THEORY OF PRODUCTION

Contents
• Concept of Production
• Production Function
•Types of Production Function
 Law of Variable Proportion
 Law of Returns to Scale
Increasing Returns to Scale
Constant Returns to Scale
Decreasing Returns to Scale
 Objectives
• Examine the economic analysis of different
types of input and the process of production

• Build up a critical appraisal of law of

variable proportion and returns to scale
 Concept of Production
• Process of converting the inputs into outputs.
• Inputs: Land, labour and capital etc..
• Output: Finished goods and services.
• Production decisions depend on the cost and revenue.
• Organizations engage in production for earning maximum profit
(difference between the cost and revenue).

The main aim of production is to produce maximum output with given

inputs.
 Definition
According to James Bates and J.R. Parkinson

“Production is the organized activity of

transforming resources into finished products in
the form of goods and services; and the objective
of production is to satisfy the demand of such
transformed resources”.
 Production Function

• Relationship between a firm’s input of resources and its

output of goods and services per unit of time.

• Relationship between quantity of inputs and outputs.

• Relationship between the inputs themselves.
 Production Function

“Production function is the name given to the relationship

between rates of input of productive services and the rate of
output.
It is the economist’s summary of technical knowledge “.

Stinger
Production function is a description of the quantitative
relationship between the inputs absorbed and the
outputs emerging from a particular production process.

Prof. Leontief

P= f(a, b, c, d, e etc….)

where, a,b,c are different factors of

production.
 Types of Production Function
Short Run Production Function Long Run Production Function

 Returns to a Factor Returns to Scale

One Factor Variable All Factors Variable

Other Factors Fixed No Factor Fixed

Law of Variable Proportion Law of Returns to Scale

 Law of Variable Proportion
 Oneinput is variable
 Other inputs are fixed

The firm’s production function exhibits “Law of Variable

Proportion”.

If the quantity of one productive factor is increased

by equal increments, the quantities of other factors
being fixed, the resulting increment of product will
decrease after a point.
Prof. Stigler
Fixed factor of production: One whose quantity cannot readily
be changed.
Examples: equipment, factory space.

Variable factor of production: One whose usage rate can be

changed easily.
Examples: Electrical power consumption, transportation
services, and raw material inputs.
 Assumptions
One factor is variable and all the other factor are
constant.

Units of variable factor is homogeneous.

Technology remains constant.

It’s a short period operation.

Graphical Representation
1.Stage I; Stage of increasing returns – TPP increases at an
increasing rate and the MPP increases too.

2.Stage II; Stage of diminishing returns–TPP continues to

increase but at a diminishing rate. MPP decreases with an
increase in the number of units of the variable factor.

3.Stage III, Stage of negative returns–TPP starts declining,

MPP decreases and becomes negative.
 Application
Law of variable proportions applies to all fields of
production and also called law of universal application.

Application to Agriculture : In agricultural production,

labour and capital can be increased to any extent but
not the land, being fixed factor. Thus when more and
more units of variable factors are applied to a fixed
factor then their marginal product starts to diminish
and this law becomes operative.
Application to Industry: The main cause of application
of this law is the fixation of any one factor. Land, mines,
fisheries, and building etc. are not the only examples of
fixed factors. Raw materials may also become fixed in
the short period. Therefore, this law holds good in all
activities of production in industries like mining,
manufacturing, automobile etc.
Law of Returns of Scale
 Law of Returns of Scale
Returns to scale implies the behaviour of output when all the factor inputs
are changed in the same proportion given the same technology.

The assumptions of returns to scale are as follows:

• The firm is using only two factors of production that are capital and
labour.
• Labour and capital are combined in one fixed proportion.
• Prices of factors do not change.
• State of technology is fixed
Stages Of Return To Scale
Increasing Returns to Scale

Constant Returns to Scale

Decreasing Returns to Scale

 Increasing Returns to Scale
When the percentage increase in total product is more
than the percentage increase in all inputs.
 Constant Returns to Scale
When the percentage increase in total product is
exactly same as the percentage increase in all
inputs.
 Decreasing Returns to Scale
When the percentage increase in total product is
less than the percentage increase in all inputs.
 Difference
Basis of Difference Law of Variable Law of Returns to Scale
Proportion

Factors One Variable Factor and All Factors are Variable.

all other factors are Fixed.

Stages Increasing, Diminishing Increasing, Constant and

and Negative Decreasing

Time Period Short run Long run

Refrences
https://www.coursera.org/lecture/advanced-competit
ive-strategy/economies-of-scale-dXlIT

https://nptel.ac.in/content/storage2/courses/11010100
5/downloads/Lecture%2018.pdf

https://www.coursera.org/lecture/market-structure/r
eturns-to-scale-4t92e
Thank you