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Production Function

The document discusses production functions and their relationship between inputs like labor, capital, land and output. It defines short run and long run production functions, returns to scale, economies and diseconomies of scale, and short run costs including total, fixed and variable costs.

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Balaji k
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20 views

Production Function

The document discusses production functions and their relationship between inputs like labor, capital, land and output. It defines short run and long run production functions, returns to scale, economies and diseconomies of scale, and short run costs including total, fixed and variable costs.

Uploaded by

Balaji k
Copyright
© © All Rights Reserved
Available Formats
Download as DOCX, PDF, TXT or read online on Scribd
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Production Function: specifies the maximum output that can be produced with a

given quantity of input.

The production function is a mathematical equation determining the


relationship between the factors and quantity of input for production
and the number of goods (output) it produces most efficiently.

It helps to identify: 1. Marginal productivity,

2. Level of production, and

3. Cheapest mode of production of goods.

Quantity of Input For Production is called factors of productions


which is used to produce goods and services, which are land ,
labor, capital and entrepreneurship .

Land : anything that comes from the land. Some common land or natural
resources are water, oil, copper, natural gas, coal, and forests.
Labor : is the effort that people contribute to the production of goods and
services.
Capital: are machinery, tools and buildings humans use to produce goods and
services

Entrepreneur is a person who combines the other factors of production - land,


labor, and capital - to earn a profit. The most successful entrepreneurs are
innovators who find new ways to produce goods and services or who develop
new goods and services to bring to market.
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.

If suppose the company uses only labour (L) and capital (C) as input
then the equation is :

Q =f (L, C)

Types of Production function:

1. Short Run Production Function

The short run production function is one in which at least is one


factor of production is thought to be fixed in supply, i.e. it cannot
be increased or decreased, and the rest of the factors are variable
in nature.
The firm’s capital inputs are assumed as fixed, and the production level can
be changed by changing the quantity of other inputs such as labour, raw
material, capital and so on.

Example : consider that a firm has 20 units of labour and 6 acres of land
and it initially uses one unit of labour only (variable factor) on its land
(fixed factor).
So, the land-labour ratio is 6:1. Now, if the firm chooses to employ 2
units of labour, then the land-labour ratio becomes 3:1 (6:2).
2. Long Run Production Function

Long run production function refers to that time period in which all the
inputs of the firm are variable. It can operate at various activity levels
because the firm can change and adjust all the factors of production and
level of output produced according to the business environment.

Differences between short run and long run production function


Returns to scale in economics is the measure of proportional change
in output with respect to the input factors in the long run at constant
technology used for the production process.

Suppose our inputs are capital and labor, and we double each of
these (m = 2). We want to know if our output will more than
double, less than double, or exactly double. This leads to the
following definitions:

 Increasing Returns to Scale: When our inputs are


increased by m, our output increases by more than m.
 Constant Returns to Scale: When our inputs are
increased by m, our output increases by exactly m.
 Decreasing Returns to Scale: When our inputs are
increased by m, our output increases by less than m.
Example for Decreasing return to scale while increasing the
labour :

Economies of Scale vs. Diseconomies of


Scale
economies of scale vs. diseconomies of scale is determined based on the
relationship between the production and price of an item or product.

Economies of Scale explains the reductions in cost that a firm experiences as the scale
of operations increase. A company would have achieved economies of scale when the cost
per unit reduces as a result of an expansion in the firm’s operations.

Cost involved in production is: fixed costs and variable costs.

Fixed costs remain the same, regardless of the number of units produced such as the cost
of property or equipment.

Variable costs are costs that change with the number of units produced, such as the cost of
raw material and labor cost and other expenses.

A firm will achieve economies of scale when the total cost per unit reduces as more
units are produced because of fixed cost remains same.

Diseconomies of scale Diseconomies of scale refers to a point at which the company no


longer enjoys economies of scale, at which the cost per unit rises as more units are
produced. Diseconomies of scale can result from a number of inefficiencies that can
diminish the benefits earned from economies of scale. For example increase in production
units increasing the transportation costs.
Economics vs Diseconomies of scale

Short run and Long run cost

Fixed Cost : fixed costs are independent of the output.

Variable cost : variable costs change with changes in the output.


Semi-Variable Costs

These costs are neither perfectly fixed nor variable in relation to the
changes in the output.

Fig 2 Completely Variable Cost


Short Run Total Costs Curves

The total cost (TC) of business is the sum of the total variable costs (TVC) and total
fixed costs (TFC). Hence, we have

TC = TFC + TVC

The following diagram represents the TC, TFC, and TVC (short-run total costs)

As we can see, the TFC curve starts from a point on the Y-axis and is
parallel to the X-axis. This implies that even if the output is zero, the
firm incurs a fixed cost.
The TVC curve, on the other hand, rises upwards. This implies that
TVC increases as the output increases. This curve starts from the origin
which shows that variable costs are nil when the output is zero.

The total cost curve (TC) is obtained by adding the TFC and TVC
vertically.

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