PRODUCTION
Any activity which creates value is production
In other words, production is transformation of
inputs (such as capital, equipment, labor and land
etc.) into output (such as good or service)
PRODUCTION FUNCTION
Production Function is an expression of the technological
relation between physical inputs and outputs of a good.
The production function can be mathematically written as:-
Q=f (L,K,T……..n)
where:
Q= output
L= land
K= capital
T= level of technology
n= other input employed in production
USES OF PRODUCTION FUNCTION
How to obtain Maximum profit
Helps the producers to determine whether
employing variable inputs are profitable
Highly useful in long run decisions
Least cost combination of inputs to produce
an output
FACTOR INPUTS
Variable factors:
Variable factor refers to those factors, which can be changed in the short run.
For example, raw material, labor, power, fuel, etc. Variable factors vary
directly with the level of output. As output increases, requirement for
variable factors also rises and vice-versa. It must be noted that variable
factors are not required in case of zero output.
Fixed factors:
Fixed factors refers to those factors, which can not be changed in the short
run. For example, plant and machinery, building, land, etc. The quantity of
fixed factors remain same in the short run irrespective of level of output,
i.e. they do not change, whether the level of output rises, falls or becomes
zero.
CONCEPTS OF PRODUCTION
TOTAL PRODUCT:
Total product refers to total quantity of goods produced by a firm or an
industry during a specified period of time.
AVERAGE PRODUCT:
Average product refers to output per unit of variable input.
AP = Total Product
No. of units of Variable factor
MARGINAL PRODUCT:
Marginal product refers to addition to total product, when one more unit of
variable factor is employed.
MP= Change in TP
Change in units of variable factor
TYPES OF PRODUCTION
FUNCTION
SHORT RUN LONG RUN
PRODUCTION PRODUCTION
FUNCTION FUNCTION
RETURNS TO RETURNS TO
FACTOR SCALE
SHORT-RUN FUNCTION
RETURNS TO A FACTOR
Law of Variable Proportions or Law of Returns
states that as we increase quantity of only one
input keeping other inputs fixed, total product
(TP) initially increases at an increasing rate,
then at a decreasing rate and finally at a
negative rate
Phase 1 (Between O to Q)
TP increases at an increasing rate and MP also increases.
Phase 2 (Between Q to M)
TP increases at decreasing rate and MP falls. This phase
ends when MP becomes zero and TP reaches its maximum
point.
Phase 3 (Beyond point M)
TP starts decreasing and MP not only falls, but also
becomes negative.
Point of Inflexion (Point Q)
Point ‘Q’ is known as point of inflexion as curvature of TP
curve changes at this point. Till point Q, TP is concave
shaped and beyond point Q, TP becomes convex shaped.
Change in TP is maximum at this point
LONG RUN PRODUCTION
FUNCTION\ RETURNS TO SCALE
In the long run, all factor-inputs can be varied. It
means, that in the long-run, we can expand or
reduce the scale of production as well. The law
which states this relationship is also called returns
to scale.
The law of return to scale explain the behavior of
output in response to a proportional or
simultaneous change in inputs.
Q=f(a,b,c,d,e)
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ISOQUANTS
• Isoquant is a curve that shows the
various combinations of two inputs
that will produce a given level of
output.
• Slope of an isoquant indicates the rate
at which factors K and L can be
substituted for each other while a
constant level of production is
maintained.
• The slope is called Marginal Rate of
Technical Substitution (MRTS)
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TYPES OF ISOQUANTS
Linear isoquant
• Perfect substitutability between factors of
production .
• An output can be produced by using either
one or both the factors.
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INPUT OUTPUT ISOQUANT
• There is strict complementarity between inputs
• If quantity of one input is increased there is no change in
output.
• It means that there is only one method of production to
produce a commodity.
• Hence, to increase output, both factors are to be
increased holding the proportion constant.
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CONVEX ISOQUANT
• In a two-product framework, when one of
the factors of production can be continuously
substituted by the other, we get a smooth
and convex isoquant
• This isoquant is ‘smooth’ because the points
on the isoquant are very close to each other.
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PROPERTIES OF ISOQUANTS
• All the points give same output
• Isoquants do not intersect.
• Isoquants are usually convex to the origin
• A Higher Isoquant Denotes a Higher Level of
Output
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ISO COST LINE
Isocost line may be defined as the line which shows different
possible combinations of two factors that the producer can afford to
buy given his total expenditure to be incurred on these factors and
price of the factors.
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SHIFT IN ISOCOST LINES
A change in total outlay will cause a parallel shift in the iso-cost
line, as there will be no change in its slope, factor prices being
constant. If the total outlay increases, the iso-cost line will shift
upward, away from the point of origin, and if the total outlay
decreases, the line will shift downward or towards the origin.
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A change in price of labour (wage rate) or capital (interest) or both will result
into a change in the slope of the iso-cost line making it flatter or steeper
depending upon the nature of change in factor prices.
If the wage rate declines, for example, without any change in the interest rate
or in the total outlay, the firm can buy more of labour and, hence the iso-cost
line will become flatter. Similarly, if labour becomes expensive the line will
become steeper. In the Figure the iso-cost line (AB) becomes flatter (AB1) when
wage rate falls and becomes steeper (AB2) when it rises.
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Slope of iso-cost line will change when interest rate changes
and it may become steeper or flatter. In the Figure, the iso-
cost line (AB) becomes flatter (A2B) when interest rate
increases and becomes steeper (A1B) when the interest rate
falls.
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