQ>QR>RS
S
R
Capital
Q
IP4 (400)
IP3 (300)
IP2 (200)
P
IP1 (100)
0
X
Labour
17.
Constant Returns to Scale
When the change in output is proportional to the change in inputs, it exhibits
constant returns to scale. For example, if quantities of both the inputs, K and L,
are doubled and output is also doubled, then returns to scale are said to be
constant.
Schedule
Labour and
Capital
Output
(TP)
Proportional
change in
labour and
capital
1+1
10


2+2
20
100
100
4+4
40
100
100
8+8
80
100
100
Proportional
change in
output
18.
Constant Returns to ScaleDiagrammatic Presentation
Y
Scale Line
A
OP=PQ=QR=RS
S
R
Capital
IP4 (400)
Q
IP3 (300)
P
IP2 (200)
IP1 (100)
0
X
Labour
19.
Diminishing Returns to Scale
When a certain proportionate change in inputs, K and L, leads to a less than
proportionate change in output. For example, when inputs are doubled and output is
less than doubled, then decreasing returns to scale is in operation.
Schedule
Labour and
Capital
Output
(TP)
Proportional
change in
labour and
capital
Proportional
change in
output
1+1
10


2+2
18
100
80
4+4
30
100
66.6
8+8
45
100
50
20.
Diminishing Returns to ScaleDiagrammatic Presentation
Y
OP<PQ<QR<RS
S
Scale Line
A
IP4 (400)
R
Capital
IP3 (300)
Q
P
IP2 (200)
IP1 (100)
0
Labour
X
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