Production Function:

The Law of Diminishing Returns, Output

Elasticity, Marginal Product, Average
Product
DR. VIGHNESWARA SWAMY
What is Production?
Production refers to the transformation of inputs
or resources into outputs of goods and services.
Production involves inputs and produces the Variable
outputs. Fixed inputs
Inputs are the resources used in the process of Inputs
production of goods and services.
Fixed Inputs are those that cannot be readily
changed during the time period of consideration. Production
Variable inputs are those that can be varied
easily and on very short notice.
Short-run is the time period during which at least
one input is fixed.
Long-run is the time period when all inputs are
Outputs
variable.

DR. VIGHNESWARA SWAMY 2

Production Function
The Production Function measures the maximum possible output that the firm can produce from a given
amount of inputs (such as labor, capital, land, raw materials, etc.) by given technology.

𝑸 = 𝒇(𝑳, 𝑲)
Where, Q is the output (number of units of the commodity)
L is the labor (number of workers employed)
K is the capital (amount of equipment used in the production)
Production functions are determined by technology, equipment and
input prices.
Discrete production functions are lumpy.
Continuous production functions employ inputs in small increments.
DR. VIGHNESWARA SWAMY 3
Empirical Production
Functions
Cobb-Douglas Production Function
Q = AKaLb

Estimated Using Natural Logarithms

ln Q = ln A + a ln K + b ln L

DR. VIGHNESWARA SWAMY 4

Production Function types
Production functions can be
understood as short-run and
long-run functions.
Short-run production
function involves a varying
labor variable and other
inputs kept constant. The law
of variable proportion
operates here.
Long-run production function
involves all the inputs varying.
The law of returns to scale
operates here.

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Production Function
With One Variable Input
Total Product (TP) is derived by holding the quantity of one input constant and the changing the
quantity of the other input.
TP = Q = f(L)
Marginal Product (MP) is the change in the total product or extra output per unit change in the labor
used.

Average Product (AP) is the total product divided by the quantity of labor used.

Output q
AP  
labor input L
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Total Product of labor curve
Table 1: Production with one variable input
Amount of labor Amount of Capital Total Output Average Product Marginal Product
(L) (K) (Q) (AP) (MP)
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 95 19 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
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Total, Marginal and Average Product of labor curves

DR. VIGHNESWARA SWAMY 8

Total, Marginal, and Average
product curves, and Stages of
Production
Stage 1 of production for labor
corresponds to the rising portion of
the AP.
Stage 2 of production covers the
range from the maximum of AP to the
zero of MP. Ideal stage for production.
Stage 3 of production occurs when
the MP is negative. The declining
portion of MP is the reaction of the
law of diminishing returns. The
rational producer does not operate
here.
DR. VIGHNESWARA SWAMY 9
 C

Implications A

TP increases rapidly up to level of labor

input (at 80) A then increases at a slower
rate as labor input increases.
TP curve becomes flatter and flatter until it
reaches maximum output level at C.
Curve implies that marginal product of labor
first increases rapidly then decreases,
eventually becoming zero or negative. B
Between zero and B, MP curve lies above
AP curve, causing AP curve to increase.
Below B, MP curve is below AP curve,
causing AP curve to decrease.

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 Output Elasticity
Output Elasticity EL of labor measures
the percentage change in output
divided by the percentage change in
the quantity of labor

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 Production and Utility Functions

Production Function Utility Function

Output from inputs Preference level from
consumption
Isoquant Curve Indifference Curve
Marginal Rate of Technical Marginal Rate of Substitution
Substitution (MRTS) (MRS)
Marginal Productivities Marginal Utilities

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 Law of Diminishing Returns
The law of diminishing returns
states that "If an increasing
amounts of a variable factor are
applied to a fixed quantity of
other factors per unit of time,
the increments in total output
will first increase but beyond
some point, it begins to
decline“.
As more and more variable
factors are added to a given
quantity of fixed factors, holding
variable factors constant,
marginal product eventually
decreases.

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Keywords
Production Function
Optimal Method of Production
Short-run production function
Long-run production function
The Law of Diminishing Returns
Output Elasticity
Marginal Product
Average Product
Fixed Factors
Variable Factors

DR. VIGHNESWARA SWAMY 14