PCP SESSION 3 - 13 NOV 2011. PREPARED BY NISHANT GARG

1. PRODUCTION
• Refers to the transformation of resources into
output of goods and services
• Short Run
– Fixed Inputs
– Variable Inputs
• Production Function (refers to relation b/w
firm’s input of resources and output of goods)
– Q = Q(L, K), where L is Labour and K is capital
• Cobb-Douglas Production Function
– Q = ALµ K1-µ

2. • Total Product
– It is the output that can be produced using
various levels of inputs
• Average Product
– It is the total production divided by the number
of variable input employed
• Marginal Product
– change in output resulting from a change in
factor of production

3. Law of Diminishing Marginal Product
• It postulates that as more units of a variable
input are used with a fixed amount of other
inputs, after a point, a smaller and smaller return
will accrue to
• each additional unit of the variable unit. In other
words, the marginal product of the variable input
eventually declines
• This occurs because each additional unit of the
variable input has less and less of the fixed
inputs with which to work.

4. Law of Diminishing Marginal Product

5. Stages of Production

6. Stage I
• TPL, APL and MPL – all are rising. This
implies that as more and more input
• TPL increasing at increasing rate
• (Labour) is used in the production
process, the output due to labour in a
given situation increases.
• When APL is maximum, is equal to MPL.

7. Stage II
• This stage II begins where stage I ends
and continues up until stage III begins.
• In this stage, TPL is rising but at a falling
rate, such that both APL are MPL are
declining
• Till MPL becomes zero corresponding to
TPL reaching maximum.

8. Stage III
• It shows that both TPL and APL are
declining, so does MPL at a faster rate
• Such that it is negative (both in terms of
absolute level of output and relative rate of
change)

9. • If the firm intends to maximise production, it should employ O-L2
• If the firm intends to maximise production per unit of labour, it should
employ O-L1.
• If it wants to maximise additional output (production) per unit of
additional labour, it should employ O-L0.
• Under no circumstances it should employ any labour beyond O-L2,
because then the (marginal) productivity of labour is zero or negative.

10. PRODUCTION IN LONG RUN
• Increasing returns to scale occurs when the
percentage change in output is greater than the
percentage change in inputs.
• Decreasing returns to scale occurs when the
percentage change in input is greater than the
percentage change in output.
• Constant returns to scale occurs when the
percentage change in output is equal to
percentage change in input.

11. Returns to Scale

12. Marginal rate of technical substitution
• Measures how one factor of production is
substituted for another while keeping the
output constant
The marginal rate of technical substitution of
labour for capital K can be determined as:

13. Isoquant
• Represents Marginal Rate of Technical Substitution between factors K and L (ML

14. Isoquant - Features
• Negative slope
• Upper Isoquants represent higher level
of output
• Do not intersect each other

15. Economic Region of Production and
Ridge Lines

16. Isocost
For any given cost, the isocost line defines all combinations of capital and
labour inputs that can be purchased for Co (level of cost)

17. Equilibrium point of the firm