Production theory presentation credited Vandana Tiwari

1. Theory of Production

2. Theory of Production
 Production is a process that create/adds value or
utility
 It is the process in which the inputs are converted in
to outputs.

3. Production function
Production is the result of co-operation of four factors of
production viz.,
•Land,
•Labor,
•Capital
• Organization.
This is evident from the fact that no single commodity
can be produced without the help of any one of these
four factors of production.
Therefore, the producer combines all the four factors of
production in a technical proportion. The aim of the
producer is to maximize his profit. For this sake, he
decides to maximize the production at minimum cost by
means of the best combination of factors of production.

4. Production Function
 Production function means the functional relationship
between inputs and outputs in the process of
production.
 It is a technical relation which connects factors inputs
used in the production function and the level of
outputs
Q = f (Land, Labour, Capital, Organization, Technology, etc)

5. Factors of Production

6. The producer secures the best combination by applying the
principles of equi-marginal returns and substitution.
According to the principle of equi-marginal returns, any
producer can have maximum production only when the
marginal returns of all the factors of production are equal to
one another. For instance, when the marginal product of the
land is equal to that of labour, capital and organisation, the
production becomes maximum.
In simple words, production function refers to the functional
relationship between the quantity of a good produced
(output) and factors of production (inputs).
“The production function is purely a technical relation which
connects factor inputs and output.” Prof. Koutsoyiannis

7. Inputs : Fixed inputs and Variable inputs
 The factors of production that is carry out the
production is called inputs.
 Land, Labour, Capital, Organizer, Technology, are
the example of inputs
Inputs Factors
Variable inputs Fixed Inputs

8. Inputs : Fixed inputs and Variable inputs
 Remain the same in the
short period .
 At any level of out put, the
amount is remain the same.
 The cost of these inputs are
called Fixed Cost
 Examples:- Building, Land
etc
 ( In the long run fixed inputs are
become varies)
Fixed inputs Variable inputs
 In the long run all factors
of production are varies
according to the volume of
outputs.
 The cost of variable inputs
is called Variable Cost
 Example:- Raw materials,
labour, etc

9. In this way, production function reflects how much output
we can expect if we have so much of labour and so much of
capital as well as of labour etc.
In other words, we can say that production function is an
indicator of the physical relationship between the inputs and
output of a firm.
The reason behind physical relationship is that money prices
do not appear in it.
However, here one thing that becomes most important to
quote is that like demand function a production function is
for a definite period.
It shows the flow of inputs resulting into a flow of output
during some time. The production function of a firm
depends on the state of technology. With every development
in technology the production function of the firm undergoes
a change.

10. Mathematically, such a basic relationship between
inputs and outputs may be expressed as:
Q = f( L, C, N )
Where Q = Quantity of output
L = Labour
C = Capital
N = Land.
Hence, the level of output (Q), depends on the
quantities of different inputs (L, C, N) available to the
firm. In the simplest case, where there are only two
inputs, labour (L) and capital (C) and one output (Q),
the production function becomes.
Q =f (L, C)

11. Definitions:
“The production function is a technical or engineering relation
between input and output. As long as the natural laws of
technology remain unchanged, the production function remains
unchanged.” Prof. L.R. Klein
“Production function is the relationship between inputs of
productive services per unit of time and outputs of product per unit
of time.” Prof. George J. Stigler
“The relationship between inputs and outputs is summarized in
what is called the production function. This is a technological
relation showing for a given state of technological knowledge how
much can be produced with given amounts of inputs.” Prof. Richard
J. Lipsey
Thus, from the above definitions, we can conclude that production
function shows for a given state of technological knowledge, the
relation between physical quantities of inputs and outputs
achieved per period of time.

12. Features of Production Function:
1. Substitutability:
The factors of production or inputs are substitutes of one another which make it
possible to vary the total output by changing the quantity of one or a few inputs,
while the quantities of all other inputs are held constant. It is the substitutability of
the factors of production that gives rise to the laws of variable proportions.
2. Complementary:
The factors of production are also complementary to one another, that is, the two or
more inputs are to be used together as nothing will be produced if the quantity of
either of the inputs used in the production process is zero.
3. Specificity:
It reveals that the inputs are specific to the production of a particular product.
Machines and equipment’s, specialized workers and raw materials are a few
examples of the specificity of factors of production. The specificity may not be
complete as factors may be used for production of other commodities too.
4. Time bound:
Production involves time; hence, the way the inputs are combined is determined to
a large extent by the time period under consideration. The greater the time period,
the greater the freedom the producer has to vary the quantities of various inputs
used in the production process.

13. The laws of production describe the technically
possible ways of increasing the level
of production. ... The expansion of output with
one factor (at least) constant is described by
the law of (eventually) diminishing returns of the
variable factor, which is often referred to as
the law of variable proportions.
Laws of Production

14. Law of Production Function
o Laws of Variable proportion- Law of
Diminishing Return ( Short run production
function with at least one input is variable)
i Laws of Return scales – Long run production
function with all inputs factors are variable.

15. •
Law of variable proportion: Short
run Production Function
 Explain short run production function
 Production function with at least one variable factor
keeping the quantities of others inputs as a Fixed.
 Show the input-out put relation when one inputs is
variable
“If one of the variable factor of production used more
and more unit,keeping other inputs fixed, the total
product(TP) will increase at an increase rate in the
first stage, and in the second stage TP continuously
increase but at diminishing rate and eventually TP
decrease.”

16. Law is based on following assumptions
• The technique of production remains same.
• This law is adopted for short run only.
• Labor and raw material are variable factors.
• Other inputs must be kept constant.
• All factors are not kept rigidly fixed proportions but the
law is based upon the possibility of varying proportions
such electricity consumption. So, this law is also called
the law of proportionality.
• Units produced during production are homogeneous in
amount and quality.

17. (L)
Capital
(K)
Total
Output
(TP)
Average
Product
(AP)
10 10 100
10
20
30
20
15
13
4
0
10
Marginal Product
(MP)
0 10 10 0 -
1 10 10 10 10
2 10 10 30 15
3 10 10 60 20
4 10 10 80 20
5 10 10 95 19
6 10 10 108 18
7 10 10 112 16
8 10 10 112 14
9 10 10 108 12
10
Labour Land
First Stage
Second Stage
-4
Third Stage
-8
Short run Production Function with Labour as Variable factor

18. A
C
B
Total Product
Labor per month
8
8
3 4
3 4
E
Average product
Marginal product
112
Output per
month
Labor per month
60
30
20
10
D
First Stage
Second Stage
Third Stage

21. Stages in Law of variable proportion
First Stage: Increasing return




TP increase at increasing rate till the end of the stage.
AP also increase and reaches at highest point at the end of the stage.
MP also increase at it become equal to AP at the end of the stage.
MP>AP
Second Stage: Diminishing return
 TP increase but at diminishing rate and it reach at highest at the end of
the stage.
 AP and MP are decreasing but both are positive.
 MP become zero when TP is at Maximum, at the end of the stage
 MP<AP.
Third Stage: Negative return


TP decrease and TP Curve slopes downward
As TP is decrease MP is negative. AP is decreasing but positive.

22. Where should rational firm produce?

23.  Stage I: MP is above AP implies an increase in input increases
output in greater proportion.
 The firm is not making the best possible use of the fixed factor.
 So, the firm has an incentive to increase input until it crosses over
to stage II.
 Stage III: MP is negative implies contribution of additional labor
is negative so the total output decreases .
 In this case it will be unwise to employ an additional labor.
Where should rational firm produce?

24.  Stage II: MP is below AP implies increase in input
increases output in lesser proportion.
 A rational producer/firm should produce in stage II.
 But where exactly the firm will operate within stage II
cannot be determined only on the basis of the product
curves.
 We need information about input costs and price of
output.

25. 2. Law of return to scales: Long run
Production Function
 long runproduction function works when the
inputs are changed in the same proportion.
 Production function with all factors of productions
are variable..
 Show the input-out put relation in the long run with
all inputs are variable.
“Return to scale refers to the relationship between
changes of outputs and proportionate changes in the
in all factors of production ”

26. Returns to scale,is the quantitative change in output of a
firm or industry resulting from a proportionate increase
in all inputs.
If the quantity of output rises by a greater proportion—
e.g., if output increases by 2.5 times in response to a
doubling of all inputs—the production process is said to
exhibit increasing returns to scale.
Such economies of scale may occur because greater
efficiency is obtained as the firm moves from small- to
large-scale operations.
Decreasing returns to scale occur if the production
process becomes less efficient as production is expanded,
as when a firm becomes too large to be managed
effectively as a single unit.

27. Law of Returns to Scale
• Following are the three laws of returns to
scale
• (1)Law of increasing Returns
• (2)Law of Constant Returns
• (3)Law of Diminishing Returns

28. Law is based on following assumptions
• There is a scope of further improvement in the
technique of production.
• At least one factor(such as land available) of
production is assumed to be indivisible.
• Some factors(labor and capital) are assumed to
be divisible.
• There is no change in the prices of factors of
production.
• All units of variable factors are equally efficient.

29. Law of return to scales: Long run Production Function
Labour Capital TP MP
2 1 8 8
4 2 18 10
6 3 30 12
8 4 40 10
10 5 50 10
12 6 60 10
14 7 68 8
16 8 74 6
18 9 78 4
Increasing returns to scale
Constant returns to scale
Decreasing returns to scale

30. •
Law of return to scales: Long run
Production Function
Increasing returns to scale
Constant returns to scale
Decreasing returns to scale
Inputs 10% increase – Outputs 15% increase
Inputs 10% increase – Outputs 10% increase
Inputs 10% increase – Outputs 5% increase

31. (1)Law of increasing Returns
• “In a given state of technology when the units
of variable factors are increased with the units
of fixed factors, the marginal productivity
increases, it is called law of increasing
returns.”

32. Application of the law
• The law of increasing return operators in such
manufacturing industries where:
• Factors of production are combined and substituted up
to some extent.
• The principle of specialization is applicable in industrial
units. The marginal productivity increase due to
specialization.
• In industrial sector human factors are more involved
than natural factors. Due to this reason natural
obstacles are less effective.
• An industry is expanded by getting the internal and
external economies of large scale of production.

33. (2)Law of Constant Returns
• “ When the units of
variable factors are
increased with the
units of other fixed
factors, the marginal
productivity remains
constant. It is called
constant return.”

34. Application of the law
• This law is applicable in those sectors where human
and natural factors play their role, for example, in
industry making blankets, pure natural wool is used
while blankets are prepared in the presence of
human factors.
• Such factors where economies of human and natural
factors are presented which counter balanced each
other and productivity is provided with constant.
• This law is more applicable in such sectors
where labor’s roe is greater than other factors of
production. the law of constant returns operates by
increasing the units of labor force

35. (3)Law of Diminishing Returns
• “In a given state of technology when the units of
variable factors of production are increased with the
units of other fixed factor, the marginal productivity
decreases it is called law of diminishing returns.”

36. Application of the law
• The natural factors have role than human
factors in agricultural sector and marginal
productivity decreases.
• The sector has very wide area and supervision
cannot be very effective.
• Scope of specialized machinery is limited.
• There are other limitations of nature e.g. rain,
climate changes etc.
• The fertility land also declines with time.

37. Alternative Method:
“However, the technological conditions of production may be such that returns to
scale may vary over different ranges of output. Over some range, we may have
constant returns to scale, while over another range we may have increasing or
decreasing returns to scale.”
To explain it we draw an expansion path OR from the origin in Fig. 11 This are
divided into segments by the successive isoquants representing equal increments
in output, i.e., 100, 200, 300 and so on. As we move along the expansion path, the
distance between the successive isoquants diminishes, it is a case of increasing re-
turns to scale.