Production

Production is the process of combining various inputs to create a product or service. Production is a key
concept in economics because it's how an economy creates supply to meet consumer demand
Production involves combining inputs such as:
 Material items: Physical items like metal, wood, glass, or plastics
 Labor: Human effort
 Technology: Tools, equipment, and machinery
 Knowledge: Plans and other immaterial resources
 Capital: Man-made goods used in production, such as buildings and transportation equipment

In simple words, the definition of production is the process in which various inputs, such as land,
labor, and capital, are used to produce the outputs in the form of products or services.

Production Analysis
Production analysis is a visual representation of production output that helps identify and calculate production
losses, and determine the reliability of manufacturing processes.
It can help companies determine where they are losing the most money and take corrective actions to increase
production and profits.
Features of production analysis:
 Economies of scale
A feature of many production processes that allows for lower per-unit costs as the scale of production
increases.
 Laws of returns
The law of diminishing returns assumes that one factor of production is always fixed and the state of
technology is constant.
  Adjustment of inputs
As the input of one factor increases while the others remain constant, the incremental output produced by each
additional unit of that factor will eventually decrease.
 Cost considerations
If the marginal cost of production is lower than the average total cost of production, the average cost will
decrease.
 Fixed and variable factors
The production process depends on two major factors: variable and fixed. Variable factors change with the
level of output, while fixed factors remain the same throughout the production process.
 Isoquants
A curve that shows all the combinations of two factors that produce a given output. Isoquants are often used
in manufacturing to show the optimal combination of inputs that will produce the maximum output at
minimum cost.
 Production cost
An important indicator of a company's activity that characterizes the company's expenditure related to
production and sales.
 Production period
Production flow analysis (PFA) is a scheduling system that aims to establish fixed planning, production, and
delivery cycles for the whole production unit.
 Returns to scale
Increasing returns to scale is a common feature of the production process

Theory of Production
Production Function is the relationship between physical inputs (land, labour, capital, etc.) and physical
outputs (quantity produced).
It is a technical relationship (not an economic relationship) that studies material inputs on one hand and
material outputs on the other hand.
Material inputs include variable and fixed factors of production. In a standard equation, the Production
function is represented by Q, Labour (Variable element) is represented by L, and Capital (Fixed element) is
represented by K.
Q = f(L,K)
In the words of Watson, “Production Function is the relationship between a firm’s production (output) and
the material factors of production (input).”

Assumptions of Production Function

  Both inputs and outputs are divisible.
 There are only two factors of production, i.e., land (Variable element) and capital (Fixed element).
 Factors of production are imperfect substitutes.
 Technology is constant.
Graphical Representation of Production Function
For example, When there are 4 units of labour and 5 units of capital, the equation for the production function
is Q = f(4,5).

In the above graph, X-axis represents inputs that are being used in the production process and Y-axis represents
outputs that get produced. Q is the Production Function.
Features of Production Function
1. Complementary: A producer will have to combine the inputs to produce outputs. Outputs can not get
generated without the use of inputs.
2. Specificity: For any given output, the combination of inputs that may be used is clearly defined. What type
of factors are needed for the production of a particular product is clearly mentioned before the actual
production gets started.
3. Production Period: The period of the production process is clearly explained to the production unit. Each
stage of production is given some specific time. Production generally gets completed over a long period of
time.
Types of Production Function
Production function on the basis of the time period can be divided into two categories: Short Run Production
Function and Long Run Production Function. In these production functions, the combination and behaviour
of variable factors and fixed factors are different.
1. Short Run Production Function: Short Run is a period of time where output can only be changed by
changing the level of variable inputs. In the short run, some factors are variable and some are fixed. Fixed
factors remain constant in the short run like land, capital, plant, machinery, etc. Production can be raised by
only increasing the level of variable inputs like labour. Therefore, the situation where the output is increased
by only increasing the variable factors of input and keeping the fixed factors constant is termed as Short Run
Production Function. This relationship is explained by the ‘Law of Variable Proportions.’
2. Long Run Production Function: Long Run is a span of time where the output can be increased by
increasing all the factors of production whether it is fixed (land, capital, plant, machinery, etc.) or variable
(labour). Long run is enough time to alter all the factors of production. All factors are said to be variable in the
long run. Therefore, the situation where the output is increased by increasing all the inputs simultaneously and
in the same proportion is termed Long Run Production Function. This relationship is explained by the ‘Law
of Returns to Scale.’
Concept of Product
Product or output refers to the volume of the goods that the company produces using inputs during a specified
period of time. The concept of product can be looked at from three different angles: Total Product, Marginal
Product, and Average Product.
1. Total Product: Total Product (TP) refers to the total quantity of goods that the firm produced during a given
course of time with the given number of inputs. Total Product is also known as Total Physical Product
(TPP) or Total Output or Total Return. For example, if 6 labours produce 10 kg of wheat, then the total
product is 60 kg. A company can increase TP in the short term by focusing primarily on the variable
components. But over time, both fixed and variable elements can be increased to raise TP.
2. Average Product: Average Product refers to output per unit of a variable input. AP is calculated by dividing
TP by units of the variable factor. For example, if the total product is 60 kg of wheat produced by 6
labours (variable inputs), then the average product will be 60/6, i.e., 10 kg.
Average Product = Total ProductUnits of Variable FactorUnits of Variable FactorTotal Product
3. Marginal Product: Marginal Product refers to the addition to the total product when one more unit of a
variable factor is employed. It calculates the extra output per additional unit of input while keeping all other
inputs constant. Other names of Marginal Product are Marginal Physical Product (MPP) or Marginal
Return
MPn = TPn – TPn-1

Here,
MPn = Marginal product of nth unit of the variable factor,
TPn = Total product of n units of the variable factor, and
TPn-1 = Total product of (n-1) units of the variable factor
Total Product
In simple terms, we can define Total Product as the total volume or amount of final output produced by a firm
using given inputs in a given period of time.
Marginal Product
The additional output produced as a result of employing an additional unit of the variable factor input is called
the Marginal Product. Thus, we can say that marginal product is the addition to Total Product when an extra
factor input is used.
Marginal Product = Change in Output/ Change in Input
Thus, it can also be said that Total Product is the summation of Marginal products at different input levels.
Total Product = Ʃ Marginal Product

Average Product
It is defined as the output per unit of factor inputs or the average of the total product per unit of input and can
be calculated by dividing the Total Product by the inputs (variable factors).
Average Product = Total Product/ Units of Variable Factor Input
Relationship between Marginal Product and Total Product
The law of variable proportions is used to explain the relationship between Total Product and Marginal
Product. It states that when only one variable factor input is allowed to increase and all other inputs are kept
constant, the following can be observed:
 When the Marginal Product (MP) increases, the Total Product is also increasing at an increasing rate.
This gives the Total product curve a convex shape in the beginning as variable factor inputs increase.
This continues to the point where the MP curve reaches its maximum.
 When the MP declines but remains positive, the Total Product is increasing but at a decreasing rate.
This give ends the Total product curve a concave shape after the point of inflexion. This continues
until the Total product curve reaches its maximum.
 When the MP is declining and negative, the Total Product declines.
 When the MP becomes zero, Total Product reaches its maximum.
Relationship between Average Product and Marginal Product
There exists an interesting relationship between Average Product and Marginal Product. We can summarize it
as under:
 When Average Product is rising, Marginal Product lies above Average Product.
 When Average Product is declining, Marginal Product lies below Average Product.
 At the maximum of Average Product, Marginal and Average Product equal each other

The Law of Variable Proportion

 The law of variable proportion, also known as the law of diminishing marginal returns,
is an economic principle that describes how the output of a production process changes
when one input factor is varied while keeping all other inputs constant.

The law of variable proportion states that when one factor of production is increased, while keeping
all other factors constant, the marginal product of that factor will decline. This is because the total
product will initially increase at an increasing rate, then at a diminishing rate, and eventually decline.
Stages
The law of variable proportion has three stages:
 Stage I: The total product increases at an increasing rate, and the marginal product
increases. This is also known as the stage of increasing returns.
 Stage II: The total product continues to increase but at a diminishing rate, and the marginal
product decreases. This is also known as the stage of diminishing returns.
 Stage III: The total product starts declining, and the marginal product decreases and becomes
negative. This is also known as the stage of negative returns.

Assumptions of the Law of Variable Proportion

1. It operates in the short run because the factors are categorised as variable and fixed.
2. The law is applicable to all fixed factors, including land.
3. The law of variable proportions allows for the combination of several variable units with fixed factors.
4. This law primarily applies to the production sector.
5. It is simple to calculate the impact of a change in output caused by a change in variable factors.
6. It is considered that after a certain point, factors of production become imperfect substitutes for one
another.
7. In order for this law to function, it is assumed that the state of technology would remain constant.
8. All variable factors are thought to be equally effective.
Law of Variable Proportions Explained in the following table:

In this example, the land is the fixed factor and labour is the variable factor. The table shows the different
amounts of output when you apply different units of labour to one acre of land which needs fixing.
The following diagram explains the law of variable proportions. In order to make a simple presentation, we
draw a Total Physical Product (TPP) curve and a Marginal Physical Product (MPP) curve as smooth curves
against the variable input (labour).

Three
Stages of the Law
The law has three stages as explained below:
1. Stage I – The TPP increases at an increasing rate and the MPP increases too. The MPP increases with
an increase in the units of the variable factor. Therefore, it is also called the stage of increasing returns.
In this example, the Stage I of the law runs up to three units of labour (between the points O and L).
2. Stage II – The TPP continues to increase but at a diminishing rate. However, the increase is positive.
Further, the MPP decreases with an increase in the number of units of the variable factor. Hence, it is
called the stage of diminishing returns. In this example, Stage II runs between four to six units of labour
(between the points L and M). This stage reaches a point where TPP is maximum (18 in the above
example) and MPP becomes zero (point R).
3. Stage III – Now, the TPP starts declining, MPP decreases and becomes negative. Therefore, it is called
the stage of negative returns. In this example, Stage III runs between seven to eight units of labour
(from the point M onwards).
 The Law of Returns to Scale
The law of returns to scale in economics is the relationship between the increase in output and the increase in
all factors of production when they change in the same proportion:
 Increasing returns to scale: The output increases at a faster rate than the increase in inputs.
 Constant returns to scale: The output increases at the same rate as the increase in inputs.
 Decreasing returns to scale: The output increases at a slower rate than the increase in inputs.
The law of returns to scale is only applicable in the long run when all factors are variable and can be increased
in the same proportion to boost production. It generally shows the variation in productivity and efficiency.
1. Increasing returns to scale

In Figure-13, a movement from a to b indicates that the amount of input is doubled. Now, the combination of
inputs has reached to 2K+2L from 1K+1L. However, the output has Increased from 10 to 25 (150% increase),
which is more than double. Similarly, when input changes from 2K-H2L to 3K + 3L, then output changes from
25 to 50(100% increase), which is greater than change in input. This shows increasing returns to scale.
2. Constant Returns to Scale:

In Figure-14, when there is a movement from a to b, it indicates that input is doubled. Now, when the
combination of inputs has reached to 2K+2L from IK+IL, then the output has increased from 10 to 20.
Similarly, when input changes from 2Kt2L to 3K + 3L, then output changes from 20 to 30, which is equal to
the change in input. This shows constant returns to scale. In constant returns to scale, inputs are divisible and
production function is homogeneous.
3. Diminishing Returns to Scale:
In Figure-15, when the combination of labour and capital moves from point a to point b, it indicates that input
is doubled. At point a, the combination of input is 1k+1L and at point b, the combination becomes 2K+2L.
However, the output has increased from 10 to 18, which is less than change in the amount of input. Similarly,
when input changes from 2K+2L to 3K + 3L, then output changes from 18 to 24, which is less than change in
input. This shows the diminishing returns to scale.

Economies of Scale
Economies of scale is a microeconomic concept that describes how a company's average costs decrease as its
output increases. This is because the fixed costs are spread across more units, and the company can negotiate
better contracts with suppliers.
Economies of scale refer to the cost advantage experienced by a firm when it increases its level of output.
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.
The graph above plots the long-run average costs (LRAC) faced by a firm against its level of output. When
the firm expands its output from Q1 to Q2, its average cost falls from C1 to C2. Thus, the firm can be said to
experience economies of scale up to output level Q2.
Types of Economies of Scale
1. Internal Economies of Scale
This refers to economies that are unique to a firm. For instance, a firm may hold a patent over a mass production
machine, which allows it to lower its average cost of production more than other firms in the industry.
2. External Economies of Scale
These refer to economies of scale enjoyed by an entire industry. For instance, suppose the government wants
to increase steel production. In order to do so, the government announces that all steel producers who employ
more than 10,000 workers will be given a 20% tax break.
Thus, firms employing less than 10,000 workers can potentially lower their average cost of production by
employing more workers. This is an example of an external economy of scale – one that affects an entire
industry or sector of the economy.
Sources of Economies of Scale
1. Purchasing
Firms might be able to lower average costs by buying the inputs required for the production process in bulk or
from special wholesalers. By negotiating with suppliers for volume discounts, the purchasing firm takes
advantage of economies of scale.
2. Managerial
Firms might be able to lower average costs by improving the management structure within the firm. The firm
might hire better skilled or more experienced managers.

3. Technological
A technological advancement might drastically change the production process. For instance, fracking
completely changed the oil industry a few years ago. However, only large oil firms that could afford to invest
in expensive fracking equipment could take advantage of the new technology.

Diseconomies of Scale
Diseconomies of scale is an economic phenomenon that occurs when a business's average unit cost increases
as production increases. This is the opposite of economies of scale, where production costs decrease as a
business produces more units.
Diseconomies of scale can be caused by a number of factors, including: Technical issues in the production
process, Organizational management issues, Resource constraints, Poor communication, and Lack of control.

Consider the graph shown above. Any increase in output beyond Q 2 leads to a rise in average costs. This is an
example of diseconomies of scale – a rise in average costs due to an increase in the scale of production.
 Types of Diseconomies of Scale

1. Internal Diseconomies of Scale

2. External Diseconomies of Scale

Diseconomies of Scale Examples