Faculty of Management

Managerial Economics
102-18

Lecture 19; 20 & 21: Production Function

Subject In-charge: Dr. Neha Singh

Designation: Assistant Professor
Mail ID: neha.j348@cgc.ac.in

CAMPUS: JHANJERI, MOHALI

 Lecture Outline
Production Function- Concept
Factor Inputs
Laws of Production

Topics Outcome: CO3: Contrast the functional relationship between production, cost
and revenue.
It’s an activity that
transforms input
into output.
Technology
Inputs
• Labor
• Capital
• Machinery
• Land
• Raw material
• Power
Time period
 Production
Function

A production function can be an equation, table or graph

presenting the maximum amount of a commodity that a
firm can produce from a given set of inputs during a period
of time.
Inputs Process Output

Land
Product or
Labour service
generated
Capital
 A computer company hires workers to use
machinery, parts, and raw materials in factories
to produce personal computers.
 The output of a firm can either be a final
commodity or an intermediate product such as
computer and semiconductor respectively.
 The output can also be a service rather than a
good such as education, medicine, banking etc.
The production function can be mathematically written as

Q = f(X1, X2, …, Xk)

where
Q = output
X1, …, Xk = inputs

For our current analysis, let’s reduce the inputs to two, capital
(K) and labor (L):
Q = f(L, K)
• How to obtain Maximum output
• Helps the producers to determine whether
employing variable inputs /costs are profitable
• Highly useful in longrun decisions
• Least cost combination of inputs and to
produce an output
• FIXED INPUTS :
Fixed inputs are those factors the
quantity of which remains constant
irrespective of the level of output
produced by a firm. For
example, land, buildings, machines,
tools, equipments, superior types of
labour, top management etc.

• VARIABLE INPUTS :
Variable inputs are those factors the
quantity of which varies with variations
in the levels of output produced by a
firm.For example, raw materials, power
fuel, water, transport, labour and
communication etc.
Short run :
Relationship between input and output are studied by
varying one input , others being held constant.
Law of Variable Proportions brings out
relationship between varying proportions of
factor inputs and output
Long run:
Production function is subject to different phases
described under the Law of Returns to Scale
– Studied assuming that all factor inputs are
variable.
Law of Variable Proportions (Short run Law of
Production)
Assumptions:
 One factor (say, L) is variable and the other factor
(say, K) is constant
 Labour is homogeneous
 Technology remains constant
 Input prices are given
No of Workers Total Product Marginal Average Stages of
L Returns
(TPl)
Product (MPl ) Product (APl )
1 24 24 24 I)
2 72 48 36 Increasing
Returns
3 138 66 46
4 216 78 54
5 300 84 60
6 384 84 64
7 462 78 66 II)
8 528 66 66 Diminishing
Returns
9 576 48 64
10 600 24 60
11 594 -6 54 III) Negative
Returns
12 552 -42 46

10
Panel A TP rises at an increasing rate till
the employment of the 5th worker.
Beyond the 6th worker until 10th
TPl
worker TP increases but rate of
Total Product

increase begins to fall

TP turns negative from 11th
worker onwards.
This shows Law of Diminishing
Marginal returns

Labour

11
 Panel B Panel B represents
Marginal and average
productivity curves of
labour
AP/MP

APL

MPL
labour

12
Increasing Returns- Stage I:
TP increases at an increasing rate.
l

Fixed factor (K) is abundant and variable factor is

inadequate. Hence K gets utilized better with
every additional unit of labour
Stage II- TPl continues to increase but at a
diminishing rate.
stage III- TPl begins to decline –Capital becomes scarce
as compared to variable factor. Hence over
utilization of capital and setting in of diminishing
returns
Causes of 3 stages: Indivisibility and inelasticity of fixed
factor and imperfect substitutability between K and L
13
Significance of Law of Diminishing Marginal Returns:
- Empirical law, frequently observed in various production
activities
- Particularly in agriculture where natural factors (say
land), which play an important role, are limited.
- Helps manager in identifying rational and irrational
stages of operation

14
-It provides answers to questions
such as:
a) How much to produce?
b)What number of workers (and other variable
factors) to employ in order to maximize
output
In our example, firm should employ a minimum of 7
workers and maximum of 10 workers (where TP is
still rising)

15
- Stage III has very high L-K ratio- as a result, additional
workers not only prove unproductive but also cause a decline
in TPl.
- In Stage I capital is presumably under- utilised.
- So a firm operating in Stage I has to increase L and that in
Stage III has to decrease labour.

16
 There are two Variable Proportions Production
Function_
1 Production Function With One Variable Input.
2 Production With Two Variable Inputs
 When discussing production in the short run,
three definitions are important:
 Total product
 Marginal product
 Average product

18
 Total Product TP = Q = f(L)

Marginal Product TP
MPL = L

Average Product TP
APL = L
Production or MPL
Output Elasticity EL =
APL

19
 Total Product

 Total product (TP) is another name for output in

the short run.

TP = Q = f (L)

20
 The marginal product (MP) of a variable input
is the change in output (or TP) resulting from a
one unit change in the input.
 MP tells us how output changes as we change
the level of the input by one unit.
 Consider the two input production function Q=f
(L,K) in which input L is variable and input K
is fixed at some level.
 The marginal product of input L is defined as
holding input K constant.
TP
MPL =
L
21
 The average product (AP) of an input is the
total product divided by the level of the input.
 AP tells us, on average, how many units of
output are produced per unit of input used.
 The average product of input L is defined as
holding input K constant.

TP
APL = L
22
 TYPES OF PRODUCTION
FUNCTION
SHORT RUN LONG RUN
PRODUCTION PRODUCTION
One variable factor All factors are variable

Works in tandem with Laws of Works in tandem with Laws of return

variable Proportions to scale

3 Stages-
• Increasing returns • Increasing returns to scale
• Negative returns • Constant returns to scale
• Diminishing returns • Diminishing returns to scale
 PRODUCTION FUNCTION

Short Run Production Function Long Run Production Function

Return to a Factor Return to Scale

One Variable Factor All factors are Variable

Laws of Variable Proportion Law of Return to Scale

 FEATURE OF PRODUCTION FUNCTION

Substitutability of factors
Complementarity of factors
Specificity of factors
SUBSTITUTABILITY OF FACTOR
The factors of production or inputs are
substitutes of one another which make it
possible to vary the total output by
changing the quantity of one or a few
inputs, while the quantities of all other
inputs are held constant.
COMPLEMENTARITY OF FACTORS
The factors of production are also
complementary to one another, i.e. the two
or more inputs are to be used together as
nothing will be produced if the quantity of
either of the inputs used in the production
process is zero.
 SPECIFICITY OF FACTORS
It reveals that the inputs are specific to
the production of a particular product.
Machines and equipment's specialized
works and raw materials are a few
examples of the specificity of factors
of production.
 RETURN TO SCALE
 It is type of Long Run Production Function
 The term return to scale refers to the changes in output as all factors
change by the same proportion.

 Returns to scale relates to the behavior of total output as all inputs are
varied and is a long run concept

 Explanation:-
In the long run, output can be increased by increasing all factors in
the same proportion. Generally, laws of returns to scale refer to an increase
in output due to increase in all factors in the same proportion. Such an
increase is called return to scale.
RETURN TO SCALE
 Production Function
P=𝒇(𝑳, 𝑪)

 If both factors of production labour and capital are

Increased in same proportion i.e., x, production
function will be rewritten as

P1=𝒇(𝒙𝑳, 𝒙𝑪)
RETURN TO SCALE
INCREASING RETURN TO
SCALE
 If all inputs are doubled, output will also increase at the
faster rate than double.
Reasons
→ Division of labour
→ Specialisation
→ External economies of scale
 CONSTANT RETURN TO
SCALE
If all inputs are doubled, output will also
doubled.
Reason
Economies of Scale is
balanced by
diseconomies of Scale
 CAUSES OF CONSTANT RETURNS
TO SCALE
Indivisibility of fixed factors.

When the factors of production are perfectly divisible, the

production function is homogenous of degree 1 showing constant

returns to scale.
DIMINISHING RETURN TO SCALE
If all inputs aredoubled, outputwill be less
than doubled.
Reasons
 Internal diseconomies
 External diseconomies
CAUSES OF INCREASING RETURNS
TO SCALE
• Size of the firms expands,
managerial efficiency decreases.
• Limited resources.
DISECONOMIES OF SCALE OF
PRODUCTION
 INTERNAL DISECONOMIES
 Inefficient Management
 Technical Difficulties
 Production Diseconomies
 Marketing Diseconomies
 Financial Diseconomies

 EXTERNAL DISECONOMIES
 Diseconomies of Pollution
 Diseconomies of Strain on Infrastructure
 Diseconomies of High Factor Prices
 References & Sources
• https://www.academia.edu/34707649/Managerial_Economics_Textbook - E-book by

Samuelson & Marks, Managerial Economics, 7th edition, Wiley Publications.

• https://books.google.co.in/ - Google E-book by Geetika, Managerial Economics, Tata

McGraw publication.

• T. R. Jain, Managerial Economics, Vikas Publications

 Topics to be covered in Next Lecture
• Determinants of cost, short run and long run cost theory.
 Thank You.
For any doubts contact me during my office hours:
Day: Wednesday
Time: 2:00 - 2:40 PM
Contact No.: 9781994550
Email ID: neha.j348@cgc.ac.in