The document discusses production theory, including defining production as the transformation of inputs into outputs. It distinguishes between fixed and variable inputs, and short-run and long-run production analysis. Key concepts covered include total, marginal, and average product; the three stages of production; and determining the optimal level of a variable input by comparing its marginal revenue product to its marginal resource cost.

1. Theory of Production

2. Agenda
• What is production?
• Fixed and Variable inputs
• Short Run and Long Run Analysis
• Total, Marginal and Average Product
• Three stages of Production
• Marginal Revenue Product and Marginal Resource Cost
• Optimal level of variable input given a fixed input

3. What is Production?
The process transforming inputs into outputs of goods or services that are valued
higher than the inputs collectively.
Inputs may be fixed in nature or may be variable
• Fixed inputs: Those inputs whose level of engagement cannot be changed during the
time when planning is completed and plant is in operation e.g. Land, Machinery,
Equated monthly instalments on loans
• Variable inputs: Those inputs whose level of engagement can be changed while the
plant is in operation e.g. Amount of raw material processed may change daily;
electricity as input may vary

4. Period of Analysis: Long vs Short Run
• Short Run: A period during which, out of many inputs that a production
process has, if at least one input can not be changed, that period is
called short run.
• Long Run: Any time period where all the inputs can be changed is called
Long Run.

5. The Production Function
• Its the expression of relationship between two or more inputs to yield
maximum output in the given time period

6. Production Function with One Variable Input
• Total Product (TPL) or Output
TPL = Q = f(K,L) where K is constant
• Marginal Product (MPL)
MPL =
• Average Product (APL)
APL =
• Production or Output Elasticity

7. Labor Total Product Marginal Product Average Product Output Elasticity
1 10 10 10 1.00
2 30 20 15 1.33
3 54 24 18 1.33
4 72 18 18 1.00
5 85 13 17 0.76
6 90 5 15 0.33
7 90 0 13 0.00
8 88 -2 11 -0.18

8. 10
30
54
72
85
90 90
88
10
20
24
18
13
5
0
-2
10
15
18 18 17
15
13
11
-20
0
20
40
60
80
100
1 2 3 4 5 6 7 8
Total,
Marginal
and
Average
Product
Labor
One Variable Production Function
Total Product
Marginal Product
Average Product

9. The Three Stages of Production
• First Stage of Production
It ranges from zero labor employment to the stage when when labor productivity in the
system is maximum i.e. APL is maximum.
• Second Stage of Production
It ranges from point where labour productivity i.e. APL is maximum to the level of labor
employment where the contribution the labor becomes zero i.e where MPL = 0.
• Third Stage of Production
It begins from the stage where labor yields zero marginal product and continues thereafter.
In this stage the Marginal Product of labor i.e. MPL < 0.
• Law of Diminishing Returns
As we increase the level of the variable input in a production system, given a fixed amount
of the other input, the output from variable inputs tends to diminish.

10. The Three Stages of Production
10
30
54
72
85
90 90 88
10
20
24
18
13
5
0 -2
10
15
18 18 17 15 13 11
-20
0
20
40
60
80
100
1 2 3 4 5 6 7 8
Total,
Marginal
and
Average
Product
Labor
One Variable Production Function
Total Product
Marginal Product
Average Product

11. Finding the Optimal level of Variable Input
• Labor will be hired till the time it is able to create a value more than what is
paid to it.
• Value that labor creates is called Marginal Revenue Product, which is a product
of MR and MPL
• MRPL = (MPL) (MR)
• The cost of labour is the wage paid to labor for producing that additional unit
or the Marginal Resource Cost
• Optimal Level of Labor input

12. Finding the Optimal level of Variable Input
Labor
Marginal
Product
Marginal
Revenue
Marginal
Revenue
Marginal
Resource Cost
MPL MR Product
1 10 10 100 65
2 20 9 180 65
3 24 8 192 65
4 18 7 126 65
5 13 5 65 65
6 5 3 15 65
7 0 0 0 65
8 -2 65

13. Finding the Optimal level of Variable Input
0
50
100
150
200
250
1 2 3 4 5 6 7
Optimal Usage of Variable Input
MRPL MRCL

14. Summary
• Production is a process of transformation of inputs into output.
• Inputs that can’t be changed during the production cycle are called fixed
inputs while the ones that can change are called variable inputs
• A production process where at least one input is fixed is called short run
production function
• In case all inputs are variable then the production function represents
long run
• Second stage of production is the most efficient stage of production as
none of the inputs have negative marginal product
• Labor will be employed to the extent when MRC = MRP