THEORY OF PRODUCTION: PART 1

MEANING OF PRODUCTION

Production in economics generally refers to the transformation of inputs into outputs.

Inputs are the raw materials or other productive resources used to produce final products
i.e., output. In technical terms, production means the creation of utility or creation of
want-satisfying goods and services. Any good becomes useful for us or satisfies our want
when it is worth consumption. Thus, a good can be made useful by adding utility. For
instance, we cannot consume wheat flour raw when we are hungry (want), unless it is
turned into bread (output). This conversion of wheat flour into bread is the process of
creating utility. Utilities can be created in three ways. These are the following:

1. By changing form or shape and size of a good. The powdery wheat flour has been
changed to slices of bread. Thus form of the good has been changed. Likewise, a
carpenter giving shape of a chair to a piece of wood or a chef turning a lump of dough
into delicious pizzas, are the examples of changing shape or size of a good/s and thereby
creating utility.

2. Using the scarce goods and services in proper time when they are most required.
Government maintains a buffer stock so that during the time of crisis, it releases food
grains in the market to meet the demand.

3. By transferring a good from one place to another where its use is worthwhile. Sand
transferred from river side to construction site increases its utility.

Thus, production is the process of adding utility to a good through form utility, place utility
and time utility.

MEANING OF PRODUCTION FUNCTION

Production function is defined as the functional relationship between physical inputs and
physical outputs. According to Stigler, “the production function is name given to the
relationship between the rates of input of productive services and the rate of output of
product. It is the economist’s summary of technological knowledge.” Production function
can be expressed as follows:
Q = F(a,b,c,d...)
Where, Q stands for output, a, b, c, d.... are the productive resources or inputs that help
producing Q output; F refers to function. Thus Q is the function of a, b, c, d....., which
means Q depends upon a, b, c, d.....
Thus a production function shows the maximum amount of output that can be produced
from a given set of inputs in the existing state of technology.
For the sake of simplicity, we often express the production function as Q = F(L,K).
Where Q is output (which is the dependent variable) and K and L are capital and labour
inputs, respectively. We can think of other inputs as well, such as land. For the sake of
convenience we assume here that the firm employs only two factors of production—
labour and capital. The firm’s output is treated as a flow, i.e., so many units per period of
time. The volume of output of the firm’s product, per period of time, depends on the
quantities of these factors that are used by the firm.
Let us now suppose that the firm wishes to increase its volume (rate) of output. This can
be achieved by increasing the inputs of one or both factors of production. However, it is
very easy to vary the quantity of labour in the production process. It can be done very
quickly (in a week or a month). On the other hand, a fairly long period of time is required
to vary the quantity of other factors, for example, change the quantity (or usage) of
capital, e.g. to install a new machine or construct a new plant.
The speed with which different kinds of factors can be varied largely depends on the time
period under consideration. Here we assume that the firm is making decisions within two
time periods — the short-run and the long-run.

SHORT RUN AND LONG RUN

The distinction between the short-run and the long-run is based on the difference
between fixed and variable factors. A factor of production is treated as a fixed factor if it
cannot be varied or changed in the short-run. Their quantity cannot readily be changed in
response to desired changes in output or market conditions. Its quantity remains the
same, whether the level of output is more or less or zero. Buildings, land, machinery, and
plants are some common examples of fixed factors. On the other hand, a variable factor
is one which can be varied in the short-run. Its quantity may be swiftly changed in
response to a change in output. Raw materials, labour, fuel, etc. are examples of variable
factors. Such factors are required more, when output is more; less, when output is less
and zero, when output is zero.

The Short-Run:
The short-run refers to the period of time over which one (or more) factor(s) of production
is (are) fixed. In the real world, land and capital (such as plant and equipment) are usually
treated as fixed factors. Here we are considering a simple production process with only
two factors. We treat capital as the fixed factor and labour as the variable factor. Thus,
output becomes a function of (i.e., output depends on the usage of) the variable factor
labour working on a fixed quantity of capital. In other words, if the firm wishes to vary its
production in the short-run, it can do so only by changing the quantity of labour. With a
fixed quantity of capital, this necessitates changing the proportions in which labour and
capital are combined in the production process.

The Long-Run:
On the other hand the long-run is defined as the period over which all factors of
production can be varied, within the confines of existing technology. In the long-run all
factors are variable. Moreover the long-run also permits factor substitution. More capital
and less labour or more labour and less capital can be used to produce a fixed amount of
output.
TP, AP, MP

Total Product:
Total Product (TP) is the total amount of final output produced by the firm, using a given
amount of inputs, for a given period of time.

Average Product:
Average Product (AP) of a factor is the total output produced per unit of the factor
employed.
Thus,
Average Product = Total Product/Number of units of a factor employed.

Marginal Product:
Marginal Product (MP) is the additional output produced as a result of using an additional
unit of input. Thus, we can say that marginal product is the addition to Total Product when
an extra factor input is used.
Marginal Product = Change in Output/ Change in Input
For instance, if we want to calculate the MP of a specific input, say labour, the formula
can also be written as:
MPL = ∆TP/∆L
Where MPL denotes Marginal Product of Labour, ∆TP denotes change in TP, and ∆L
denotes change in quantity of labour.

RETURNS TO A FACTOR AND RETURNS TO SCALE

There are generally two types of production functions mostly used in economics. First,
the production function when the quantities of some inputs are kept fixed and the
quantity of one or few input/s are changed. This kind of production functions are studied
under law of variable proportions. These are also called short-run production function.
The short-run is a period during which one or more factors of production are fixed in
amount. There is no time to change plants or equipments of an enterprise.
Secondly, the production functions in which all inputs are changed. This forms the subject
matter of the law of returns to scale. These are also called long-run production function.
The long run is a period during which all factors become variable. A new plant can be
constructed, new machinery may be installed, and so on. We will discuss these laws in
detail in the next Notes.