Theory of Production

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 Inputs : Fixed inputs and Variable inputs

⚫ The factors of production that is used to carry out

the production is called inputs.
⚫ Land, Labour, Capital, Organizer, Technology, are
the example of inputs

Inputs
Factors

Variable Fixed
inputs Inputs
 Inputs : Fixed inputs and Variable inputs

Fixed inputs Variable inputs

❑ Remain the same in the ❑ In the long run all factors

short period . of production varies
❑ At any level of out put, the according to the volume of
amount remains same.
outputs.
❑ The cost of these inputs are
❑ The cost of variable inputs
called Fixed Cost
is called Variable Cost
❑ Examples:- Building, Land
etc ❑ Example:- Raw materials,
❑ ( In the long run fixed inputs also labour, etc
varies)
 Production Function

⚫ Production function shows the functional relationship

between inputs and outputs in the process of production.

⚫ It is a technical relation which connects factor inputs used

in the production function and the level of output.

Q = f (Land, Labour, Capital, Organization, Technology, etc)

 Production Function With One Variable Input-
Law of Variable Proportions
7

● The short run production function shows the

maximum output a firm can produce when only
one input can be varied.
● When discussing production in the short run,
three definitions are important:
Total product
Marginal product
Average product
Production Function With One Variable Input
8

Total Product TP = Q = f(L)

Marginal Product ΔTP

MPL =
ΔL

Average Product TP
APL =
L
Production or MPL
Output Elasticity EL = AP
L
 Total Product
9

● Total product (TP) is another name for output

in the short run.

TP = Q = f (L)
 Marginal Product
10

● The marginal product (MP) of a variable

input is the change in output (or TP)
resulting from a one unit change in the
input.
● MP tells us how output changes as we
change the level of the input by one unit.
● Consider the two input production function
Q=f (L,K) in which input L is variable and
input K is fixed at some level.
● The marginal product of input L is defined
as holding input K constant.
ΔTP
MPL =
ΔL
 Average
11
Product

● The average product (AP) of an input is the

total product divided by the level of the
input.
● AP tells us, on average, how many units of
output are produced per unit of input used.
● The average product of input L is defined
as holding input K constant.

TP
APL =
L
 Production Function With One Variable Input-Example
12

Total, Marginal, and Average Product of Labor, and Output Elasticity

L Q/ MP L AP L EL
0 TP0 - - -
1 3 3 3 1
2 8 5 4 1.25
3 12 4 4 1
4 14 2 3.5 0.57
5 14 0 2.8 0
6 12 -2 2 -1
Production Function With
13
One Variable Input
The Law of Diminishing
14 Returns

Increasing Returns

MP Diminishing Returns Begins

X
MP
The Three Stages of Production
15
 Law of Production Function

1) Laws of Variable proportion- Law of

Diminishing Return ( Short run production
function with at least one input is variable)

2) Laws of Return scales – Long run production

function with all inputs factors are variable.
 1. Law of variable proportion: Short run
Production Function

⚫ Explain short run production function

⚫ Production function with at least one variable factor
keeping the quantities of others inputs as Fixed.
⚫ Show the input-out put relation when one input is
variable
“If one of the variable factor of production used more
and more, keeping other inputs fixed, the total
product(TP) will increase at an increase rate in the
first stage, and in the second stage TP continuously
increase but at diminishing rate and eventually TP
decrease.”
 Short run Production Function with Labour as Variable factor
Labour Land Capital Total Average Marginal Product
(L) (K) Output Product
(TP) (MP)
(AP)
Fi
0 10 10 0 - rs
1 10 10 10 10 10 t
10 20 St
2 10 30 15
ag
3 10 10 30
Production60 20Input
with One Variable e
10 20 Se
4 10 80 20
co
5 10 10 95 19 15 n
6 10 10 108 18 13 d
St
7 10 10 112 16 4
ag
8 10 10 112 14 0 e
T
9 10 10 108 12 -4 hi
rd
10 10 10 100 10 -8
St
ag
e
 D
112
Output per
month Total Product
C

60 B

A
Se
co Labor per month
3 4 8 T
n
30 d hi
St rd
ag St
E e ag
20 e
Fi
rs
t
Average product
10 St
ag
e 8 Labor per month
3 4
Marginal product
 Stages in Law of variable proportion
First Stage: Increasing return
▪ TP increase at increasing rate till the end of the stage.
▪ AP also increase and reaches at highest point at the end of the stage.
▪ MP also increase at it become equal to AP at the end of the stage.
▪ MP>AP

Second Stage: Diminishing return

▪ TP increase but at diminishing rate and it reach at highest at the end of
the stage.
▪ AP and MP are decreasing but both are positive.
▪ MP become zero when TP is at Maximum, at the end of the stage
▪ MP<AP.
Third Stage: Negative return
▪ TP decrease and TP Curve slopes downward
▪ As TP is decrease MP is negative. AP is decreasing but positive.
 2. Law of return to scales: Long run Production
Function

⚫ Explain long run production function when the

inputs are changed in the same proportion.
⚫ Production function with all factors of production
being variable.
⚫ Show the input-out put relation in the long run
with all input variations.
“Return to scale refers to the relationship between
changes of outputs and proportionate changes in all
factors of production ”
 Assumptions

⚫ Techniques of production is unchanged

⚫ All units of factors are homogeneous
⚫ Returns are measured in physical terms
Law of return to scales: Long run Production
Function
Labour Capital TP MP

2 1 8 8
4 2 18 10 Increasing returns to scale

6 3 30 12
8 4 40 10
10 5 50 10 Constant returns to scale
12 6 60 10
14 7 68 8
16 8 74 6 Decreasing returns to scale

18 9 78 4
Law of return to scales: Long run Production
Function

Inputs 10% increase – Outputs 15% increase Increasing returns to scale

Inputs 10% increase – Outputs 10% increase Constant returns to scale

Inputs 10% increase – Outputs 5% increase Decreasing returns to scale

 Returns to scale

Y
constant
increas
e diminishing
Marginal
product

B C

A D

X
O
Scale of
proportion