THEORYOF

PRODUCTION
 MEANING

Any activity directed to produce goods and

services for the satisfaction of human wants
is called production.
In the production process the inputs are
transformed in to output. Whatever goes in
the process of production is called input and
whatever comes out as a result of their
efforts is called output or production.
 FACTORS OF PRODUCTION

Production is the outcome of the efforts of

factors of production such as land, labour,
capital, enterprise , etc. Factors of production
are also known as inputs.
 PRODUCTION FUNCTION

Production function is a technological and

engineering relationship between the inputs
and the physical output. It can be presented
in a mathematical form as follows:
Qx = f (a, b, c, d, …..T)
Where Qx is the physical quantity,
 a, b, c, d are the inputs and
T is the state of technology.
 PRODUCTION FUNCTION

Economists believe that there are two major

factors of production, therefore, a simple
production function can be presented in the
following form:
Qx = f (L,K)
Where L and K represent labour and capital
respectively.
 PRODUCTION FUNCTION IN THE
SHORT-RUN
In the short-run, it is assumed that all other
inputs are fixed, whereas only one input is
variable. How the output responds to a
change in the variable input is called returns
to a variable input. There are three
possibilities:
1. Law of Increasing Returns
2. Law of Constant returns
3. Law of Diminishing Marginal Returns
 Law of Increasing Returns.

As the units of a variable input are increased,

keeping the supply of other inputs constant,
the total product increases in an increasing
propor-tion or the average and marginal
product increase.
 LAW OF CONSTANT RETURNS

Keeping the Supply of other inputs constant,

if the units of a variable input are increased,
the total product increases in the same
proportion as the increase in the input or the
average and marginal product remain
constant.
LAW OF DIMINISHING MARGINAL
RETURNS

Keeping the supply of all other inputs

constant, if the units of a variable input are
increased, the total output increases in a
diminishing proportion or the average and
marginal product decrease.
 THE LAW OF VARIABLE
PROPORTIONS

The law states that keeping the supply of

other inputs and technology constant, if the
units of a variable input are increased, the
total output in the beginning increases up to
a certain point, and thereafter increases at a
diminishing rate and eventually falls. In other
words, the average and marginal product
increase in the beginning and after a point
decrease.
PRODUCTION SCHEDULE

Labour Total Average Marginal Stage

Input Output Output Output
 1 20 20 20 ┐
 2 50 25 30 │ I
 3 90 30 40 ┘
 4 120 30 30 ┐
 5 135 27 15 │
 6 144 24 9 │ II
 7 147 21 3 ┘
 8 148 18.5 1┐
 9 148 16.4 0┘ III
LAW OF VARIABLE PROPORTIONS
Y

T
P
R P TP
O
D
U
C
T M

AP
O MP
L L1 X
LABOUR INPUT
LAW OF VARIABLE PROPORTIONS

Stage I: This stage of production continues

Up to L units of labour where the AP is
maximum.
Stage II: This stage operates between L and
L1 units of labour. In this stage the total
product Starts increasing at a diminishing
rate, i.e., the AR and MR decrease.
Stage III: This stage operates after
employing labour beyond L1 units. In this
stage the TP starts decreasing and MP is
negative.
 ASSUMPTIONS OF THE LAW

1. The law assumes that only one input is

variable whereas other inputs are constant.
2. The state of technology is given.
3. All the units of a variable input are equally
efficient.
4. Possibility of changing the proportions in
which productive services combine.
 PRODUCTION FUNCTION IN
THE LONG RUN
In the long run it is possible to increase the
supply of all the inputs. In case we classify
the inputs in to two broad categories, i.e.,
labour and capital, the supply of these two
inputs could be raised in the long run.
However, the assumption is that both the
inputs should be increased in the same
proportion. It is called Returns to Scale
The law of returns to scale states that if both
the inputs are increased in the same
proportion then The total product in the
beginning increases in an increasing
proportion then in the same proportion and
finally in a diminishing proportion.
Accordingly we have three stages of returns
to scale which are as follows:
1. The Law of Increasing Returns to Scale.
2. The Law of Constant returns to Scale.
3. The Law of Diminishing returns to Scale.
The three law could be explained with the help
of a schedule as follows:
 INCREASING RETURNS TO
SCALE
M
% CHANGE IN OUTPUT

Y50

20

10 20 X
O
% CHANGE IN INPUTS
 CONSTANT RETURNS TO
% CHANGE IN OUTPUT
SCALE
y
M

35

20

o
20 35 x
% CHANGE IN INPUTS
LAW OF DIMINISHING RETURNS TO
DIMINISHING RETURNS
SCALE TO SCALE

% CHANGE IN OUTPUT Y

M
20

O X
40
% CHANGE IN INPUTS
RETURNS TO SCALE SCHEDULE

 Labour Capital % increase Total % increase

Returns
Input Input in L & K Output in Output to
Scale
 1 100 …… 100 …… ┐
 2 200 100 220 120 │
 3 300 50 350 59.1 │Increasing
 4 400 33.3 500 42.9 ┘
 5 500 25 625 25 ┐
 6 600 20 750 20 ┘Constant
 7 700 16.6 860 14.6 ┐
 8 800 14.3 940 9.3
│Diminishing
 9 900 12.5 1000 6.4 ┘
In the production schedule given above the
law of increasing returns to scale operates up
to 4 units of labour and capital because the
percentage increase in output is more than
the percentage increase in inputs.
The law of constant returns to scale operates
on the 5th and 6th units of labour and capital.
In this Case the percentage increase in output
is equal to the percentage increase in inputs.
Beyond 7 units of labour and capital the law
of diminishing returns to scale operates. In
this case the percentage increase in output is
less than the percentage increase of inputs.
 PRODUCER’S EQUILIBRIUM

The producer is interested in maximizing the

output and minimizing the cost. This
objective could be attained with the help of
isoquant and iso-cost line.
An isoquant represents equal level of output
whereas an iso-cost line shows the same cost
irrespective of the combination chosen of the
two inputs. This can be explained graphically
as follows:
 OPTIMISATION OF OUTPUT
AND MINIMISATION OF COST

Y
IQ
C ISO-COST
A LINE
P
M
I
P 150
T K
A N
5 0 1OO
L
O
L X
LABOUR
Thank You