PRODUCTION FUNCTION

Let us understand the following points

 A producer some desirable product like shoes, bags, jackets etc. makes use of various inputs
(known as factors of production)
 Production is an important economic activity as it enhances the utility of the product by changing it
in the form needed by the consumers
 For example: Leather is of less use in its raw form until it is transformed into desirable product like
shoes, bags, jackets, etc.
 The term production, in economics, covers a much wider range of activities, than in its everyday
use.

PRODUCTION REFERS TO TRANFORMATION OF INPUTS INTO OUTPUT. FOR EXAMPLE, SHOES

(OUTPUT), WE NEED VARIOUS INPUTS LIKE LEATHER, NAILS, LAND, LABOUR, CAPITAL,
SERVICE OF ENTREPRENEUR ETC.

Production Function
It is an expression of the technological relation between physical inputs and output of a good.

Symbolically: Ox = f (i1 , i2 , i3 ………….. in)

{Where: Ox = Output of commodity x; f = Functional Relationship; i1 , i2 = inputs needed for O }
x

Example of Production Function:

Suppose a firm is manufacturing chairs with the help of two inputs, say Labour (L) and Capital (K)

Then the Production Function can be written as: (Ochairs) = f (L, K)

Production function defines the maximum chairs (Ochairs), which can be produced with the given capital and
labour inputs.

If this production function is expressed as 250 = (7L, 2K). It means, 7 units of labour and 2 units of capital
can produce maximum 250 chairs.

Features Production Function

1. It specifies either the maximum output that can be produced with the given inputs or the minimum
quantity of inputs needed to produce a given level of output.
2. It establishes a relationship between input and output, which is technical in nature
Production function is not economical in nature as we do not consider the value of input and output.
3. It is always defined with respect to a given technology. If there is an improvement in the technique
of production, then increase output can be obtained with same physical inputs.
4. It includes only the technically efficient methods of production as no rational entrepreneur will use
inefficient method.
5. It is expressed with reference to a particular period of time. It changes with different time periods.

SHORT RUN AND LONG RUN

The functional relationship between change in output due to change in inputs is studied in two phases:
Short run and Long run Time Periods.

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SHORT RUN

 This refers to a period in which output can be changed by changing only Variable factors.
 In the Short Run, fixed inputs like plant, machinery, building etc. cannot be changed.
 It means, production can be raised by increasing variable factors, but till the extent of capacity of
fixed factors.
For Example: If a producer wants to increase output in the short run, then this objective can be achieved by
using more of raw materials and increasing number of workers with the existing factory building,
machinery and other equipment.

So, it means in the short run some factors are fixed and some are variable and fixed factors cannot be
changed during such a short span of time.

LONG RUN

 It refers to a period in which output can be changed by changing all factors of production.
 It is a period, that is long enough for the firm to adjust all its inputs according to change in the
conditions
 In the Long run, firm can change its factory size, switch to new techniques of production, purchase
new machinery, etc.

REMEMBER ABOUT SHORT RUN AND LONG RUN

 The distinction between short run and long run does not refer to a calendar period and is not based
on a fixed time span.
 The period is rather a functional concept, which depends on production conditions. It varies from
firm to firm and industry to industry.
For Example: A period of 1o years may be short run period for a steel industry, while, a period of
one year may be a long run period for a wheat producer.

DIFFERENCE BETWEEN SHORT RUN AND LONG RUN

Basis Short Run Long Run

Meaning It refers to a period in which It refers to a period in which
output can be changed by output can be changed by
changing only variable factors changing all factors of
production
Classification Factors are classified as variable All factors are variable in the
and fixed factor in the short run long run
Price Determination In the short run, demand is more In the long run, both demand and
active in price determination as supply play equal role in price
supply cannot be increased determination as both can be
immediately with increase in increased.
demand.

VARIABLE FACTORS AND FIXED FACTORS

Production is the result of combined efforts of the factors of production. These factors are broadly
classified as: (i) Variable Factors; (ii) Fixed Factors.

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VARIABLE FACTORS

It refers to those factors, which can be changed in the short run. For example, raw material, casual labour,
power, fuel, etc.
The 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

It refers to those factors, which cannot be changed in the short run. For example, plant and machinery,
building, land, etc.

The quantity of fixed factors remains same in the short run irrespective of level of output, i.e. they do not
change, whether the level of output rises, falls or become zero.

DEFFERENCES BETWEEN VARIABLE FACTORS AND FIXED FACTORS

Basis Variable Factors Fixed Factors

Meaning These refer to those factors, These refer to those factors
which can be changed in the which cannot be changed in the
short run short run
Relation with output They vary directly with output They do not vary directly with
output
Example Raw material, casual labour, Building, plant and machinery,
power fuel, etc. permanent staff, etc.

TYPES OF PRODUCTION FUNCTION

1. Short Run Production Function (Variable Proportion Type): This refers to a situation when
output is increased by changing only one input while keeping other inputs unchanged.
As there is change in variable input only, the ratio between different inputs tends to change at
different levels of output.

2. Long Run Production Function (Constant Proportion Type): This refers to a situation when
output is increased by increasing all the inputs simultaneously and in the same proportion.
As all inputs are variable in the long run, the ratio between different inputs tends to remain the same
at different levels of output.

CONCEPT OF PRODUCT

Product or output refers to the volume of goods produced by a firm or an industry during a specified period
of time.
It can be looked at from three different angles:
(i) Total Product
(ii) Marginal Product
(iii) Average Product

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TOTAL PRODUCT (TP)

It refers to total quantity of goods produced by a firm during a given period of time with given number of
inputs.
For Example: If 10 labour produce 60 kg of rice, then total product is 60 kg
 In the short run, a firm can expand TP by increasing only the variable factors
 In the long run, TP can be raised by increasing both fixed and variable factors.
Total Product is also known as ‘Total Physical Product (TPP)’ or ‘Total Return’ or ‘Total Output’

AVERAGE PRODUCT (AP)

It refers to output per unit of variable input.

For Example: If TP is 60 kg of rice, produced by 10 labour (variable input), then average product will be 60
÷ 10 = 6 kg

AP is obtained by dividing TP by units of variable factor.

Total Product (TP)

Average Product (AP) =
Units of Variable Factor (n)

TP in terms of AP will be: TP = AP x Units of Variable Factor

Average Product is also known as ‘Average Physical Product’ or ‘Average Return’

MARGINAL PRODUCT (MP)

It refers to addition to total product, when one more unit of variable factor is employed.
It measures extra output per extra unit of input holding all other factors fixed.

MPn = TPn – TPn-1

Where:
MPn = Marginal Product of nth unit of variable factor
TPn = Total Product of n units of variable factor
TPn-1 = Total Product of (n-1) units of variable factor
n = number of units of variable factor

For Example: If 10 labourers make 60 kg of rice and 11 labourers make 67 kg of rice, then MP at 11th
labour will be:

MP11 = TP11 – TP10

MP11 = 67 – 60 = 7 kg

Marginal Product is also known as ‘Marginal Physical Product (MPP)’ or ‘Marginal Return’

One More Way to Calculate MP

MP is the change in TP when one more unit of variable factor is employed. However, when change in
variable factor is greater than one unit, then MP can be calculated as:

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 Change∈Total Product ΔTP
MP = =
Change∈units Variable Factor Δn

Suppose 2 labours produce 60 units and 5 labour produce 90 units, then MP will be

TP of 5 labours−TP of 2 labours
MP =
5 labours−2labours

90−60 30
Or MP =
5−2
= 3 =10 units
‘
TP is summation of MP

Total Product can also be calculated as the sum of Marginal Product

It means, TPn = MP1 + MP2 + MP3 + ……… MPn

Or TP = ∑ MP

RETURNS TO A FACTOR: LAW OF VARIABLE PROPORTION

Returns to a factor refers to the resultant increase in the total product (return) when only one factor is
increased, keeping all other factors fixed.

 In short run, when one input is variable and all other inputs are fixed, the firm’s production function
exhibits the Law of Variable Proportions.

 Law of Variable Proportions or LVP in one of the most important laws of production. It shows the
nature of rate of change in output due to a change in only one variable factor of production.
 Law of Variable Proportions is also known as ‘Law of Returns’ or ‘Law of Returns to Factors’ or
‘Returns to Variable Factors’.

Statement of Law of Variable Proportions

Law of Variable Proportions (LVP) 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.

According to the Law of Variable Proportions (LVP), changes in TP and MP can be classified into
following three phases:

Phase I: TP rises at increasing rate.

MP increases

Phase II: TP rises at decreasing rate.

MP decreases and is positive

Phase III: TP falls

MP becomes negative

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 Assumptions of Law of Variable Proportions

1. It operates in short run, as factors are classified as variable and fixed factors.
2. The law applies to all fixed factors including land.
3. Under this law, different units of variable factor can be combined with fixed factor
4. This law applies to the field of production only
5. The effect of change in output due to change in variable factor can be easily determined
6. It is assumed that, factors of production become imperfect substitutes of each other beyond a certain
limit.
7. The state of technology is assumed to be constant during the operation of this law.
8. It is assumed that al variable factors are equally efficient.

Let us understand the law with help of an example

Suppose, a farmer has 1 acre of land (fixed factor) on which he wants to increase the production of wheat
with help of labour (variable factor). When he employed more and more units of labour, initially output
increased at an increasing rate, then at a decreasing rate and finally, at a negative rate. This behaviour of
output is shown in the table below

Fixed Factor Variable Factor TP MP Phase

(Land in acres) (Labour) (units) (units)
1 1 10 10 Phase I: Increasing Returns to a Factor
1 2 30 20
1 3 45 15 Phase II: Diminishing Returns to a Factor
1 4 52 7
1 5 52 0
1 6 48 -4 Phase III: Negative Returns to a Factor
Y

60
M (TP is Maximum)
50
TP (in units)
40 Point TP
of Inflexion
30
 Phase I (Between O to Q) Q
TP increases at an
Increasing rate and MP 20
also increases. 10
 Phase II (Between Q to
M) TP increases at Units of X
variable factors
decreasing rate and MP O 1 2 3 4 5 6
falls. This phase ends 60
when MP becomes 0 and
TP reaches its maximum 50Phase I Phase II Phase III
point MP (in units)
40
 Phase III (beyond point
M) TP starts decreasing 30 MP is
and Maximum
MP not only falls, but 20 P
also becomes negative
 Point of Inflexion (Point 10
S (MP=0)
Q) Point Q is known as X
Point of inflexion as O 1 2 3 4 5 6
curvature of TP curve
changes
At this point
Units of variable factors
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Phase I: Increasing returns to a factor (TP increases at an increasing rate): In the first phase, every
additional variable factor adds more and more to the total output. It means TP increases at an increasing
rate and MP of each variable factor rises.
 It happens because initially quantity of variable input is too small as compared to the fixed input. As
production starts, there is efficient use of fixed input, which raises the productivity of variable input
due to division of labor.
 As seen in given schedule and diagram (above) one labor produces 10 units, while two labors
produce 30 units. It implies, TP increases at increasing rate (till point ‘Q’) and MP rises till it
reaches its maximum point ‘P’, which marks the end of the first phase.

Phase II: Diminishing returns to a factor (TP increases at diminishing rate): In the second phase, every
additional variable factor adds lesser and lesser amount of output. It means, TP increases at a diminishing
rate and MP falls with increase in variable factor. That is why, this phase is known as diminishing
return to a factor
 It happens because after a level of output, pressure on fixed input leads to a fall in productivity of
the variable input
 The second phase ends at point ‘S’, when MP is zero and TP is maximum (point ‘M’) at 52 units.
 2nd phase is very crucial as a rational producer will always aim to produce in this phase because TP
is maximum and MP of each variable factor is positive.

Phase III: Negative returns to a factor: In the third phase (starting from 6 units of labour), the employment
of additional variable factor causes TP to decline. MP now becomes negative. Therefore, this phase is
known as negative returns to a factor
 It happens because amount of variable input becomes too large in comparison to the fixed input
which leads to decline in TP.
 The third phase starts from point ‘S’ on MP curve and point ‘M’ on TP curve
 MP of each variable factor is negative in the 3rd phase. So, no firm would deliberately choose to
operate in this phase.

From above description what we understand –

1. A rational producer will always seek to operate in phase II of law of variable proportions.
2. In Phase I, employment of every additional unit of variable factor gives more and more output i.e.
MP increases. It means, there is scope for more profits, if production is increased with more
units of variable factor.
3. In Phase III, MP of each variable factor is negative. So, this phase is ruled out on ground of
technical inefficiency and a rational producer will never produce in the third phase.

REASONS FOR LAW OF VARIABLE PROPORTIONS

Reasons for Increasing Returns to a Factor (Phase I)

1. Better utilization of the fixed factor: In the first phase, the supply of the fixed factor (say, Land) is
too large, whereas variable factors are too few. So, the fixed factor is not fully utilized. When
variable factors are increased and combined with fixed factor, then fixed factor is better utilized and
output increases at an increasing rate.

2. Increased efficiency of Variable Factor: When variable factors are increased and combined with
the fixed factor, then variable factor is utilized in a more efficient manner. At the same time, there is

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 greater cooperation and high degree of specialization between different units of the variable factor
due to division of labour.

3. Indivisibility of Fixed Factor: Generally, the fixed factors which are combined with variable
factors are indivisible. Such factors cannot be divided into smaller units. Once investment is made
in an indivisible fixed factor, then addition of more and more units of variable factor, improves the
utilization of fixed factor. The increasing returns apply as long as optimum level of combination
between variable and fixed factor is achieved.

Reasons for Diminishing Returns to a Factor (Phase II)

1. Optimum Combination of Factors: Among the different combinations between variable and fixed
factor, there is one optimum combination, at which TP is maximum. After making the optimum use
of fixed factor, the marginal return of variable factor begins to diminish.
For Example: If a machinery (fixed factor) is at its optimum use, when 4 labour are employed, then
addition of one more labour will increase TP by very less amount and MP will start diminishing.

2. Over-utilization of Fixed Factor: As we keep on increasing the variable factor, eventually a

position comes when the fixed factor has its limits and starts yielding diminishing returns.

3. Imperfect Substitutes: Diminishing returns to a factor occurs because fixed and variable factors
are imperfect substitutes of one another. There is a limit to the extent of which one factor of
production can be substituted for another
For Example: Labour can be substituted in place of capital or capital can be substituted in place of
labour till a particular limit. But, beyond the optimum limit, they become imperfect substitutes of
one another, which leads to diminishing returns.

Reasons for Negative Returns to a Factor (Phase III)

1. Limitation of Fixed Factor: The negative returns to a factor apply because some factors of
production are of fixed nature, which cannot be increased with increase in variable factor in the
short run.

2. Poor Coordination between Variable and Fixed Factor: When variable factor becomes too
excessive in relation to fixed factor, then they obstruct each other. It leads to poor coordination
between variable and fixed factor. As a result, total output falls instead of rising and marginal
product becomes negative.

3. Decrease in Efficiency of Variable Factor: With continuous increase in variable factor, the
advantages of specialization and division of labour start diminishing. It results in inefficiencies of
variable factor, which is another reason for the negative returns to eventually set in.

POINT OT REMEMBER
Law of Variable Proportions (LVP) is an extension of another famous law, known as ‘Law of
diminishing Returns’

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LAW OF DIMINISHING RETURNS

Law of diminishing returns states that when more and more units of a variable factor are employed with
a fixed factor, then marginal product of the variable factor must fall.

It means that marginal returns diminish when proportion between variable and fixed factors
increases.

This law is also known as Law of Diminishing Marginal Product.

Let us understand this better:

Law of Diminishing Returns Y Law of Diminishing

Fixed Variable TP MP Returns
Factor Factor (in units) (in units) 20
Marginal Product
(Land in (Labour
acres) ) 16
1 1 12 12 12
1 2 22 10 8
1 3 30 8 4
MP
1 4 36 6 X
1 5 40 4 O
1 2 3 4 5
Units of Variable Factor

As seen in the table and the fig, MP falls when more and more units of variable factor (labour) are
employed with the fixed factor (Land). This law considers only the falling phases of MP and ignores the
phase of increasing MP.

Why LVP is an extension of Diminishing Returns?

LVP is an extension of Law of Diminishing Returns as it also considers the phase of rising MP in
addition to falling MP. The common element between both the laws is that MP is bound to decrease
sooner or later with increase in units of variable factor.

IN THE SHORT RUN AND LONG RUN

 In short run, a firm can change the output by changing the quantity of variable factors only.
 In long run, all the factors become variable, i.e. the distinction between fixed and variable factors
disappears.
 The resultant change in output due to change in all factor inputs is studied under ‘Law of Returns to
Scale’

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RELATION BETWEEN TP AND MP

It can be best understood with the help of following schedule and diagram

Fixed Factor (Land in Variable Factor TP MP

acres) (Labour) (in Units) (units) (units)
1 0 0 -
1 1 10 10
1 2 30 20
1 3 45 15
1 4 52 7
1 5 52 0
1 6 48 -4
Y

Relationship Between
60 TP and MP
M (TP is Maximum)
50
TP/MP (In Units) TP
40

P
30

20

10
N (MP is Zero)
X
O
1 2 3 4 5 6
Units of Variable Factors MP
This relation can be summarized as under:

1. As long as TP increases at increasing rate (till point ‘P’), MP also increases.

2. When TP increases at diminishing rate, MP decreases. It starts happening when 3 units of labour are
employed and continues till 5 units of variable factor.
3. When TP reaches its maximum point (point M), MP becomes zero (point N), i.e. at 5th unit of
variable factor.
4. When TP starts decreasing, MP becomes negative, i.e. from 6th unit of variable factor.

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RELATIONSHIP BETWEEN AP AND MP

It can be best understood with the help of following schedule and diagram

Fixed Factor (Land in Variable Factor AP MP

acres) (Labour) (in Units) (units) (units)
1 0 - -
1 1 10 10
1 2 15 20
1 3 15 15
1 4 13 7
1 5 10.40 0
1 6 8 -4

Relationship Between
AP and MP
25
AP/MP (In Units)
20

15

10

AP
5

X
O
1 2 3 4 5 6
Units of Variable Factors MP
This relation can be summarized as under:

1. As long as MP is more than AP, AP rises, i.e. up to 2nd unit of variable factor
2. When MP is equal to AP, AP is at its maximum, i.e. at 3rd unit of variable factor.
3. When MP is less than AP, AP falls (from 4th unit of variable factor)
4. Thereafter, both AP and MP fall, but MP becomes negative, whereas, AP remains positive. MP falls
at a faster rate in comparison to fall in AP.

POINTS TO BE NOTED
 Both AP and MP are derived from TP
 AP is calculated on basis of all the units
 MP is based on the additional unit only
 It is the MP which pulls the AP up or down.

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NUMERICALS

EXAMPLE: Calculate Average Product (AP) and Marginal Product (MP)

Variable 0 1 2 3 4 5
Factors
Total 0 8 20 28 28 25
Product

Solution:

Variable Factor TP AP (in units) MP (in units)

(VF) (in units) TP ÷ VF = AP TPn - TPn-1 = MPn
0 0 - -
1 8 8÷1=8 8–0=8
2 20 20 ÷ 2 = 10 20 – 8 = 12
3 28 28 ÷ 3 = 9.33 28 – 20 = 8
4 28 28 ÷ 3 = 7 28 – 28 = 0
5 25 25 ÷ 5 = 5 25 – 28 = -3

1. Calculate AP and MP from the following particulars

Land 1 1 1 1 1 1 1 1 1 1
Labour 0 1 2 3 4 5 6 7 8 9
TP 0 20 50 90 120 140 150 150 140 120
(Units)

2. Calculate TP and AP
Variable 1 2 3 4 5 6 7
Factor
MP (in 24 20 16 12 8 0 -8
units)

3. Find out the values of TP and MP

Variable 1 2 3 4 5
Factor
AP (in 8 10 8 6 4
units)

4. Find out the missing values from the following table

Variable 0 1 2 3 4 5 6 7
Factor
TP (in ---- ---- ---- ---- 25 ---- ---- ----
units)
AP (in ---- 5 ----- ----- ----- ----- ----- -----
units)
MP (in ---- ----- 8 4 ----- 5 0 -4
units)

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 5. Complete the following table
Units of Labour Average Product Marginal Product
(units) (units) (units)
1 8 ----
2 10 ----
3 --- 10
4 9 ----
5 ---- 4
6 7 ----

6. Identify the different output levels, which mark the three phases of the operation of the Law
of Variable Proportions, from the following table
Units of 0 1 2 3 4 5
Variable
Factor
TP (in 0 8 20 28 28 20
units)

7. Identify different phases of the Law of Variable Proportions from the following schedule. Give
reasons for your answer.
Variable Inputs (Units) Total Physical Product (Units)
1 4
2 9
3 13
4 15
5 12

8. Calculate the MP of variable factor and indicate the various phases of Law of Variable Proportions
from the following schedule
Units of 0 1 2 3 4 5 6
Variable
Factor
TP (in 0 50 110 150 180 180 150
units)

9. Identify the three phases of the Law of Variable Proportions from the following and also give
reasons behind each phase.
Variable Inputs (Units) Total Physical Product (Units)
1 10
2 22
3 30
4 35
5 30

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QUESTIONS

EXAMPLE:
Let the production function of the firm be: Q =2L2K2. Find out the maximum possible output that the firm
can produce with 5 units of L and 2 units of K. what is the maximum possible output that the firm can
produce with zero unit of L and 10 units of K.

For ease let’s make a schedule

Units of L 5 0
Units of K 2 10

Given Q =2L2K2 (Values L = 5 and K =2)

Putting values of L and K in the function above

Q = 2(5)2 (2)2 = 2x(25x4) = 200 units

Maximum possible output with 0 unit of L and 10 units of K

Q =2L2K2; here L = 0 and K =10

Q = 2(0)2 (10)2 = 0 unit

1. Find out the maximum possible output for a firm with zero unit of L and 10 units of K when its
production function is: Q = 5L + 2K
2. Let the production function of a firm be: Q = 5L½ K½. find out the maximum possible output that
the firm can produce with 100 units of L and 100 units of K.

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