2. What is production?
“Production is the process that transforms
inputs into output.”
“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.”
3. Production Function
“ A production function refers to the functional relationship,
under the given technology, between physical rates of
input and output of a firm, per unit of time.”
Q = f ( a, b, c…..n T)
Q = f ( K, L)
Attributes of production function
- Flow concept
- Physical concept
- State of technology and inputs
4. Managerial uses of production function
- Least-Cost-Factors combination
- Optimum level of output
- Programming technique in production planning
- Equilibrium level of output
- Returns to scale
Short run: Short run refers to a period of time in which
supply of certain factor inputs is fixed or inelastic.
Long 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.
Very long 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.
5. Key terms in production analysis
Total product (TP): The total amount of output
resulting from a given production function
Average product(AP): Total product per unit of
given input factor.
Marginal product(MP): The change in total
product per unit change in given input factor.
6. Short run analysis of production function
Law of diminishing marginal returns/Law of
returns to a variable input
“ As more and more units of a variable factor input are
employed, all other input quantities held constant, the total
output may initially increase at an increasing rate and then
at a constant rate but it will eventually increase at
diminishing rates”
“During short period, under the given state of technology and
other conditions remaining unchanged, with the given
fixed factors, when the units of a variable factor are
increased in the production function in order to increase the
TP, the TP initially may rise at an increasing rate and after
a point it tends to increase at a decreasing rate because the
MP of the variable factor in the beginning may tend to rise
but eventually tend to diminish.”
7. Assumptions
- State of technology is given
- Labour is homogeneous
- Input prices are given
Three stages of production
- Stage I: Increasing Returns – TP increases at increasing
rate, indicated by increasing MP.
- There is intermediary constant stage between stage I &
stage II. TP increases at a constant rate indicated by
constant MP
- Stage II: Diminishing Returns – TP continues to increase
but at diminishing rates, indicated by declining MP
- Stage III: Negative Returns – TP begins to decline,
indicated by negative MP
8. Three stages of production
Continues to diminish
(but must always be
greater than zero)
Keeps on declining and
becomes negative
STAGE III
Reaches its maximum,
becomes constant and
then starts declining
Starts diminishing
Starts diminishing and
becomes equal to zero
STAGE II
Increases at a
diminishing rate and
becomes maximum
Increases (but slower
than MP)
Increases and reaches
its maximum
STAGE I
Increases at an
increasing rate
Average Product
Marginal Product
Total Product
9. Factors behind the law
-- Stage I & II ( up to optimum fixed & variable
factor combination )
- Indivisibility of fixed factors
- Division of labour
-- Stage III
- Improper substitution of variable factor for fixed
factor
10. Production Function With Two Variable
Inputs
This may be taken either as a short run or a long run
analysis of production process.
- Long run analysis : The firm uses only two inputs and both
of them are variable.
- Short run analysis : The firm uses more than two inputs but
only two of them are variable and others are fixed.
Isoquants : An Isoquant is a curve representing various
combinations of two variable inputs that produce same
amount of output.
- This is also known as Iso-Product curve, Equal-Product
curve or Production Indifference curve.
11. Properties of Isoquants
It is downward sloping to the right (negatively inclined)
It is convex to origin (Marginal Rate of Technical
Substitution)
Higher isoquant represents larger output
No two isoquants intersect
Types of Isoquants
Linear isoquants – Perfect substitutability between
factors of production
Input-Output isoquants – Strict complimentarity / zero
substitutability between input factors (fixed factor – proportion
isoquants)
Kinked isoquants – Limited substitutability between
input factors
Smooth, convex isoquants – Continuous substitutability
over a certain range between the input factors
12. Marginal Rate of Technical Substitution
MRTS is the number of units of an input factor ( ex: K ) that a
producer is willing to sacrifice for an additional unit of another
input factor (ex: L) , so as to maintain the same level of output.
(i.e., to remain on the same isoquant.)
Isoquant Map: A whole array of isoquants represented on a
graph is called an isoquant map.
Economic Regions of Production – The ridge lines : The ranges
over which the marginal products of the inputs are diminishing
but positive.
- On a convex isoquant the MRTS decreases along the isoquant
and can become zero. A zero MRTS determines the minimum
quantity of an input which must be used to produce a given
output. Beyond this point an additional employment of one
input will necessitate employing additional units of other input.
- A ridge line is the locus of points of isoquants where MP of
input is zero.
13. Input Prices And Isocost Line ( budget line)
Optimal Factor Combination
- Production of given output at given cost
- Production of maximum output with the given level of cost
- Changes in firm’s resources and output: The Expansion path
- Changes in factor prices and choice of technique
14. Laws of Returns to Scale
The percentage increase in output when all inputs vary in
the same proportion is known as returns to scale. It
obviously relates to greater use of inputs maintaining the
same technique of production.
Three Situations of Returns To Scale
- Increasing Returns to Scale – Output increases by a
greater proportion than the increase in input.
- Constant Returns to Scale – Output increases in same
proportion as increase in inputs.
- Decreasing Returns to Scale – Output increases in a lesser
proportion than the increase in input.
15. Economies of Large Scale Production
Internal Economies of scale: They are those advantages
which are open to an individual firm when its size expands.
Labour Economies
Technical Economies
- Superior Technique - Increased Dimension
- Linked Processes - By- products
Managerial Economies
Marketing or Commercial Economies
Financial Economies
Transport & Storage Economies
Overhead Economies
Economies of Vertical Integration
Risk bearing Economies
- Diversification of output - Diversification of market
- Diversification of source of supply – Diversification of
process of manufacturing
16. External Economies of scale: They are those benefits or advantages
available to all the firms in the industry from outside, irrespective of
their size and scale of operation, due to expansion of the industry size.
Economies of Localisation / Concentration`
Economies of Information
Economies of Vertical Disintegration
Economies of By- products
Internal Diseconomies of scale:
Difficulties of management
Difficulties of Co-Ordination
Difficulties of Decision making
Increased risk
Labour Diseconomies
Scarcity of Factor Supplies
Financial difficulties
Market diseconomies
External Diseconomies of scale:
