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PRODUCTION ANALYSIS
PRODUCTION FUNCTION :
Production means translation of physical input into physical output. A firm is required to coordinate
different types of production factors like land, labour, capital and so on to undertake production activity.
Here, the term “Input'' is taken as a wider concept rather than only land capital. Here, raw – material,
fuel, steel and other services that are used for the production activity are included in input. Either they are
treated as land or capital.
The relation between input and output can be expressed with the help of a production function. Under
the conditions of given technology. Thus, by particular production technology, production depends upon the
quantity of two or more inputs.
Production function can be explained symbolically as given below.
Q = F (L, M, K……..) where, Q = quantity of output,
L = Labour
N = Land,
K = Capital
The above equation explains the quantity of output produced depending upon the quantity of inputs that
are used in the production process. Production function expresses the relationship between quantity of input and
quantity of output.
Here, we are required to note down 2 points over here.
1) Production function must be considered with reference to a particular period of time.
2) Production function is also determined by the state of technology because a change in technology
brings about change in production. With the use of better production technology, there will be greater flow of
production with smaller quantities of input.
Production function can be divided into two types;
1) Short run production function,
2) Long run production function.

(1) SHORT RUN PRODUCTION FUNCTION:

Short run production function is also known as “Single variable production functions” is that where the
quantities of some inputs like land and capital are kept constant and say labour is varied it can be explained as
under:
Q = F (L, K)

(2) LONG RUN PRODUCTION FUNCTION:

The long run production function signifies variation in all inputs and is expressed as follows.
Q = F( L, K, N……..)

Production function is also based on some assumptions.

1) Limited substitution of one factor or other.
2) Constant technology
3) Inelastic supply of fixed factors in the short run.

THE LAW OF DIMINISHING RETURNS

OR
THE LAW OF VARIABLE PROPORTION

Introduction-
The law of diminishing return can be explained as given below.
If we keep the quantity of one or more factors of production constant and gradually increase the quantity
of other various factors, then after a certain point of time, corresponding return to every additional unit of
variable factors will begin to diminish. In other words, additional quantity or variable factors will after a certain
point, yield diminishing return. This law is also known as the law of variable proportion or as a part of the law of
non proportional output. It explains the relationship between production factors (input) and production (output).
In the short run, this law explains that if we increase variable factors leaving other factors constant, then from a
certain point, proportion of production will be less compared to increase in variable factors (input).
The following assumptions should be taken into account for this theory.

(1) THERE SHOULD NOT BE ANY CHANGE IN PRODUCTION METHOD:

Here we assume that there is no change in production method because if any good change is made,
then there may be increase in production rather than decrease. So as a result, the law of diminishing return
may not apply.

(2) FACTORS OF PRODUCTION ARE OF SAME QUALITY:

Here it is also assumed that factors which are used or employed are of same quality, because if there is
a difference in quality of variable factors, then the law of production may not be applied

(3) COMBINATION OF FACTORS IS CHANGEABLE:

 Here factors of production are assumed to be changeable. It means, we can make changes in variable
factors leaving fixed factors constant. It means change in production factors is possible.

We are having two factors i.e. Land & capital as fixed factors, while labor is a variable factor. After a
certain point, the return received will begin to diminish. It means the law of production does apply.
We can see this fact by studying the below given table & diagram.

In this example, the land is the fixed factor and labour is the variable factor. The table shows the different
amounts of output when you apply different units of labour to one acre of land which needs fixing.

The following diagram explains the law of variable proportions. In order to make a simple presentation, we
draw a Total Physical Product (TPP) curve and a Marginal Physical Product (MPP) curve as smooth curves
against the variable input (labour).

The law has three stages as explained below:

1. Stage I – The TPP increases at an increasing rate and the MPP increases too. The MPP increases
with an increase in the units of the variable factor. Therefore, it is also called the stage of
increasing returns. In this example, the Stage I of the law runs up to three units of labour (between
the points O and L).
2. Stage II – The TPP continues to increase but at a diminishing rate. However, the increase is
positive. Further, the MPP decreases with an increase in the number of units of the variable factor.
 Hence, it is called the stage of diminishing returns. In this example, Stage II runs between four to
six units of labour (between the points L and M). This stage reaches a point where TPP is
maximum (18 in the above example) and MPP becomes zero (point R).
3. Stage III – Now, the TPP starts declining, MPP decreases and becomes negative. Therefore, it is
called the stage of negative returns. In this example, Stage III runs between seven to eight units of
labour (from the point M onwards).

Significance of the three stages

Stage I
A producer does not operate in Stage I. In this stage, the marginal product increases with an increase in
the variable factor.
Therefore, the producer can employ more units of the variable to efficiently utilize the fixed factors. Hence,
the producer would prefer to not stop in Stage I but will try to expand further.
Stage II
Any rational producer avoids the first as well as third stages of production. Therefore, producers prefer
Stage II – the stage of diminishing returns. This stage is the most relevant stage of operation for a
producer according to the law of variable proportions.
Stage III
Producers do not like to operate in Stage III either. In this stage, there is a decline in total product and the
marginal product becomes negative.
In order to increase the output, producers reduce the amount of variable factors. However, in Stage III, he
incurs higher costs and also gets lesser revenue thereby getting reduced profits.

BENEFITS OF LARGE SCALE PRODUCTION.

OR
INTERNAL & EXTERNAL ECONOMIES & DISECONOMIES OF SCALE.

If the production unit is undertaking production on a large scale then it will be possible for the firm to
reduce the cost up to some extent. It is known as economies of scale. These are the benefits, which are
received by only large units and these benefits received by large units are considered as economies of scale.
Robinson has given these 5 types of Economies of Scale in his book “structure of Competitive
industries”

ECONOMIES OF SCALE
(A) INTERNAL ECONOMIES OF SCALE

(I) TECHNOLOGICAL BENEFIT

(a) Benefits of division of labor
Large scale units can gain the benefits of division of labor. It means work is distributed amongst
different persons as per their skill and qualification. Therefore, large units can gain the benefit of increased
productivity. Division of labor also gives the benefit of research.

(B) BENEFITS OF LARGE INVESTMENT

Sometimes heavy machineries may not be affordable because they are very costly. E.g. crane. It may
not be available with small size units & if small units purchase these kinds of machines, it may increase the cost
rather than reducing the cost.

(C) COMBINATION OF DIFFERENCE PRODUCTION METHODS

Due to large scale production, it may be possible for the large unit to combine different production
processes. If different production processes are undertaken by the large units, it saves money, time and energy.
It means we can save all these three and that will again reduce the cost.

(D) BENEFITS OF INCREASE IN AREA

Sometimes large areas can give benefits to the unit because the firm will be able to utilize all its
resources at optimum level. E.g. a bus with 2 floors will not cost double but we can receive higher income.

(E) BENEFITS OF USE OF BY PRODUCTS

Sometimes production of one commodity itself produces another commodity. If the production is
undertaken on a large scale, then it will be possible for the firm to sell those products and to receive income
which in turn reduces cost of production. E.g. wastage from the production of oil can be used as a food for
cattle. It means use of by products will reduce the cost.

(II) MANAGEMENT RELATED BENEFITS.

If production is undertaken on a large scale, then it will be possible for the firm to employ skilled and
qualified personnel in the unit. It means by employing qualified people, the work will be accurate, efficient and
can be completed in a short period. All these things will reduce the cost for large size units.
(III) PURCHASE SALES BENEFIT
Large size units can also receive the benefits of purchase and sales also. Large size units can
purchase raw material in bulk quantity that again reduces the price of raw material by purchasing material at a
cheaper rate.
Large scale units can also make more advertisement expenditure and can arrange exhibitions to
increase the sales. Thus large size units can gain the benefits of large scale purchase & sales.

(IV) FINANCIAL BENEFIT

Being a large unit of production, the firm gains the benefits of its prestige and credit of the market. It
means the unit can easily gain financial resources. They can also receive it at a cheaper rate of interest.

(V) BENEFIT FOR TAKING THE RISK

If the production is undertaken for multiple products then it will be possible for the firm to take risk of
introducing new products because loss of one product can be recovered by selling other products. The same as
loss of one market can also be covered by increasing the sales in another market. Moreover, large scale units
purchase material from various parties so the unit has not to depend upon a particular person or party.

(B) EXTERNAL ECONOMIES OF SCALE

If a particular industry is expanded on a large scale then every firm in industry can take external benefits
and these are known as external economies of scale. External economies of scale can be explained as given
below.

(I) BENEFIT OF RESEARCH & DEVELOPMENT

If a particular company is performing on a small scale then it may not be affordable for the company to
spend large amounts on research & development because research & development require large investment but
if the industry is expanded then all firms together form an association and they can spend large amounts for
research & development. Therefore, every firm in industry can produce better quality with the help of research &
development.

(II) ADVANTAGES OF ANCILLARY INDUSTRIES

If a particular industry is expanded at a particular location then it also provides opportunity for ancillary
industry to be expanded in that area. Therefore, a company can gain raw material and other parts from their
location to near them.
It will reduce transportation cost and firms can also maintain production schedules in time, so all these will
reduce overall expenditure of the firm.

(III) BENEFIT OF LOCATION

It is possible to maintain & manage the business smoothly only when primary infrastructure facilities are
available. If a particular industry is expanded at a particular location, it will be the responsibility of the
government to provide various infrastructural facilities like roads, transportation, water supply, electricity,
banking, communication, insurance etc. If the government is not providing these kinds of facilities then firms
can require spending money to gain some facilities. It means the location of industries will reduce overall
expenditure of the company.

DIS ECONOMIES OF SCALE

It should be remembered that there are certain limits to the advantages of large scale production. It is
because beyond a certain point, the firm does not expand and increase its production because further
expansion results, not in economies but in these economies of scale. These diseconomies of scale or what may
be called as the limits to large scale production may briefly be discussed as follows.

(A) INTERNAL DISECONOMIES

(I) DISADVANTAGE OF MANAGEMENT

If a particular company is performing on a large scale, then it will have a large number of employees.
Large human resources sometimes also generate some problems in management.
It becomes very difficult for the company to maintain sound controlling, organizing, staffing, directing
and so on. There are a large number of employees which makes management complex and it generates many
problems for the company.

(II) PURCHASE SALE DISADVANTAGES

If a company is running on a large scale, then the company can gain some financial benefits. It means
a company can make bulk purchases so it reduces the cost of particular products.
But sometimes, it happens that after making bulk purchases, there may be fall in price. So the company
has to bear loss from two sides-
(1) The loss of the block of investment
(2) Companies can not increase their prices due to stiff competition.

(II) TECHNICAL DISADVANTAGES

If a company is running on a large scale, then it can take the help of the latest technology and can
undertake different processes in their companies. But it also becomes necessary to co ordinate all these
processes because stoppage of one process disturbs the whole production schedule
(B) EXTERNAL DISECONOMIES

(I) ENVIRONMENTAL ASPECT

If the particular industry is located at a particular place, then it may generate noise pollution, water
pollution, pollution in the form of smoke (air pollution) etc. Here companies are required to establish a proper
wastage clearance system otherwise the government is required to take measures to prevent pollution.

(II) INDUSTRIAL PROBLEMS:

When the large scale production of the company will have more number of employees then they can
compare the facilities which are provided by other companies. Employees become more aware about their
rights and also form labor unions. If the demand of labor unions is not satisfied, then they may go on strike and
it will generate disputes between employer and employees which in turn disturbs the industrial peace.

ISOQUANT AND ITS PROPERTIES(CHARACTERISTICS) -

INTRODUCTION:

Isoquant curve, the focus of all combinations of two factors of production that yield the same level of output and
isoquant is also known as equal product curve, One which shows a number of alternative combinations of factor
input which lead to the same level of output.
The definition of isoquant can be given as below:
“An isoquant may be defined as a curve, which shows the different combinations of two inputs,
producing the same level of output”.
It means that different combinations of two inputs can give the same level of output. Thus, the main
theme of an isoquant theory is that production remains the same. It means there is no change in the level of
production with the different combination of two inputs.
An isoquant theory can be explained in a better way with the help of the below given table and diagram.

SCHEDULE:

Combination Capital Labour

A 1 8
B 2 6
C 3 4
D 4 3

DIAGRAM:
 In the diagram, we can see that various combinations indicate the same level of output .

In the above given isoquant map, we can see that higher isoquant indicates higher production and lower
isoquant indicates lower production.

ASSUMPTIONS OF THIS THEORY:

1) There are uses of labour and capital only.
2) Other factors remain constant.
3) Production method is given and there is no change in production method.
4) Optimum utilization of labour and capital

PROPERTIES (CHARACTERISTICS) OF ISOQUANT THEORY:

1) Isoquant slopes downward from left to right.
2) Higher isoquant or lower isoquant.
3) Isoquant do not intersect each other.
4) Isoquant are convex to origin or convex downward.

(1) ISOQUANT SLOPES DOWNWARD FROM LEFT TO RIGHT :

As the main theme of an isoquant theory, is that the proportion of output remains the same. It is possible
only if there is an increase in the amount of one factor and decrease in the amount of another factor. Isoquant
always slopes downward from left to right because if it slopes upward from left to Right, it indicates increase or
decrease in output. An isoquant may not be horizontal and vertical because this curve indicates increase in one
factor and same amount of increase in another factor. It leads to change in production, so it is not possible.

(2) HIGHER ISOQUANT OR LOWER ISOQUANT:

As we discuss, that in isoquant map, that, in upward shift of an isoquant indicates high level of output
and vice-a –versa.

1) ‘B’ Combination indicates more numbers of laborers are used and units of capital remain the
same. Obviously it leads to an increase in production.
2) ‘D’ Combination indicates use of more units of capital and units of labour remain same, it will also
increase the production.
3) ‘C ‘Combination indicates more units of labour and more units of capital are used so it will change
the level of output. Thus, we can say that upward shifts of an isoquant leads to increase in
production.

(3) ISOQUANT DO NOT INTERSECT EACH OTHER:

The main theme of an isoquant theory is the level of output remains the same with different
combinations of inputs.
In the above given diagram, Isoquants intersect each other but it is not possible because in the diagram,
‘A’. Combination of labour and capital indicates different units of output as ten units and 20 units but in theory, it
is not possible that the same combination shows different levels of output.

4) ISOQUANT ARE CONVEX TO ORIGIN :

Combination of the same level of output can be satisfied only if there is an increase in marginal
productivity of one factor and decrease in marginal productivity of another factor. or only if decrease in marginal
productivity of one factor and increase in marginal productivity of another factor. Otherwise the condition of the
same level of output can not be satisfied.

RETURNS TO SCALE:
Returns to scale indicates use of different inputs and output. Moreover, various returns to scale indicate increase
in inputs and at a same time increase in output.
With this reference we can discuss it into 3 parts.
1) Increasing returns to scale
2) Constant returns to scale
3) Diminishing returns to scale

(1) INCREASING RETURNS TO SCALE:

Increasing return of scale indicates that output increases more than proportionate change in input and
so we will have an increase in returns to scale. In the beginning the early age of the company receives
increasing returns to scale.
 In the above given diagram ox represents units of labour and oy represents units of land. We can see
here that the company gains more increase in production proportionately compared to increase in input.

(2) CONSTANT RETURNS TO SCALE:

Constant returns to scale indicates that the company gains the same increase in output as increase in
input. After some extent the production company gains constant returns to scale.

In the above given diagram ox represents units of labour and oy represents units of land. Here, we can see that
the company gains the same increase in output as input.

(3) DIMINISHING RETURNS TO SCALE:

Diminishing returns to scale indicates that the company gains less increase in output, proportionately
compared to increase in output. When fixed factors are fully utilized and then also company increasing variable
factors then companies start to gain diminishing returns.

In the above given diagram ox represents units of labour oy represents units of labour oy represents units of
land. Here, we can see that the company gains less increase in output compared to increase in input.

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