CHAPTER FOUR
Theory of Production
Theory of Production
Production is a process that create/adds value or
utility
It is the process in which the inputs are converted in
to outputs.
Production Function
Production function means the functional relationship
between inputs and outputs in the process of
production.
It is a technical relation which connects factors inputs
used in the production function and the level of
outputs
Q = f (Land, Labour, Capital, Organization, Technology, etc)
Con’t
If the quantity of at least one input remains fixed,
the above mentioned production function is called
short run production function.
But if all of the inputs are variable, the production
function is called long run production function.
Factors of Production
Inputs : Fixed inputs and Variable inputs
The factors of production that is carry out the
production is called inputs.
Land, Labour, Capital, Organizer, Technology, are
the example of inputs
Inputs Factors
Variable inputs Fixed 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 are varies
❑ At any level of out put, the according to the volume of
amount is remain the same. outputs.
❑ The cost of these inputs are ❑ The cost of variable inputs
called Fixed Cost is called Variable Cost
❑ Examples:- Building, Land ❑ Example:- Raw materials,
etc labour, etc
❑ ( In the long run fixed inputs are
become varies)
production function with one variable input
Total Product is the amount produced by the
factors employed over a period of time
Average Product- Ratio of Total Product and one variable
inputs
Marginal Product – The rate of change of out put as a
result changes in one variable input
Relationship between Average Product and
Marginal Product
The patterns of average product and marginal
product curves are similar. As the amount of the
variable inputs increases, both average product and
marginal product curves rise; reach their respective
maximum and then decline
Whenever marginal product of the variable input is
greater than the average product, the average
product increases [whenever MP>AP AP
increases].
Con’t
Whenever marginal product of the variable input is
less than the average product, the average product
decreases [whenever MP<AP AP decreases].
Finally, when the marginal product equals average
product, average product reaches its maximum.
When total product is maximum, then marginal
product is zero.
Short run Production Function with Labour as Variable factor
Labour Land (K) Total Average Marginal Product
(L) Output Product (AP) (MP)
(TP)
0 10 0
1 10 10
2 10 30
3 10 60
4 10 80
5 10 Production95with One Variable Input
6 10 108
7 10 112
8 10 112
9 10 108
10 10 100
Short run Production Function with Labour as Variable factor
Labour Capital Total Average Marginal Product
(L) (K) Output Product (MP)
(TP) (AP)
0 10 0 -
1 10 10 10 10
2 10 30 15 20
3 10 60 20 30
4 10 80 20 20
5 10 Production95
with One Variable
19Input 15
6 10 108 18 13
7 10 112 16 4
8 10 112 14 0
9 10 108 12 -4
10 10 100 10 -8
D
112
Output per
month Total Product
C
60 B
Labor per month
3 4 8
30
E
20
Average product
10
3 4 Labor per month
8
Marginal product
Law of Production Function
1) Laws of Variable proportion- Law of
Diminishing Return ( Short run production
function with at least one input is fixed)
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
The law states that as increasing amount of a variable
input is combined with fixed inputs, eventually the
contribution of each additional amount of the
variable input to the total product declines.
“If one of the variable factor of production used more
and more unit, 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 (MP)
(TP) (AP)
0 10 10 0 -
1 10 10 10 10 10
2 10 10 30 15 20 First Stage
3 10 10 60 20 30
4 10 10 80 20 20
5 10 10 Production95
with One Variable
19Input 15
6 10 10 108 18 13
7 10 10 112 16 4
8 10 10 112 14 0 Second Stag
9 10 10 108 12 -4
10 10 10 100 10 -8
Third Stage
D
112
Output per
month Total Product
C
60 B
Labor per month
3 4 8
30 Second Stage
Third Stage
E
20
First Stage Average product
10
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.
Where should rational firm produce?
Stage I: MP is above AP implies an increase in input increases
output in greater proportion.
The firm is not making the best possible use of the fixed factor.
So, the firm has an incentive to increase input until it crosses over
to stage II.
Stage III: MP is negative implies contribution of additional labor
is negative so the total output decreases .
In this case it will be unwise to employ an additional labor.
Stage II: MP is below AP implies increase in input
increases output in lesser proportion.
A rational producer/firm should produce in stage II.
But where exactly the firm will operate within stage II
cannot be determined only on the basis of the product
curves.
We need information about input costs and price of
output.
2. . Production Function with Two
Variable Input
Explain long run production function when the
inputs are changed in the same proportion.
Production function with all factors of productions
are variable..
Show the input-out put relation in the long run with
all inputs are variable.
the various combinations of labor and capital which
gives the firms the same level of the output is called
isoquant schedule or equal product schedule.
4
Isoquant Map: is a set of isoquants or
equal product curves
Properties of Isoquants
i. Isoquant slopes downward. As the use of one
variable input increases, the quantity of the other
variable input should decrease so as to produce the
same level of total product.
ii. Isoquant is convex to the origin. We will discuss
about it when we discuss about the marginal rate of
technical substitutions.
iii. Isoquants never cross each other.
Marginal Rate of Technical Substitution
[MRTS]
The rate by which one factor of production is
substituted for another, keeping the output constant,
is called MRTS. Note that substitution of one factor
of production for another takes place without any
change on the output level. The marginal rate of
technical substitution of capital for labor is measured
as
MRTS of capital for labor = L/C
Where, L is change in unit of labor
C is change in unit of capital
Con’t
Returns to Scale
Returns to scale are a property of production
function that indicates the relationship between
proportionate change in all inputs and the resulting
change in total product. It is a property that applies
only in the long run.
We can identify three types of returns to scale.
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
1. 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
Effect of technological change on
production function
technological
advancement makes our
limited resources more
productive. This means
we can produce:
more output from the
existing level of inputs,
or
the existing level of
output by using less of
the inputs
Exercises
1. Given the cobb-douglas production function :q=f(K,L)=2K0.5L0.25
a. what is the marginal product of capital function(MPK)?
b. what is the marginal product of labor function(MPL)?
c. what is the Average product of labor function(APL)?
d. if capital is fixed at [Link] is the short run production function?
e. At K fixed at [Link] is the marginal product of labor?
f. In the short run, is there problem of diminishing marginal product of labor?
g. In the long run, what types Returns to scale will this firm experience?