10) Production function and laws of production.pptx

Production theory presentation credited Vandana Tiwari

1. Theory of Production

2. Theory of Production Production is a process that create / adds value or utility It is the process in which the inputs are converted in to outputs.

3. Production function Production is the result of co-operation of four factors of production viz., Land, Labor, Capital Organization. This is evident from the fact that no single commodity can be produced without the help of any one of these four factors of production. Therefore, the producer combines all the four factors of production in a technical proportion. The aim of the producer is to maximize his profit. For this sake, he decides to maximize the production at minimum cost by means of the best combination of factors of production.

4. Production Function Production function means the functional relationship between inputs and outputs in the process of production. It is a technical relation which connects factors inputs used in the production function and the level of outputs Q = f (Land, Labour, Capital, Organization, Technology, etc)

5. Factors of Production

6. The producer secures the best combination by applying the principles of equi -marginal returns and substitution. According to the principle of equi -marginal returns, any producer can have maximum production only when the marginal returns of all the factors of production are equal to one another. For instance, when the marginal product of the land is equal to that of labour , capital and organisation , the production becomes maximum. In simple words, production function refers to the functional relationship between the quantity of a good produced (output) and factors of production (inputs). “The production function is purely a technical relation which connects factor inputs and output.” Prof. Koutsoyiannis

7. Inputs : Fixed inputs and Variable inputs The factors of production that is carry out the production is called inputs. Land, Labour, Capital, Organizer, Technology, are the example of inputs Inputs Factors Variable inputs Fixed Inputs

8. Inputs : Fixed inputs and Variable inputs Remain the same in the short period . At any level of out put, the amount is remain the same. The cost of these inputs are called Fixed Cost Examples:- Building, Land etc ( In the long run fixed inputs are become varies) Fixed inputs Variable inputs In the long run all factors of production are varies according to the volume of outputs. The cost of variable inputs is called Variable Cost Example:- Raw materials, labour, etc

9. In this way, production function reflects how much output we can expect if we have so much of labour and so much of capital as well as of labour etc. In other words, we can say that production function is an indicator of the physical relationship between the inputs and output of a firm. The reason behind physical relationship is that money prices do not appear in it. However, here one thing that becomes most important to quote is that like demand function a production function is for a definite period. It shows the flow of inputs resulting into a flow of output during some time. The production function of a firm depends on the state of technology. With every development in technology the production function of the firm undergoes a change.

10. Mathematically, such a basic relationship between inputs and outputs may be expressed as: Q = f( L, C, N ) Where Q = Quantity of output L = Labour C = Capital N = Land. Hence, the level of output (Q), depends on the quantities of different inputs (L, C, N) available to the firm. In the simplest case, where there are only two inputs, labour (L) and capital (C) and one output (Q), the production function becomes. Q =f (L, C)

11. Definitions: “The production function is a technical or engineering relation between input and output. As long as the natural laws of technology remain unchanged, the production function remains unchanged.” Prof. L.R. Klein “Production function is the relationship between inputs of productive services per unit of time and outputs of product per unit of time.” Prof. George J. Stigler “The relationship between inputs and outputs is summarized in what is called the production function. This is a technological relation showing for a given state of technological knowledge how much can be produced with given amounts of inputs.” Prof. Richard J. Lipsey Thus, from the above definitions, we can conclude that production function shows for a given state of technological knowledge, the relation between physical quantities of inputs and outputs achieved per period of time.

12. Features of Production Function: 1. Substitutability: 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. It is the substitutability of the factors of production that gives rise to the laws of variable proportions. 2. Complementary: The factors of production are also complementary to one another, that is, 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. 3. Specificity: It reveals that the inputs are specific to the production of a particular product. Machines and equipment’s, specialized workers and raw materials are a few examples of the specificity of factors of production. The specificity may not be complete as factors may be used for production of other commodities too. 4. Time bound: Production involves time; hence, the way the inputs are combined is determined to a large extent by the time period under consideration. The greater the time period, the greater the freedom the producer has to vary the quantities of various inputs used in the production process.

13. The  laws of production  describe the technically possible ways of increasing the level of  production . ... The expansion of output with one factor (at least) constant is described by the  law  of (eventually) diminishing returns of the variable factor, which is often referred to as the  law  of variable proportions. Laws of Production

14. Law of Production Function o Laws of Variable proportion - Law of Diminishing Return ( Short run production function with at least one input is variable ) i Laws of Return scales – Long run production function with all inputs factors are variable .

15. • Law of variable proportion: Short run Production Function Explain short run production function Production function with at least one variable factor keeping the quantities of others inputs as a Fixed. Show the input-out put relation when one inputs is variable “If one of the variable factor of production used more and more unit,keeping other inputs fixed, the total product(TP) will increase at an increase rate in the first stage, and in the second stage TP continuously increase but at diminishing rate and eventually TP decrease.”

16. L aw is based on following assumptions The technique of production remains same. This law is adopted for short run only. Labor and raw material are variable factors. Other inputs must be kept constant. All factors are not kept rigidly fixed proportions but the law is based upon the possibility of varying proportions such electricity consumption . So , this law is also called the law of proportionality. Units produced during production are homogeneous in amount and quality.

17. (L) Ca pi t a l (K) Total O u tput (TP) A v e r a ge Product (AP) 1 1 1 00 1 2 3 2 1 5 1 3 4 1 Marginal Product (MP) 10 10 - 1 10 10 10 10 2 10 10 30 15 3 1 10 60 20 4 1 10 80 20 5 1 10 95 19 6 1 10 108 18 7 1 10 112 16 8 1 10 112 14 9 1 10 108 12 1 Labour Land First Stage Second Stage -4 Third Stage -8 Short run Production Function with Labour as Variable factor

18. A C B Total Product Labor per month 8 8 3 4 3 4 E Average product Marginal product 1 12 Output per month Labor per month 6 3 2 1 D First Stage Second Stage Third Stage

19. Stages in Law of variable proportion First Stage: Increasing return     TP increase at increasing rate till the end of the stage. AP also increase and reaches at highest point at the end of the stage. MP also increase at it become equal to AP at the end of the stage. MP>AP Second Stage: Diminishing return TP increase but at diminishing rate and it reach at highest at the end of the stage. AP and MP are decreasing but both are positive. MP become zero when TP is at Maximum , at the end of the stage MP<AP. Third Stage: Negative return   TP decrease and TP Curve slopes downward As TP is decrease MP is negative. AP is decreasing but positive.

20. Where should rational firm produce?

21. Stage I: MP is above AP implies an increase in input increases output in greater proportion. The firm is not making the best possible use of the fixed factor. So, the firm has an incentive to increase input until it crosses over to stage II. Stage III: MP is negative implies contribution of additional labor is negative so the total output decreases . In this case it will be unwise to employ an additional labor. Where should rational firm produce?

22. Stage II: MP is below AP implies increase in input increases output in lesser proportion. A rational producer/firm should produce in stage II. But where exactly the firm will operate within stage II cannot be determined only on the basis of the product curves. We need information about input costs and price of output.

23. 2. Law of return to scales: Long run Production Function long runproduction function works when the inputs are changed in the same proportion. Production function with all factors of productions are variable.. Show the input-out put relation in the long run with all inputs are variable. “Return to scale refers to the relationship between changes of outputs and proportionate changes in the in all factors of production ”

24. Returns to scale ,is the quantitative change in output of a firm or industry resulting from a proportionate increase in all inputs. If the quantity of output rises by a greater proportion—e.g., if output increases by 2.5 times in response to a doubling of all inputs—the production process is said to exhibit increasing returns to scale. Such economies of scale may occur because greater efficiency is obtained as the firm moves from small- to large-scale operations. Decreasing returns to scale occur if the production process becomes less efficient as production is expanded, as when a firm becomes too large to be managed effectively as a single unit.

25. Law of Returns to Scale Following are the three laws of returns to scale (1)Law of increasing Returns (2)Law of Constant Returns (3)Law of Diminishing Returns

26. Law is based on following assumptions There is a scope of further improvement in the technique of production. At least one factor(such as land available) of production is assumed to be indivisible. Some factors(labor and capital) are assumed to be divisible. There is no change in the prices of factors of production. All units of variable factors are equally efficient.

27. Law of return to scales: Long run Production Function Labour Capital TP MP 2 1 8 8 4 2 18 10 6 3 30 12 8 4 40 10 10 5 50 10 12 6 60 10 14 7 68 8 16 8 74 6 18 9 78 4 Increasing returns to scale Constant returns to scale Decreasing returns to scale

28. • Law of return to scales: Long run Production Function Increasing returns to scale Constant returns to scale Decreasing returns to scale Inputs 10% increase – Outputs 15% increase Inputs 10% increase – Outputs 10% increase Inputs 10% increase – Outputs 5% increase

29. (1)Law of increasing Returns “In a given state of technology when the units of variable factors are increased with the units of fixed factors, the marginal productivity increases, it is called law of increasing returns.”

30. Application of the law The law of increasing return operators in such manufacturing industries where: Factors of production are combined and substituted up to some extent. The principle of specialization is applicable in industrial units. The marginal productivity increase due to specialization. In industrial sector human factors are more involved than natural factors. Due to this reason natural obstacles are less effective. An industry is expanded by getting the internal and external economies of large scale of production.

31. (2)Law of Constant Returns “ When the units of variable factors are increased with the units of other fixed factors, the marginal productivity remains constant. It is called constant return.”

32. Application of the law This law is applicable in those sectors where human and natural factors play their role, for example, in industry making blankets, pure natural wool is used while blankets are prepared in the presence of human factors. Such factors where economies of human and natural factors are presented which counter balanced each other and productivity is provided with constant . This law is more applicable in such sectors where labor’s roe is greater than other factors of production. the law of constant returns operates by increasing the units of labor force

33. (3)Law of Diminishing Returns “In a given state of technology when the units of variable factors of production are increased with the units of other fixed factor, the marginal productivity decreases it is called law of diminishing returns.”

34. Application of the law The natural factors have role than human factors in agricultural sector and marginal productivity decreases. The sector has very wide area and supervision cannot be very effective. Scope of specialized machinery is limited. There are other limitations of nature e.g. rain, climate changes etc. The fertility land also declines with time.

35. Alternative Method: “However, the technological conditions of production may be such that returns to scale may vary over different ranges of output. Over some range, we may have constant returns to scale, while over another range we may have increasing or decreasing returns to scale.” To explain it we draw an expansion path OR from the origin in Fig. 11 This are divided into segments by the successive isoquants representing equal increments in output, i.e., 100, 200, 300 and so on. As we move along the expansion path, the distance between the succes­sive isoquants diminishes, it is a case of increasing re­turns to scale.