Production Analysis

Dr. Kishor Bhanushali

Faculty – Economics
IBS - Ahmedabad
Concepts…………………………
Production is basically an activity of
transformation of factor input to
output
Production Function is purely
technical relationship between factor
input and output
Method of Production is a
combination of the factor inputs
required to produce one unit of
output
 The Production Function
Production function is purely technical relations,
which relates factor input and output
The production function represent the technology
of the firm or industry of the economy as a whole
It gives the maximum amount of output that can
be obtained by employing different inputs
The method of production or process or activity is
a combinations of the factors inputs required for
the production of one unit of output
The production process is technically efficient if it
uses less of at least one factor or production and
no more from the other factor, compared to any
other process of production
The production function can be constructed on
the assumption that the technology is given and
out put can be increased by increasing input
 Production Function
When technology changes, production
function itself changes
Selection of best input combination for the
production of a particular output level
depends upon input and output prices
Q

Q = f (K,L)

0 L
 Production function depends on
- Quantities of resources used
- State of technology
- Size of the firm
- Nature of firms organization
- Relative prices of factors
- Combinations of factors of production
Average and Marginal Product
Average product of a factor of production
can be defined as its total productivity
divided by its quantity
Marginal product of a factor of production
can be defined as the change in output
resulting from a very small change in one
factor input, keeping the other factor input
constant
 Law of Diminishing Returns or
Law of Variable Proportions
The law of diminishing returns states the with a
given state of technology, if the quantity of one
factor input is increased by equal increments,
the quantities of other factor inputs remaining
fixed, the resulting increment of the total
product first increase but decrease after a
particular point
It is also known as the law of diminishing
returns to factor. It state that as we go on
employing more of one factor of production
other factors remaining the same, its marginal
productivity will diminish after some point.
Three assumptions (1) State of technology is
given (2) one factor to be kept constant (3) law
is not applicable when to inputs are used in
fixed proportion
 Relation between TP, AP & MP
No of Workers TP MP AP
0 0 - -
1 7 7 7.00
2 18 11 9.00
3 33 15 11.00
4 46 13 11.50
5 55 9 11.00
6 60 5 11.00
7 63 3 9.00
8 65 2 8.13
9 66 1 7.33
10 66 0 6.60
11 64 -1 5.82
12 60 -4 5.00
Production Curve & MP
Ridge Lines
 Three Stages in Production
Stage I –Average product is increasing and
Marginal product is greater than
average product (Stage of Increasing
Returns)
Stage II – Average product is decreasing
and marginal product is also decreasing ,
but marginal product is positive (Stage of
Decreasing Returns)
State III- Total product is decreasing and
the marginal product is negative (Stage of
Negative Return)
In the first stage, the quantity of
fixed factor of production is
abundant relative to variable factor
of production. Therefore when more
and more units of variable factors is
used, the fixed factor is used more
intensively and efficiently. This cause
production to increase at rapid rate
implying increasing AP and MP
In the second stage variable factor
is used at such a rate that ensures
the efficient utilization of the fixed
factor, any further increase in
variable factor cause AP and MP to
fall because the quantity of fixed
factor is now become limiting
compared to variable factor
In the Third Stage the quantity of
variable factor is so large compared
to fixed factor that the former comes
in each other’s way reducing the
efficiency of the fixed factor which
results in a fall in total product
instead of rising. This is the reasons
behind the negative marginal
product
The combinations of labor and capital
attained maximum efficiency of labor
at the boundary line between stage I
and stage II and maximum efficiency
of capital at boundary line between
stage II and stage III

The proportion in which labor and

capital will be used will depend on
their relative prices
 Short Run and Long Run
The short run is a period during
which some inputs cannot be veried.
The long run is a period of
production that gives managers
adequate time to vary all the imputs
to produce goods
 Returns to Scale
By returns to scale we mean the behavior
of production or returns when all factors
are increased or decreased simultaneously
in the same ratio.
In returns to scale we analyze the effect of
doubling, trebling, quadrupling and so on
of all inputs of productive resources on the
output of the product
Constant returns to scale
Increasing returns to scale
Decreasing returns to scale
 Returns to Scale
Sr. No. Inputs TP MP Returns

1 1 L+3C 2 2 Increasing

2 2L+6C 5 3 Increasing

3 3L+9C 9 4 Increasing

4 4L+12C 14 5 Increasing

5 5L+15C 19 5 Constant

6 6L+18C 24 5 Constant

7 7L+21C 28 4 Decreasing

8 8L+24C 31 3 Decreasing

9 9L+27C 33 2 Decreasing

Underlying cause of the changing returns to scale is the possibility

or otherwise of division of labor
 Economies of Scale
Efficient use of capital equipment
Economy of specialized labor
Better utilization and greater specialization in
management
Economies of buying and selling
Economy of the overhead charges
Economy in rent
Experiment and research
Advertisement and salesmanship
Utilization of by-products
Credit availability
 Internal and External
Economies
Technical economies
Managerial economies
Commercial economies
Risk bearing economies
Economies of concentration
Economies of information
Economies of disintegration
 Diseconomies of Scale
Over worked management
Individual tastes ignored
No personal elements
Cut throat competition
Lack of adaptability
 Technological Changes
Production function shifts upwrd

Higher level of output can be produced

with a same level of input
Q
Q = f(L,K)
A
Q = f(L,K)
B

New Product
Improvement for existing products
Better management

0 M L
ISOQUANT or Equal Product Curves
ISOQUANT shows all possible combinations of
two inputs physically capable of producing the
given level of output

Combination Factor Factor

X Y
A 1 12

B 2 8

C 3 5

D 4 3

E 5 2
 ISOQUANT Curve & Map
ISOQUANT Curve ISOQUANT Map
Y
Y

a A

a’ B
C
a”
IQ
IQ IQ IQ
0 X
0 b b’ b” X
 Indifference Curve & Map
Indifference Curve Indifference Map
Y
Y

a A

a’ B
C
a”
IC
IC IC IC
0 X
0 b b’ b” X
 Marginal Rate of Technical Substitution
K
Combination Factor Factor MRTS of X
X Y for Y
A 1 12 -

B 2 8 4:1

P C 3 5 3:1

D 4 3 2:1

R Q E 5 2 1:1

S
T

0 L
Marginal Rate of Technical Substitution

Marginal rate of technical

substitution of X for Y is the number
of units of factor Y which can be
replaced by one unit of factor X,
quantity of output remaining
unchanged
MRTS = ∆X
∆Y
 Equal Cost Lines
Equal cost line shows various
combinations of tow factors which
can be purchased with a given
amount of total money
E

C
Factor Y
A

0 Factor X
Least Factor Combinations
X

Maximization of output subject

to cost constraints

E
A

IQ3
IQ2
IQ1

0 V
Least Factor Combinations
X

Minimization of cost for a

given level of output

E
A

IQ

0 V
B
 Numerical
Q = 4 L + 6 K − 2 LK
2 2

w = 10
r = 10
C = 720
MPl = 8L-2K
MPk = 12K-2L
L = 1.4K
10L+10K =720
K = 30
L = 42
Q = 9936
Expansion Path