Symbiosis Institute of Business Management, Hyderabad

Name of the Faculty Dr. PV Durga Rao

Course Economics for Managers

Semester – I Batch of 2020-22

Assignment Date 29/08/2020

Submission Date 05/09/2020

Topic: - Production function in Short Run & Long Run

Group 3-Automobile

Sl. No. PRN Name Remarks

1. 20021141134 PRATIK MUKHERJEE

2. 20021141126 VAIBHAV AGARWAL

3. 20021141107 SHRIVASTAVA VANDIT RAKESH

4. 20021141088 RAYYAN DARUWALA

5. 20021141139 SHUBHAM THAKUR

 ASSIGNMENT

Production function

Firms can turn inputs into outputs in a variety of ways using various combinations of labour,
materials and capital. We can describe the relationship between the inputs into the
production process and the resulting output by a production function. The production
function is a technological relationship between the physical input and the physical output
in a particular time, given the technology. The characteristics of a production function are as
follows:
 It depicts a technological relationship between the inputs and the outputs of a firm.
 It relates to a time where the inputs and outputs are flow concepts
 The state of technology is assumed to be given for that time
 Only the technically efficient combinations of the factors of production are included
in the production process.
 The factors are used jointly to produce the output
A general production function can be expressed as:
X= f (L, K, M, N, T)
Where X= output
L= Labour
K= Capital
M= Materials
N= Land
T= Technology
For the sake of convenience, when there are only two factors of production, the production
function is written as X= f (L, K) ceteris paribus.

Marginal Product
Marginal product of a factor of production is defined as change in output resulting from a
very small change in one input factor, keeping the other input factors constant.
MP= dQ/dL

Average product
Average product is the total product divided by the amount of variable factor employed to
produce the product.
AP= Q/L
 Law of diminishing returns
Law of diminishing returns states that with a given state of technology if the quantity of one
input factor is increased, by equal increments, the quantities of other input factors
remaining fixed, the resulting increment of total product will first increase but decrease
after a particular point.

Three stages of Production

A diminishing marginal product of labour holds for most production process. When the
labour input is small, extra labour adds considerably to output, often because workers are
allowed to devote themselves to specialized tasks. Eventually, however, the law of
diminishing returns applies when there are too many workers, some workers become
ineffective and the marginal product of labour falls.
The law of diminishing marginal returns usually applies to short run when at least one input
is fixed. However, it can also apply to the long run.
The Following table contains the information (hypothetical) data of the firm
manufacturing cookies:

No. of Total production of Marginal Product of Average product of

labor Labor Labor Labor
0 0
1 7 7 7
2 18 11 9
3 33 15 11
4 46 13 11.5
5 55 9 11
6 60 5 10
7 63 3 9
8 65 2 8.1
9 66 1 7.3
10 66 0 6.6
11 64 -2 5.8
12 60 -4 5

Marginal product Average Product

66

56

46
No. of units

36

26

16

-4 0 1 2 3 4 5 6 7 8 9 10 11 12

Number of men
 Short Run and Long Run
It takes time for a firm to adjust its inputs to produce its product with differing amounts of
labour and capital. A new factory must be planned and built, and machinery and other
capital equipment must be ordered and delivered. Such activities can easily take a year or
more to complete. As a result, looking at production decisions over a short period of time,
such as a month or two, the firm is unlikely to be able to substitute very much capital for
labour.
The short run refers to a period of time in which the quantities of one or more factors of
production cannot be changed. In other words, in the short run there is at least one factor
that cannot be varied; such a factor is called a fixed input.
The long run is the amount of time needed to make all inputs variable usually within the
confines of existing technology. Long run also permits factor substitution. Moreover in Long
run, different combinations of inputs can be used to produce a fixed amount of output. In
the short run, firms vary the intensity with which they utilize a given plant and machinery; in
the long run, they vary the size of the plant. All fixed inputs in the short run represent the
outcomes of previous long-run decisions based on estimates of what a firm could profitably
produce and sell.

Return to scale
INCREASING RETURNS TO SCALE

If output more than doubles when inputs is doubled, there are increasing returns to scale.
This might arise because the larger scale of operation allows managers and workers to
specialize in their tasks and to make use of more sophisticated, large-scale factories and
equipment. The automobile assembly line is a famous example of increasing returns.
The prospect of increasing returns to scale is an important issue from a public- policy
perspective. If there are increasing returns, then it is economically advantageous to have
one large firm producing (at relatively low cost) rather than to have many small firms at
relatively high cost). Because this large firm can control the price that it sets, it may need to
be regulated.

Capital

6
 300Q

100Q

3 6
Labour

CONSTANT RETURNS TO SCALE

A second possibility with respect to the scale of production is that output may double when
inputs are doubled. In this case, we say there are constant returns to scale. With constant
returns to scale, the size of the firm's operation does not affect the productivity of its factors
because one plant using a particular production process can easily be replicated two plants
produce twice as much output.

Capital
6

3 200Q

100Q

3 6 Labour

Finally, output may be less than double when all inputs double. This case of decreasing
returns to scale applies to some firms with large-scale operations. Eventually, difficulties in
organizing and running a large-scale operation may lead to decreased productivity of both
labour and capitals. Communication between workers and managers can become difficult to
monitor as the workplace becomes more impersonal. Thus, the decreasing returns case is
likely to be associated with the problems of coordinating tasks and maintaining a useful line
of communication between management and workers.

3 150 Q

100 Q
 3 6 Labour

Economies of scale

Economies of Scale refer to the cost advantage experienced by a firm when it increases its
level of output. The advantage arises due to the inverse relationship between per-unit fixed
cost and the quantity produced. The greater the quantity of output produced, the lower
the per unit fixed cost. Economies of scale also result in a fall in average variable
costs (average non-fixed costs) with an increase in output. This is brought about by
operational efficiencies and synergies as a result of an increase in the scale of production
Economies of scale can be implemented by a firm at any stage of the production process. In
this case, production refers to the economic concept of production and involves all activities
related to the commodity, not involving the final buyer. Thus, a business can decide to
implement economies of scale in its marketing division by hiring a large number of
marketing professionals. A business can also adopt the same in its input sourcing division by
moving from human labour to machine labour.

Isoquants

An isoquant depicts the various combinations of two factors of production, for example,
labour and capital, using which a firm can produce the same level of output. It is also called
an isoproduct curve or an equal product curve. Similar to an indifference schedule, one can
have an isoquant schedule. While constructing an isoquant, the following assumptions are
made:
(i) There are only two factors of production.
(ii) Technology is given.
(iii) There is continuity in the production function

An isoquant is negatively sloped or downward sloping (in the relevant range). This is
because if a producer employs more of one factor he will have to cut down on the
employment of the other factor if he has to remain on the same isoquant and his level of
output has to remain the same.
This implies that the two factors can be substituted for each other.
By analogy to the indifference curve analysis, one can prove that an isoquant does not slope
Upwards, is not a straight line parallel to the Y axis and is not a straight line parallel to the X
axis. Thus, it slopes downward in the relevant range.
An isoquant is convex to the origin.

Marginal rate of technical substitution

The marginal rate of technical substitution is the slope of an isoquant. It shows the
substitutability between the factors labour and capital.

MRTS = Slope of an isoquant = ΔK /ΔL

The marginal rate of technical substitution of labour for capital, MRTSLK, is the quantity of
capital that a firm is ready to give up for an additional unit of labour so that the level of
output remains the same. As the quantity of labour with the firm increases (and that of
capital decreases) the marginal rate of technical substitution of labour for capital decreases.
A producer is more and more unwilling to part with capital as the quantity of capital with
the firm decreases. The reason is that as the quantity of labour with the firm increases,
there is a decrease in the marginal productivity of labour. Simultaneously, as the quantity of
capital decreases, there is an increase in the marginal productivity of capital. Hence, to
maintain the output constant, a smaller amount of capital is required to substitute every
additional unit of labour. Thus, marginal rate of technical substitution diminishes.
We can express this analysis algebraically:
 Loss in output as quantity of capital with the firm decreases
 Gain in output as quantity of labor with the firm increases

MRTS = ΔK/ΔL = MPL /MPK

The marginal rate of technical substitution is the ratio of the marginal products of the
factors of production.