module 2 em

04/27/2023Kiran.Shetty , Assistant professor, BGSIT, BG NAGAR

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Module 2Production function


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Production functionMeaning of Production Function:

A production function refers to the functional relationship, under the given technology, between physical rates of input and output of a firm, per unit of time.

In other words, it shows for a given technology (technique) of production the output that can be obtained from various levels of factor inputs, during a given period of time.

Since it relates inputs to outputs it is also called as, “Input-Output Relation”.


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•Production function – the physical or technological relationship between inputs and output.

•Input output ratio.•Shows the productive efficiency of the

firm


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•Production function is divided into a) Short run Production function b) Long run Production function


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•The short run is a period of time in which at least one of the factors of production is fixed.

•The fixed factors of production,, are the inputs that cannot be increased during the short-run productive process.

•variable factors of production, or variable inputs, are those inputs that can be increased during production.


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In economic theory we come across 3 types of production function

-production function with one variable input(law of diminishing marginal returns)

-production function with two variable input(Iso-quant analysis)

-production function with all variable input (Laws of returns to scale)


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Total, average and marginal physical product•Total product: total product is the total

quantity of output produced by a firm for a given quantity of inputs.

•Total physical product is the total production of output by a firm based on the quantity of inputs used. While total physical product usually goes physical product usually goes by the shorter name “total product”


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Average physical product •Average physical product is the quantity

of total output produced per unit of a variable input , holding all other inputs fixed. Average physical product , usually abbreviated APP, is found by dividing total physical product by the quantity of the variable input.

•Average physical product Total physical productVariable input


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Marginal physical product •It is the change in the quantity of total

physical product resulting from a unit change in a variable input, keeping all other inputs unchanged .

•Marginal physical product, usually abbreviated MPP,

•It is found by dividing the change in total physical product by the change in the varible input.


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•MPP =change in total physical product change in variable input


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Meaning and definition of law of variable proportion•It is also known as production function

with one variable•The law is about the production function

(relationship between input and output) with one factor variable keeping quantity of other factor fixed .i.e by bringing about the changes in proportion between variable factor and fixed factor.


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1) Only one factor unit is to be varied, while all other factors should be kept constant.

2) Different units of variable factors are homogenous.

3) Techniques of production remain constant.

4) The law will hold good only for short and given period.

5) It is possible to vary the proportion in which the various inputs are considered


13Units of variable input

TP (Rs)

AP (Rs)

MP (Rs)

Stages

0 0 0 0 1 10 10 10 2 24 12 14 First stage

3 39 13 15 4 52 13 13 5 60 12 8 6 66 11 6 7 70 10 4 Second

stage 8 72 9 2 9 10

72 70

8 7

0 -2 Third stage


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Trends in OutputFrom the above table we can observe the we can observe the following tendencies in TP, AP and MP:

1. Total output goes on increasing as long as MP is positive. It is the highest when MP is zero and TP declines when MP becomes negative.

2. MP increases in the beginning, reaches highest point and then diminishes at the end.

3. AP will have the same tendencies as the MP. In the beginning MP will be higher than AP but at the end AP will be higher than MP.


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Diagrammatical Representation


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Explanation of diagrammatic representation

From the diagram it is clear that there are three stages:

I. First stage : The Law of Increasing Returns

II. Second stage : The Law of Diminishing Returns

III. Third stage : Negative Returns


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Uses in Decision Making / Practical Importancei. It helps to work out the more ideal

combination of factor inputs or the least cost combination of factor inputs.

ii. It is useful to a businessman in the short run production planning at the micro level.

iii. The law gives guidance, that by making continuous improvements in technology, the producer can postpone the occurrence of diminishing returns.


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Iso-quants and iso-costsProduction Function with two variable inputs.(Isoquant Analysis)There are a large number of combinations

of factor inputs which can produce a given output and the producer has to select the most economical combination out of them.

Iso quant curve is a technique developed in recent years to show the equilibrium of a producer with two variable input.


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•Isoquant – Two variable inputs resulting in the same level of output.

•A graph that shows all the combinations of capital and labor that can be used to produce a given amount of output is called an isoquant


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Meaning and definitions: The term ‘Isoquant’ consists of 2 words – ‘iso’ and ‘quant’. ‘Iso’ means ‘equal’ and ‘quant’ means ‘quantity’.

Therefore Isoquant curve means Iso-product curve or equal product curve or constant product curve.

Iso-product curve may be defined as “ A curve which shows the different combinations of two inputs producing the same level of output”.


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Continued…..•According to Prof. Keinstead, “ Iso-

product Curve represents all possible

combinations of two factors that will give the same TP”.

The following table shows the various hypothetical combinations of 2 factor inputs-labour and capital, which are capable of producing the same quantity of output –100 units of a commodity.


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Isoquant Table


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•As we move along the isoquant the output remains same.

•An increase in one input requires decrease in other input to keep total output unchanged.

•More specifically as we move along the curve we are substituting one input for other.


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Iso-Quant Map

•A catalogue of different combinations of inputs with different levels of output shown on a graph is called as Iso-quant map or equal-product map.

•In other words, a number of iso quants representing different quantities of output are known as Iso-quant map.


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Graphical Representation


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Properties Of Iso-Quants / Equal Product Curves1. The Iso-quant curves slope downwards from

left to right – This is so because, if one factor is increased, another factor must be reduced in order to produce the same quantity of output.

2. Iso-quant curves cant intersect each other – This is so because the amount of factors required to produce 100 units of a commodity

cant be equal to the amount of factors required to produce 200 units of a commodity.


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Continued….. 3. Iso-product curve lying to the right or

higher level indicates the higher level of output and vice versa.

4. The Iso-quant curves are convex to the point of origin .

5. An Iso-product curve will not touch either X or Y axis.


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Iso – cost Curves or Lines:

An Iso-cost line is a line which shows various combinations of two inputs that the firm can buy at given prices with a given outlay. It shows two things:

1. Prices of two inputs2. Total outlay of the firm.


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Graphical Representation


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Producers Equilibrium (Least cost combination of factors)• The producing firm needs two

instruments to find out the equilibrium position. They are:

1. Its Iso-quant map2. Its Iso-cost line An iso-product curve represents

different possible combinations of two factor inputs with the help of which a given level of output can be produced. On the other hand, an Iso-cost line shows the total outlay of the producer and the prices of factors of production.


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Illustration •Factor X : Rs. 50/unit•Factor Y : Rs. 40/unit

X YAt Rs. 2000 50 40At Rs. 3000 75 60At Rs. 4000 100 80


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Graphical Representation of least cost combination of factors


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-Production function with all variable input (Laws of returns to scale)


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•Law of returns to scale -When all the inputs are increased firm

experiences following possibilities -Increasing returns to scale -Constant returns to scale -Decreasing returns to scale.


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•Increasing returns to scale -long run production function -Given percentage of increase inputs

results in larger percentage of output. -Suppose if firm doubled or tripled

input, it would more than double or triple output.

-Increasing returns to scale implies that LAC declines.


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•Constant returns to scale -Technically the quantitative

relationship between input and output remains constant.

-If a firm doubles the input, it doubles the output, if it triples the input, it triples the output and so on.

-Constant returns to scale implies that LAC remains same.


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•Decreasing returns to scale - Given percentage of increase inputs

results in smaller percentage of output. -Suppose if firm doubled or tripled

input, it would less than double or triple output.

-Decreasing returns to scale implies that LAC increases.


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Economies and diseconomies of scale•They are advantages that arise due to

large scale production. It refers to the notion of increasing efficiencies of the production of goods as the number of goods being produced increases.

•Typically the average costs of producing a good will diminish as each additional good is produced, since the fixed costs are shared over an increasing number of costs.


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Due to economies of scale , larger companies have greater access to markets in terms of selecting media to access those markets, and can operate with larger geographic reach.

According to porter: economies of scale is the “ declines in the unit’s cost of production


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Dis economies of scale•When a firm continues to expand its size, a

stage comes when diminishing returns to scale set in. As a firm expands beyond a level, it encounters growing diseconomies.

•Technical factors are unlikely to produce dis economies of scale.

•When diseconomies of scale arise they are most likely to be associated with the human and behavioral problems of managing a large enterprise


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Kinds of economies and dis economies of scaleInternal economies and diseconomies 1.Technical economies and diseconomies –

large scale production is associated with technical economies. As the firm increases its scale of operations , it is possible to use more specialized and efficient form of all factors, specially capital equipment and machinery.


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2.Managerial economies and diseconomies- managerial economies refer to reduction in managerial cost. when output increases, division of labour can be applied to management.

•Eg: sales can be split into sections for advertising exports and customer service.


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3. Commercial economies and diseconomies:

production of big volumes of goods requires enough material and components.

This enables the firm to place a bulk order for materials and components and enjoy lower prices for them.


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4. Financial economies and diseconomies: in raising finance for expansion large firm is in favorable position. For example: it can offer better security to bankers and, because it is well known , raise money at lower cost, since investors have confidence in it and prefer shares, which can be readily sold on the stock exchange.


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•5. Risk bearing economies and diseconomies-

it is said that a large business with diverse and multi production capability is in a better position to withstand economic ups and downs, and therefore, enjoys economies of risk bearing


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External economies and diseconomies of scale

1. Cheaper raw materials and capital equipment- the expansion of an industry may result in exploration of new and cheaper sources of raw materials , machinery and other types of capital equipment

2. Technological external economies- when the whole industry expands it may result in the discovery of new technical knowledge and in accordance with that the use of improved and better machinery than before. This will change the technical co efficient of prodcution


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3. Development of skilled labour- when an industry expands in an area the labour in that area is well accustomed to do the various productive processes and learns a good deal from the experience.


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4. Growth of ancillary industries – with the growth of an industry a number of ancillary industries may specialize in production of raw materials, tools, and machinery. They can provide them at a lower price to the main industry.


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5. Better transportation and marketing facilities- the expansion of an industry resulting from entry of new firms may make possible and development of transportation and marketing network to a great extent, which will greatly reduce cost of production and development of transportation and marketing network to a great extent

module 2 em

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