Module 2:

Production
Function

Fidelis Ogwumike and Oyeteju Odufuwa

April 2021
Production Function and Production Technology
 Production relates to the activities of the firm.
2

 However, there are various constraints that can limit the level of
production of firms.
 Technology can also be a source of constraint in production.
 Inputs in production are called factors of production
 The firm’s production technology is the set of constraints that can be
combined to produce different levels of output.
 The firm’s production function for a particular good (q) shows the
maximum amount of the good/output that can be produced using
alternative combinations of capital (k) and labor (l) q = f(k,l)
 Assumptions of the Production Function
These can also be termed the properties of technology:
 No free-lunch: If there is no input, then there can be no output.
 Monotonicity or Free disposable: If you increase the amount of at least one of the inputs, it should be possible
to produce at least as much as you were producing originally. If it is possible to produce a given level of output
using a combination of input, then it is possible to use the same input, you can produce less output.
 Non-recoverable or non-reversibility: It is impossible to recover input from output once outputs are produced.
 Additivity Assumption : If it is possible to produce a combination of X and Y, it is also possible to produce X or
Y given the combination of inputs
 Divisibility Assumption: If it is possible to produce an output with 4 units of labour or 5 units of capital, it is
also possible to produce a given level of output using a fraction of those inputs
 Convexity: if there are two ways of producing y units of output. Method 1 : X (𝑥1 𝑥2 ). 𝑎𝑛𝑑 Method 2 : Z(𝑧1 𝑧2 ).
Then you can still produce Y using a fraction of X and Y. If you can produce 5 units of outputs using 3 units of
Capital and 4 units of labour, you can still produce 5 Units of outputs using 2 units of Capital and 5 units of
labour.
 Marginal Physical Product (MPP)
4

 To study variation in a single input, we define marginal physical product as

the additional output that can be produced by employing one more unit of
that input while holding other inputs constant

q = f(k,l)
q
marginal physical product of capital  MPk   fk
k

q
marginal physical product of labor  MPl   fl
l
 Diminishing Marginal Productivity
5
 The marginal physical product of an input depends on
how much of that input is used.
 In general, we assume diminishing marginal productivity

MPk  f 2
MPl  2 f
 2  fkk  f11  0  2  f ll  f 22  0
k k l l
 But changes in the marginal productivity of labor over
time also depend on changes in other inputs such as
capital.
we need to consider flk which is often > 0
 6 Average Physical Product (APP)
– Labor productivity is often measured by average productivity

output q f (k, l )
APl   
labor input l l

output q f (k , l )
APk   
capital input k k

• Note that APl also depends on the amount of capital employed

while APk also depends on the amount of labour employed
 A Two-Input Production Function
7

– The marginal productivity function is

MPl = q/l = 120,000l - 3000l2

which diminishes as l increases
– This implies that q has a maximum value:

120,000l - 3000l2 = 0
40l = l2
l = 40
– Labor input beyond l = 40 reduces output
A Two-Input Production Function
8
Suppose the production function for cooking oil can be
represented by:
q = f(k,l) = 600k 2l2 - k 3l3
To construct MPl and APl, we must assume a value for k
– let k = 10
In fact, when l = 30,
The production function becomes both APl and MPl
are equal to
q = 60,000l2 - 1000l3 900,000
To find average productivity, we hold k=10 and solve
APl = q/l = 60,000l - 1000l2 Thus, when APl is at
APl reaches its maximum where its maximum, APl
APl/l = 60,000 - 2000l = 0 and MPl are equal
l = 30
 ISOQUANT
Capital (K)

An Isoquant is a
Isoquant {Y = f(K, L)} graph that shows the
locus of the different
combinations of two
𝑘∗ inputs necessary to
produce the same
level of outputs.

𝑙∗ Labour (L)
 Isoquant Maps
10

– To illustrate the possible substitution of one input for another, we use

an isoquant map
– An isoquant shows those combinations of k and l that can produce a
Capital (K)
given level of output (q0) f(k,l) = q0

Each isoquant
Q3>Q2>Q1 represents a different
level of output. The
output rises as we
move northeast
Q3 = 75
Q2 = 50
Q1 = 25 Labour (L)
Marginal Rate of Technical Substitution (RTS)
• The slope of an isoquant shows the rate at
11

which l can be substituted for k

- slope = marginal rate of technical
substitution (RTS)
k per period
RTS > 0 and is diminishing for
increasing inputs of labor
A
kA
B
kB
q = 20

l per period
lA lB
 12

Marginal Rate of Technical Substitution (RTS)

– The marginal rate of technical substitution (RTS) shows the rate at which
labor can be substituted for capital while holding output constant along an
isoquant  dk
RTS (l for k ) 
dl q  q 0
The MRTS is the rate at which capital is exchanged for labour in order to achieve a given
level of output. It measures the rate at which one input can be substituted for the other
while maintaining the same level of output
MPl change in labour
MRTS (l for k )  
MPk change in capital
RTS and Marginal Productivities
13

– Take the total differential of the production function:

f f
dq   dl   dk  MPl  dl  MPk  dk
l k
• Along an isoquant dq = 0, so
MPl  dl  MPk  dk
 dk MPl
RTS (l for k )  
dl q q0 MPk
 Returns to Scale
14

– How does output respond to increases in all inputs together?

– suppose that all inputs are doubled, would output double?
– Returns to scale have been of interest to economists since the days
of Adam Smith
– Smith identified two forces that come into operation as inputs are
doubled
– greater division of labor and specialization of function
– loss in efficiency because management may become more difficult given the
larger scale of the firm
 Returns to Scale
15

– If the production function is given by q = f(k,l) and all

inputs are multiplied by the same positive constant (t >1),
then

Effect on Output Returns to Scale

f(tk,tl) = tf(k,l) Constant
f(tk,tl) < tf(k,l) Decreasing
f(tk,tl) > tf(k,l) Increasing
 16
Constant Returns to Scale
 Constant returns-to-scale production functions are homogeneous of degree one
in inputs
 f(tk,tl) = t1f(k,l) = tq
 This implies that the marginal productivity functions are homogeneous of degree
zero
 if a function is homogeneous of degree k, its derivatives are homogeneous of
degree k-1
 The marginal productivity of any input depends on the ratio of capital and labor
(not on the absolute levels of these inputs)
 The RTS between k and l depends only on the ratio of k to l, not the scale of
operation
 Returns to Scale
17

– Returns to scale can be generalized to a production function

with n inputs
q = f(x1,x2,…,xn)
– If all inputs are multiplied by a positive constant t, we have
f(tx1,tx2,…,txn) = tkf(x1,x2,…,xn)=tkq
– If k = 1, we have constant returns to scale
– If k < 1, we have decreasing returns to scale
– If k > 1, we have increasing returns to scale
 Exercises on returns to scale
– Consider the following production functions:
1 1
– 𝑌 = 𝑓 𝐾, 𝐿 = 𝐾 2 𝐿 2

– 𝐼𝑛𝑡𝑟𝑜𝑑𝑢𝑐𝑒 𝛽 𝑖𝑛𝑡𝑜 𝑡ℎ𝑒 𝑒𝑞𝑢𝑎𝑡𝑖𝑜𝑛 𝑡ℎ𝑢𝑠:

1 1
– 𝑌 = 𝑓 𝛽𝐾, 𝛽𝐿 = 𝛽(𝐾 2 𝐿 2 )
1 1
= (𝛽𝐾) 2 (𝛽𝐿) 2

1 1 1 1
– Consider the following production =𝛽 2 𝛽 2 𝐾 2 𝐿 2

functions: 1 1 1 1
=𝛽 2 + 2 𝐾 2 𝐿 2
1 1
– 𝑌 = 𝑓 𝐾, 𝐿 = 𝐾 2 𝐿 2 1 1
= 𝛽1 𝐾 2 𝐿 2
1 1 1 1
– 𝑌 = 𝑓 𝐾, 𝐿 = 𝐾 4 𝐿 4
= 𝛽 (𝐾 2 𝐿 2)

– 𝑌 = 𝑓 𝐾, 𝐿 = 𝐾 2 𝐿2 (constant returns to scale)

 Elasticity of Substitution
19

– The elasticity of substitution () measures the proportionate change in

k/l relative to the proportionate change in the RTS along an isoquant

%(k / l ) d (k / l ) RTS  ln( k / l )

   
%RTS dRTS k / l  ln RTS
• The value of  will always be positive because k/l
and RTS move in the same direction.
• The EOS measures the change in input –factor
ration as the slope of the isoquant changes.
 Elasticity of Substitution
20

• Both RTS and k/l will change as we

move from point A to point B
k per period  is the ratio of these
proportional changes

RTSA  measures the

A
RTSB
curvature of the
isoquant
(k/l)A q = q0
B
(k/l)B
l per period
 Elasticity of Substitution
– If  is high, the RTS will not change much relative to k/l
21

– the isoquant will be relatively flat

– If  is low, the RTS will change by a substantial amount as k/l

changes
– the isoquant will be sharply curved

– It is possible for  to change along an isoquant or as the scale of

production changes
Generalizing the elasticity of substitution to the many-input case raises several
complications
if we define the elasticity of substitution between two inputs to be the
proportionate change in the ratio of the two inputs to the proportionate change
in RTS, we need to hold output and the levels of other inputs constant
Examples of Technology or Types of Isoquant

Isoquants can take the following forms:

– Linear Production Function (Perfect Substitutes)
– Fixed Proportions
– Cobb-Douglas Production Function
– Leontief Production Function
The Linear Production Function
23
Suppose that the production function is :q = f(k,l) = ak + bl
This production function exhibits constant returns to scale

f(tk,tl) = atk + btl = t(ak + bl) = tf(k,l)

All isoquants are straight lines RTS is constant ask/l changes  = 
k per period

slope = -b/a =

Capital and labor are
perfect substitutes
q1 q2 q3
l per period
 Fixed Proportions
24

– Suppose that the production function is

q = min (ak,bl) a,b > 0

– Capital and labor must always be used in a fixed ratio
– the firm will always operate along a ray where k/l is constant

– Because k/l is constant,  = 0

 Fixed Proportions
25
No substitution between labor and capital
is possible

k per period k/l is fixed at b/a

=0
q3/a q3

q2

q1

l per period
q3/b
Cobb-Douglas Production Function
26
– Suppose that the production function is
q = f(k,l) = Akalb A,a,b > 0
– This production function can exhibit any returns to
scale: f(tk,tl) = A(tk)a(tl)b = Ata+b kalb = ta+bf(k,l)
– if a + b = 1  constant returns to scale
– if a + b > 1  increasing returns to scale
– if a + b < 1  decreasing returns to scale

The Cobb-Douglas production function is linear in logarithms

ln q = ln A + a ln k + b ln l
a is the elasticity of output with respect to k
b is the elasticity of output with respect to l
 CES Production Function
27

– Suppose that the production function is

q = f(k,l) = [k + l] /   1,   0,  > 0

–  > 1  increasing returns to scale
–  < 1  decreasing returns to scale
– For this production function

 = 1/(1-)
–  = 1  linear production function
–  = -  fixed proportions production function
–  = 0  Cobb-Douglas production function
28
A Generalized Leontief
Production Function
– Suppose that the production function is

q = f(k,l) = k + l + 2(kl)0.5
Leontief Technology is a
– Marginal productivities are technology in which inputs
must be combined at a fixed
fk = 1 + (k/l)-0.5 proportion for any level of
output. It has zero elasticity of
fl = 1 + (k/l)0.5 substitution.
– Thus,

fl 1  ( k / l )0 .5
RTS  
f k 1  ( k / l )  0 .5
 Summary
29

– If all but one of the inputs are held constant, a relationship

between the single variable input and output can be derived
– the marginal physical productivity is the change in output resulting from a
one-unit increase in the use of the input
– assumed to decline as use of the input increases

– The entire production function can be illustrated by an isoquant

map
– the slope of an isoquant is the marginal rate of technical substitution (RTS)
– it shows how one input can be substituted for another while holding output constant
– it is the ratio of the marginal physical productivities of the two inputs
 Summary
30

 Isoquants are usually assumed to be convex

 they obey the assumption of a diminishing RTS
 this assumption cannot be derived exclusively from the assumption of diminishing marginal productivity
 one must be concerned with the effect of changes in one input on the marginal productivity of other inputs

 The returns to scale exhibited by a production function record how output responds
to proportionate increases in all inputs
 if output increases proportionately with input use, there are constant returns to scale

 The elasticity of substitution () provides a measure of how easy it is to substitute

one input for another in production
 a high  implies nearly straight isoquants
 a low  implies that isoquants are nearly L-shaped
Assignment (not to be submitted)

– Proof using mathematical

equations that the Elasticity of
Substitution (EOS) is the change in
input –factor ration as the slope of
the isoquant changes.
Thank you!!!