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Chapter 03.3 - Production Analysis

The document discusses production functions and returns to scale. It defines returns to scale as the percentage change in output divided by the percentage change in inputs. There are three types of returns to scale: increasing returns to scale where a proportional increase in inputs leads to a more than proportional increase in output; constant returns to scale where proportional increases in inputs and output are equal; and diminishing returns to scale where a proportional increase in inputs leads to a less than proportional increase in output. The production function helps management determine input requirements, plan production, and find the least-cost combination of inputs.

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174 views4 pages

Chapter 03.3 - Production Analysis

The document discusses production functions and returns to scale. It defines returns to scale as the percentage change in output divided by the percentage change in inputs. There are three types of returns to scale: increasing returns to scale where a proportional increase in inputs leads to a more than proportional increase in output; constant returns to scale where proportional increases in inputs and output are equal; and diminishing returns to scale where a proportional increase in inputs leads to a less than proportional increase in output. The production function helps management determine input requirements, plan production, and find the least-cost combination of inputs.

Uploaded by

phannarith
Copyright
© Attribution Non-Commercial (BY-NC)
We take content rights seriously. If you suspect this is your content, claim it here.
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Download as PDF, TXT or read online on Scribd
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Chapter- 3.

3
Production Function
and Analysis

LR Production Function
(With all inputs variable)
À In the LR, all inputs become variable, i.e.,
the scale of production can be changed.
À The relationships between changes in scale
and changes in Q are described in Returns
to Scale.
À Returns to scale examines the % increase in
output when a firm increases all of its input
by a given %.

1
% change in output
À Returns to Scale = -------------------------
% change in inputs
À When all the inputs are increased in the
same proportions, the proportion between
the different inputs remains unchanged,
refers to as Returns to Scale.
Types of Returns to Scale
À Increasing returns to scale (IRS)
À Constant returns to scale (CRS)
À Diminishing returns to scale (DRS)
3

IRS: A proportionate > in all input


quantities results in a greater-than-
proportionate > in output.
CRS: A proportionate > in input quantities
results in the same proportionate > in
output.
DRS: A proportionate > in all input
quantities results in a less-than-
proportionate > in Q.

2
Returns to Scale

Units of Units of Labor Total output Increase in Increase in total


Capital size of firm output

4 20 100
8 40 250 100% 150% IRS

12 60 420 50% 68% IRS


16 80 560 33.3% 33.3% CRS

20 100 672 25% 20% DRS

24 120 780 20% 16% DRS

Explanation of Returns to scale


through IQ curves.
À As Q increases from 10 to 20, 30 ,40 and 50
the factor input combination points shift
from E to F, G, H and I.
À The distance between the combination
points goes on gradually decreasing, OE >
EF > FG > GH > HI, hence IRS.
À The additional inputs required to produce a
proportionate increase in output go on
declining in case of IRS.
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3
À In case of CRS, OE = EF = FG, proportionate
in inputs yields a proportionate increase in
output.
À In DRS, FG > EF > OE, proportionate
increase in output requires a more than
proportionate increase in inputs.
Managerial Significance of Production
Function
À Enables the management to know in
advance the requirements of factor inputs,
given the state of technology.

À Enables the management to calculate


production chart with one fixed input and
one variable input.
À Enables the management to prepare a chart
of input-out relationship for long run
planning of production, expansion,
replacement, etc.
À Given the input prices, it helps in finding out
the least cost combination of inputs.
À Helps in deciding for larger plant taking
advantage of the scale-economies, there by
reducing per unit cost.
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