Production

Meaning
• Production is an activity that transforms inputs into output.
• For example, a sugar mill uses such inputs as labour, raw
materials like sugarcane, and capital invested in
machinery,factory building to produce sugar.
• This process of transformation can be: a change in form
(e.g. wood into furniture), a change in space (e.g. rail
transportation), or a change in time (e.g. cold storage).
• These three kinds of transformations help in enhancing
usability of goods and materials.
• Production, thus, involves producing, storing and
distributing goods and services .
 Contd.
• Tangible like steel and intangible like banking,insurance
etc.
• Production is, thus, an activity that increases consumers’
usability of the good.
 Factors Affecting Production
• Technology
• Inputs
• Time Period of Production

• The production function

Q= F(L,N,K,…)
The production function is purely a technological relationship
which expresses the relation between output of a good and
the different combinations of inputs used in its production.
 Attributes
• Flow Concept
• Physical Concept
• State of technology and inputs
• Inputs
• Some inputs may be specific
• Factors Combination for the Maximum output
• Short Run and Long Run production function
 Time element and Production
function
• The Short Run- The term “short run” is defined as a period
of time over which the inputs of some factors of
production cannot be varied.
• Factors which cannot be altered in the short-run are called
fixed factors.
• In the short period ,some factors are fixed and some are
variable. Elements of capital such as plant, machinery and
equipment are generally fixed in the short-run.
• Q= f( a/p,c,…,n,T)
 The long run
• The term “ long run” is defined as a period of time long
enough to permit variations in the inputs of all factors of
production employed by a firm.
• In other words ,the long period is such a time period over
which all factors become variable.
• There is no distinction between fixed and variable factors
in the long run, as all factors become variable factors.
• Long run (normal period) is associated with the change in
the scale of production, assuming the basic technology of
production to be constant.
 Long Run Production Function
• In the long run, the firm operates with the
changing scale of output and its size as a whole is
varied.
• Thus, long run production can be stated as under:
Q=f(l,k)
It is evident that all factors are denoted as variable
components in production in the long run.
 ISOQUANT
• A production function with two variable factors is analysed
with the help of isoquants (IQ).
• Isoquants are variously called Equal Product Curves (EPC)
or Isoproduct Curves (IPC) or Production Indifference
Curves (PIC) or Constant Product Curves (CPC).
• An isoquant represents different combinations of two
variable inputs which are capable of producing the same
level of output.
• According to Cohen and Cyert, “An isoproduct curve is a
curve along which the maximum achievable rate of
production is constant”.
 Contd.
• The producer, therefore , would be indifferent to the
various combinations as they represent the same level of
output.
• For this reason, the isoquants are often called production
indifference curves.
 Important concepts of isoquants
• (a) Marginal Rate of Technical Substitution (MRTS)-
The downward slope of isoquant from left to right shows the
technical substitutability of factor inputs for one another
in the productive process. For instance, labour can be
substituted for capital and vice versa. This means, if less
of one factor is used, then more of the other must be
produce the same level of output.
(b) Diminishing Marginal Technical Substitution (DMRTS)
The principle of DMRTS is an important feature of EPC. This
means that the MRTS as more and more labour is
substituted for capital to maintain constant output.
 Properties of isoquants
• All equal product curves slope downwards from left to
right, i.e. they are negatively inclined.
• Isoquants are convex to the origin ‘O’
(i) Factor inputs are perfect substitutes
(ii) Factor inputs are perfect complements
• No two isoquants can intersect or cut each other
• Isoquants need not be parallel to each other
• There can be a number of isoquants in between two
isoquants
 Contd.
• An isoquant cannot touch either axis
• Higher isoquant represents a higher output level
• An isoquant is oval in shape
 Isocost line
• Isocost line is a graphical device.

• It is a line showing all the combinations of the two factors

(say labour and capital) that can be purchased for a given
expenditure outlay by the firm.
• MRTS =Px/Py
 Laws of production
• The law of diminishing marginal returns was originally
explained by the classical economists with reference to
agriculture.
• Marshall stated this law as follows: “An increase in capital
and labour applied in the cultivation of land causes in
general a less than proportionate increase in the amount of
produce raised, unless it happens to coincide with an
improvement in the arts of agriculture.”
• It is applicable in all fields of production like industry,
mining, fishing, house construction, etc, along with
agriculture.
 The law of variable proportions
• This is the modern version of the law of diminshing
marginal returns .
• Under this law it is assumed that only one factor of
production is variable while other factors are fixed.
• Prof.Benham states the law as follows:
“As the proportion of one factor in a combination of factors is
increased after a point, the average and marginal
production of that factor will diminish.
 Contd.
• To clarify the relationship further,the following
measurements of product are adopted:
• Total Product- Total number of units of output produced
per unit of time by all factor inputs is referred to as total
product. TP= F(QVP), where TP denotes total produce and
QVF denotes the quantity of the variable factor.
• Average factor (AP)- The average product refers to the
total product per unit of a given variable factor.Thus by
dividing the total product by the quantity of the variable
factor. AP= TP/QVF
 Contd.
• Marginal Product (MP)-
• Owing to the addition of a unit to a variable factor, all
other factors being held constant, the addition realised in
the total product is technically referred to as the marginal
product.
• MPn = TPn-TPn-1 where , MPn stands for the marginal
product when n units of a variable factor are employed.
 The Laws of Returns to scale
• “As a firm in the long run increases the quantities of all
factors employed, other things being equal ,the output
may rise initially at a more rapid rate than the rate of
increase in inputs, then output may increase in the same
proportion of input, and ultimately, output increases less
proportionately.”
• Assumptions: The law, however,assumes that:
1. Technique of production is unchanged.
2. All units of factors are homogeneous.
3. Returns are measured in physical terms.
 Contd.
• There are three phases of returns in the long run which
may be separately described as:
(1) The law of increasing returns
(2) The law of constant returns
(3) The law of decreasing returns
(1) The law of increasing returns describes increasing returns
to scale.There are increasing returns to scale when a
given percentage increase in input will lead to a greater
relative percentage increase in the resultant output.
 The Law of constant returns
• The process of increasing returns to scale, however, cannot
go on forever.It may be followed by constant returns to
scale.
• As a firm continues to expand its scale of operations, it
gradually exhausts the economies responsible for the
increasing returns.Then,the constant returns may occur.
• There are constant returns to scale when a given
percentage increase in inputs leads to the same percentage
increase in output.
• Conditions when: 1.All factors are homogeneous
 Contd.
2. All factors are perfectly substitutable .
3.All factors are infinitely divisible
4.The supply of all factors is perfectly elastic at the
given prices.
 Contd.
The Law of decreasing returns
As the firm expands, it may encounter growing
diseconomies of the factors employed. As such
when powerful diseconomies are met by feeble
economies of certain factors, decreasing returns to
scale set in.

There are decreasing returns to scale when the

percentage increase in output is less than the
percentage increase in input .
 Economies and Diseconomies
• The advantages and disadvantages that accrue to a firm
because of scale of operation or due to the location of the
firm.
• The advantages and disadvantages thus experienced are
reflected in the cost of production.
• Those advantages or disadvantages that accrue to a firm
from within , as a result of its operation are referred to as
Internal economies and diseconomies.
• Wherein those advantages or disadvantages which come to
the firm from outside and are experienced by the industry
as a whole mainly due to localization are referred to as
External economies and diseconomies.
 Internal Economies

1) Technical Economies
2) Managerial Economies
3) Commercial Economies
4) Financial Economies
5) Risk-Bearing Economies
 Internal Diseconomies
1. Efficiency to inefficiency
2. Administrative difficulties
3. Industrial unrest
4. High cost of Reconversion
5. Enhancement of Risks
6. Increasing Costs
 External Economies
• External Economies are those advantages which accrue
indirectly and externally from the growth, not in the size
of the firm but in the size of the industry as a whole.
i) Economies of concentration
ii) Economies of Information
iii) Economies of Disintegration
 External Diseconomies
• Excessive pressure on transport
• Land values will soar high
• Labour cost will also show arise
• The cost of capital will rise
• Power and raw materials shortages
• Pollution
• Over-crowding and unhygenic conditions