Information about production theory..

1. Prepared by
Raj Naik
SY CE-1
150410107053

2.  Production theory is the study of production, or
the economic process of converting inputs into
outputs.
 An input is good or service that goes into the
process of production and output is any good or
service that comes out of production process.
 Production involves transformation of inputs such
as capital, equipment, labor, and land into output
- goods and services

4.  The factors of production describe the function that
each resource performs in the business
environment.
 The inputs or resources used in the production
process are called factors of production.
 They are:
1.Land
2.Labour
3.Capital
4.Entrepreneurship

5.  Land is the economic resource encompassing
natural resources. This resource includes timber,
fisheries, farms etc.
 Land is usually a limited resource for many
economies.
 Nations must carefully use their land resource by
creating a mixture of natural and industrial uses.

6.  Labor represents the human capital available to
transform raw materials into consumer goods.
 This factor of production is a flexible resource as
workers can be allocated to different areas of the
economy for producing consumer goods or services.

7.  Capital can represent the monetary resources
companies use to purchase natural resources , land
and other capital goods.
 Capital also represents the major physical assets
that companies and individuals use when producing
goods and services.

8.  Entrepreneurs usually have an idea for creating a
valuable good or service and assume the risk
involved with transforming economic resources into
consumer products.
 Entrepreneurship is also considered as a factor of
production since someone must complete the
managerial functions of gathering, allocating and
distributing economic resources or consumer
products to individuals and other businesses in the
economy.

9.  The production function shows the relation between input
changes and output changes. It also shows the maximum
amount of output that can be obtained by the firm from a
fixed quantity of resources.
 Production Function is the relation between a firms
physical production and the material factors of
production.
 Q= f (L, C, N )
Where, Q= quantity of output,
L=Labour, C=Capital, N=Land

10.  The volume of output of the firm’s product, per
period of time, depends on the quantities of these
factors that are used by the firm.
 The firm wishes to increase its volume of output.
This can be achieved by increasing the inputs of one
or both factors of production.
 However, it is very easy to vary the quantity of labour
in the production process. It can be done very
quickly (in a week or a month).
 On the other hand, a fairly long period of time is
required to vary the quantity of other factors, for
example, change the quantity (or usage) of capital,
e.g. to install a new machine.

11.  Here, the firm is making decisions within two time
periods which are production function — the short-
run and the long-run.
 The distinction between the short-run and the long-
run is based on the difference between fixed and
variable factors.
 A factor of production is treated as a fixed factor if it
cannot easily be varied over the time period under
consideration. Ex. Capital
 On the other hand, a variable factor is one which
can be varied over the time period under
consideration. Ex. Labor

12.  The short-run refers to the period of time over which one
or more factors of production are fixed.
 In the real world, land and capital (such as plant and
equipment) are usually treated as fixed factors. Here we
are considering a simple production process with only
two factors. We treat capital as the fixed factor and labour
as the variable factor.
 An increase in production during this period is possible
only by variable input.
 If the firm wishes to vary its production in the short-run, it
can do so only by changing the quantity of labour.
 In some Industries short run maybe a matter of few
weeks or a few months and in some others it may extent
even up to three or four years.

13.  On the other hand the long- run is defined as the
period over which all factors of production can be
varied, within the confines of existing technology.
 In the long-run all factors are variable.
 More capital and less labour or more labour and less
capital can be used to produce a fixed amount of
output.
 The long run refers to a period of time in which
supply of all the input is elastic; but not enough to
permit a change in technology.
 Thus in long run, production of commodity can be
increased by employing more of both ,variable and
fixed inputs.

14.  The boundary between the short-run and the long-
run is not defined by reference to any calendar—a
year, or a month or a quarter.
 It varies from industry to industry and from time to
time within the same industry.
 In most plantation industries the long-run is 15-20
years.
 For example, rubber trees require a very long time to
grow. On the other hand, in a barber’s shop it may
be just a week.

15.  This law examines the production function with one factor
variable, keeping the quantities of other factors fixed.
 In other words, it refers to the input-output relation when
output is increased by varying the quantity of one input.
 When the quantity of one factor is varied, keeping the
quantity of other factors constant, the proportion between
the variable factor and the fixed factor is altered.
 Variable proportions is also known as the “Law of
Diminishing Returns” of classical economics.
 This law has played a vital role in the history of economic
thought and occupies an equally important place in
modern economic theory.

16.  Total Product is the total of output, resulting from
efforts of all factors of production.
 Average Product is the total product per unit of the
variable factor.
 Marginal Product is addition made to the Total
Product as a result of production of one more unit of
output.

17.  The law of “Diminishing returns” levels that any
attempt to increase output by increasing only one
factor finally faces diminishing returns.
 The law states that when some factor remain
constant, more and more units of a variable factor
are introduced the production may increase initially
at an increasing rate; but after a point it increases
only at diminishing rate.
 Land and Capital remain fixed in the short term
whereas labour shows a variable nature.

18. Amount of
variable factor
Total Product Average Product Marginal Prouct
1
2
3
4
5
6
7
8
9
10
10
22
36
52
66
76
82
85
85
83
10
11
12
13
13.2
12.7
11.7
10.5
9.05
8.3
10
12
14
16
14
10
6
3
0
-2

19.  Here from the table both AP and MP first rise, reach a
maximum then decline.
 AP is the product for a unit of labour. It is arrived by
dividing the TP by number of workers.
 MP is found out by dividing the change in TP by the
change in worker.
 Here additional labour at the 4th place which clearly faces
the law of diminishing returns.
 The maximum MP is 16 after which it continues to fall,
ultimately becoming negative.
 Thus when more and more units of labour are combined
with other fixed factors the total output increases first at
an increasing rate than at a diminishing rate finally it
becomes negative.
 The graphical representation is as below,

21.  Here the TP curve has a steep rise till the employment of
the 4th worker. This shows that the output increases at an
increasing rate till the employment of the 4th labour. TP
curve still goes on increasing but only at a diminishing
rate. Finally TP curve shows a downward trend.
 At the first stage, TP increasing at a increasing rate. The
MP at this stage increases in a increasing rate resulting
in a greater increases in TP. The average product also
increases. This stage continues up to the point where AP
is equal to MP. The law of increasing returns is in
operation at this stage.
 The law of increasing returns operates from the second
stage onwards. At second stage, the TP continues to
increase but at a diminishing rate. As the MP at this stage
starts falling, the AP also declines. The second stage
comes to an end where TP become max and MP become
zero.
 The MP becomes negative in the third stage. So the TP
also decline in the third stage.

22.  The production technology remains unchanged. If
there is improvement in the technology, then
marginal and average products may rise instead of
diminishing.
 There must be some inputs whose quantity is kept
fixed. This law does not apply in case all factors are
proportionately varied.
 The variable factor is homogeneous.
 Any one factor is constant.

23.  In the long run all the factor of production are
variable and an increase in output is possible by
increasing all the inputs.
 The law of returns to scale explains, how a
simultaneous and proportionate increase in all
the inputs affect the total output.

24. Returns to scale are of the following
three types:
 Increasing Returns to scale
 Constant Returns to Scale
 Diminishing Returns to Scale

25.  When proportionate increase in all factor of
production results in a more than proportionate
increase in output and this results in the first stage of
production which is known as increasing returns to
scale.
 Marginal output increases at this stage.
 Higher degree of specialization, falling cost will lead
higher efficiency which results increase returns in
very first stage of production

26.  The table shows that the input is increasing by
100%, on the other hand the output is increased by
150%. This shows the increasing returns to scale. As
changes in the output is more than the change in
input.

27.  Firms cannot maintain increasing returns to scale
indefinitely after the first stage , firm enters a stage
when total output tends to increase at a rate which is
equal to rate of increase in inputs.

28.  The above example shows that as the inputs (i.e.
labour and capital) increased to 100%, output also
increased to 100%.

29.  In this stage ,a proportionate increase in all the input
result only less than proportionate increase in output.
 When the firm grows further , the problem of
management arise which result inefficiency and it will
affect the position of output.

30.  The above shows, that inputs ate increases to 100%
but the increase output is 50%, which shows that
there is decreasing returns to scale.

31.  Philips was established in 1891 and made light bulbs - a
simple product.
 Throughout the years the company increased its
portfolio into technology products that became too
complex for most users.
 When Philips realised this, it decided to make life
easier and so launched a brand repositioning all about
simplicity.
 'sense and simplicity' is the brand promise that Philips
has identified through its research.

32.  It illustrates two key dimensions:
1. Simplicity
2. value-for-money technology products.

33.  The stages involved in moving a product are:
1. Carrying out research to find out the weaknesses of
the starting position
2. Researching a right direction
3. Making plans and taking actions to improve the
position.

34.  The brand promise 'sense and simplicity' is so
important to Philips.
 This entails three main elements:

35.  The problem facing the company was lack of constancy and
direction.
 Resources were being spread too thinly across too many
products.
 Decision making within the Philips organisation had
become patchy.
 This was plain to see - there were too many products, too
many markets and a lack of consistency in advertising.
 For the consumer it was hard to tell what was and what was
not a Philips product.
 The first challenge was to change the Philips image.
 This was built around 'sense and simplicity'.

36.  They have main focused on meeting customer needs.
 New Philips' products are:
1. Advanced - based on market leading technologies
2. Designed around you - based on the findings of
careful customer research
3. Easy to experience - easy to use.
 Philips is also looking at all of its existing products to
make sure they fit the needs of 'sense and simplicity'.

37.  We can show the new repositioning strategy by taking
the example of some of the high-tech products that
Philips has just worked on.
 A good example of this is Senseo®.
 Senseo® Coffee System has been developed through a
partnership between Philips and Sara Lee, a Fast
Moving Consumer Goods (FMCG) supplier.
 The key aspects of Senseo® are:
1. Cool design
2. Easy-to-use technology
3. Amazing coffee.

38.  Between 2001 and 2005 more than 10 million of
these coffee machines were sold in eight countries
- an impressive total. The product embodies what
Philips is trying to achieve in everything it does.
This is to join an exciting state-of-the-art product
with simplicity. The coffee makers are combined
with Douwe Egberts Senseo® coffee pods to give
customers the taste they want.

39.  At the heart of business, success is good communication.
 There are a number of ways that Philips does this:
1. As it is a global company, it is important to make direct contact
from the centre. This ensures that the 'Philips message' is
conveyed consistently.
2. Philips believes that there should be a single insight for each
product.
3. All creative work carried out by advertising agencies must be
based on the 'sense and simplicity' promise.
4. Television and print (for example, magazine) adverts are
presented in a standard way - at least three Philips adverts in a
single magazine.

40.  ‘Sense and simplicity’ is the brand promise for the Philips
organisation.
 The need for change was seen as a result of customer research.
Products and processes need to be made with the customer in
mind.
 Modern consumers want to use high-tech products. They also
want to find that these products are simple and easy to use.
 Philips has therefore transformed all aspects of its planning.
 It has also looked closely at operations to make sure that
'sense and simplicity' drives everything that the company
does.
 It also operates with outside experts, such as the Simplicity
Advisory Board, to create an outside-in way of working.