UPES

Theory of Production

Dr. B.K.Chaturvedi

| Jul 2012| © 2012 UPES

Meaning of Production and Production factor

 Production is a transformation of resources (input)in to commodities

(output).

 Output of goods depends on the factors of production.

 The resources needed to produce goods are termed as factors of production

or factor inputs.

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Concept of Product
 There are three basic concepts of product:

Total product or Total Physical Product (TP or TPP)

Average Product or Average physical product(AP or APP)

Marginal Product or Marginal Physical product (MP or MPP)

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Total Product (TP):
TP is the total amount of a commodity produced by a given number of
variable inputs, keeping all other input is constant. It is also known as total
returns.
Average Product (AP):
AP of a factor is the total product divided by the number of units of a factor.
Thus average product (AP) means the per units output of variable input.
 AP = TP/N where N= number of units of a factor
Marginal Product (MP):
MP is the change in total product resulting from the use of one more (or one
less) unit of the variable input, keeping all other inputs constant.
In short it is called incremental product
MP = Change in TP/ Change in factor input

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Shapes of TP AP and MP
Land Labor TP MP AP
(Fixed factor) (Variable Factor) (Units) (Units) (Units)
1 0 0 - -
1 1 20 20 20
1 2 50 30 25
1 3 90 40 30
1 4 120 30 30
1 5 140 20 28
1 6 150 10 25
1 7 150 0 21.43
1 8 140 -10 17.5
1 9 120 -20 13.33

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Relationship among different concepts of Product
► Relationship Between TP & MP:
MP
 When TP increases at an increasing rate, MP also increases.
 When TP increases at diminishing rate, MP declines
 When TP reaches at maximum, MP becomes zero.
 When total product begins to decline, MP becomes negative.

► Relationship Between AP & MP:

► When MP is greater than AP, the AP rises.
► When MP becomes equal to AP, The AP reaches its maximum.
► When MP is less than the AP, The AP starts declines.
► In the beginning AP and MP both rise, and then after reaching their maximum,t
hey starts to declines

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Short Run & Long Run
 Short Run: The time period during which a firm, in order to make change in its
production can change only in its variable factors but not in its fixed factors.
In the short period, a firm cannot change in its scale of plant.
► Thus in short run there are two factor-fixed factor & Variable factor

Fixed Factor-the factor which can not be varied in the short period. it is
called fixed factor.
Ex. Land Plant machinery, heavy equipments, factory building.
Variable factor-the factor which can easily be varied, in the short run. It is
called variable factor.
Ex. Labour, raw material, power, fuel.
Long Run: The time period in which a firm can change all the factorw of
production, is termed as long Run

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Types of Production Function

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2- Long Run Production Function:
In the long run, all factor- inputs can be varied. it means that in the long-
run , we can expand or reduced to scale of production as well.
The law which states this relationship is called returns to scale. Since it is
related to the long period, it is called long run production function.

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Short Run Production Function: The law of variable
proportions or Returns to a variable factor

 Assumption of Law:
1-Technique of production does not change. The law does not apply if there is
improvement in technology.
2-All units of variable factor are equally efficient.
3-Factors of production can not be fully substituted
4-There must be some inputs whose quantity is kept fixed.
Meaning of Law:
The law of variable proportions (or returns to a variable factor) states that with
the increase in a variable factor, keeping other factors constant, initially the
total product rises but after reaching a certain level of production it starts
decline

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Three stages of the Law :
The relation between variable factor and physical output has three stages
which are shown in the example and the diagram.

Stage I: Stage in increasing Returns to a factor

Stage II: Stage of Diminishing Returns to a factor
Stage III : The stage of negative Returns to a factor

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Long Run production function or Return to Scale

Increasing Return to Scale

Constant Retun to Scale
Decreasing Return to Scale

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 (1) Increasing Returns to Scale:
 If the output of a firm increases more than in proportion to an equal percentage
increase in all inputs, the production is said to exhibit increasing returns to scale.
 For example, if the amount of inputs are doubled and the output increases by more
than double, it is said to be an increasing returns returns to scale. When there is an
increase in the scale of production, it leads to lower average cost per unit produced as
the firm enjoys economies of scale.
 (2) Constant Returns to Scale:
 When all inputs are increased by a certain percentage, the output increases by the
same percentage, the production function is said to exhibit constant returns to scale.
 For example, if a firm doubles inputs, it doubles output. In case, it triples output. The
constant scale of production has no effect on average cost per unit produced.

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 (3) Diminishing Returns to Scale:
 The term 'diminishing' returns to scale refers to scale where output increases
in a smaller proportion than the increase in all inputs.
 For example, if a firm increases inputs by 100% but the output decreases by
less than 100%, the firm is said to exhibit decreasing returns to scale. In case
of decreasing returns to scale, the firm faces diseconomies of scale. The
firm's scale of production leads to higher average cost per unit produced.

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