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Production Theory

The document discusses key concepts in production theory including: 1) Production involves transforming inputs like labor, capital and raw materials into outputs. Inputs can be fixed or variable depending on their flexibility in the short and long run. 2) Production functions show the relationship between inputs and output mathematically. They can model single or multiple inputs. 3) The laws of production include diminishing returns and returns to scale. Diminishing returns states that adding more of a variable input will increase output at a decreasing rate. Returns to scale measures how output changes with proportional input changes.

Uploaded by

Nandini Shekhar
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© Attribution Non-Commercial (BY-NC)
Available Formats
Download as PPT, PDF, TXT or read online on Scribd
81 views

Production Theory

The document discusses key concepts in production theory including: 1) Production involves transforming inputs like labor, capital and raw materials into outputs. Inputs can be fixed or variable depending on their flexibility in the short and long run. 2) Production functions show the relationship between inputs and output mathematically. They can model single or multiple inputs. 3) The laws of production include diminishing returns and returns to scale. Diminishing returns states that adding more of a variable input will increase output at a decreasing rate. Returns to scale measures how output changes with proportional input changes.

Uploaded by

Nandini Shekhar
Copyright
© Attribution Non-Commercial (BY-NC)
Available Formats
Download as PPT, PDF, TXT or read online on Scribd
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Theory of Production

Basic concepts
Production

Production means transforming inputs (labor, capital, raw materials, time, etc.) into output. o Input and Output -Input is a good or service that goes into the process of production. -Output is any good or service that comes out of production process.

Basic concepts
Fixed and Variable Input

-Fixed input is one whose supply is inelastic in the short-run. -A variable input is one whose supply in the short-run is elastic, e.g., labor and raw material, etc. All the users of such factors can employ a larger quantity in the shortrun as well as in the long run.

Basic concepts
Short-Run and Long-Run

-Short run refers to a period of time in which the supply of certain inputs (e.g. plant, building, machinery etc.) is fixed or inelastic. -Long run refers to a period of time in which all the inputs is elastic.

Production Function
Production function is a mathematical presentation of input-output relationship.

Production Function
The production function is generally expressed as

Q = f (LB, L, K, M, T, t)
The production function for two inputs:

Q = F(K,L)
Q = Output, K = Capital, L = Labor

Production Function
Short-run Production Function

Q = f (L )
Long -run Production Function

Q = F (K, L)

Laws of Production
Short-run laws of Production (Production with one

variable input) Long-run laws of Production (Production with two variable input)

Law of Diminishing Returns


It states that when more and more units of a variable input are used with a given quantity of fixed inputs, the total output may initially increases at increasing rate and then it increases at diminishing rates and thereafter it turns negative.

Production with One Variable Input (Labor)


Amount of Labor (L)
0 1 2

Amount Total of Capital (K) Output (Q)


10 10 10 0 10 30

Average Product
--10 15

Marginal Product
--10 20

3
4 5 6 7 8 9 10

10
10 10 10 10 10 10 10

60
80 95 108 112 112 108 100

20
20 19 18 16 14 12 10

30
20 15 13 4 0 -4 -8

Production with One Variable Input (Labor)


Output per Month

112

C 60

Total Product

B
A

A: slope of tangent = MP (20) B: slope of OB = AP (20) C: slope of OC= MP & AP

0 1

2 3

5 6

7 8

10 Labor per Month

Production with One Variable Input (Labor)


Outpu t per Month Observations: Left of E: MP > AP & AP is increasing Right of E: MP < AP & AP is decreasing E: MP = AP & AP is at its maximum

30
Marginal Product

20

Average Product

10

0 1

2 3

5 6

7 8

10 Labor per Month

Production with One Variable Input (Labor)


AP = slope of line from origin to a point on TP, lines b, & c. MP = slope of a tangent to any point on the TP line, lines a & c.
Output per Month 112 C 60 A 0 1 2 3 4 5 6 7 8 9 10
Labor per Month

Output per Month

30
E

20
10
0 1 2 3 4 5 6 7 8 9 10 per Month
Labor

Production with One Variable Input (Labor)


The Law of Diminishing Marginal Returns
As the use of an input increases in equal increments, a point will be reached at which the resulting additions to output decreases (i.e. MP declines).

Production with One Variable Input (Labor)


The Law of Diminishing Marginal Returns
When the labor input is small, MP increases due to

specialization.
When the labor input is large, MP decreases due to

inefficiencies.

Production with Two Variable Inputs

Long-run production K& L are variable.


Isoquants analyze and compare the different

combinations of K & L and output

The Shape of Isoquants


Capital per year

5
4 3 2

In the long run both labor and capital are variable and both experience diminishing returns.

Q3 = 90 1 1 2 3
D

Q2 = 75 Q1 = 55 4 5
Labor per year

Production with Two Variable Inputs


Substituting Among Inputs The slope of each isoquant gives the trade-off between two inputs while keeping output constant.

Laws of Returns to Scale


Measuring the relationship between the scale (size) of

a firm and output


1)

Increasing returns to scale: output more than doubles when all inputs are doubled
Larger output associated with lower cost (autos)
One firm is more efficient than many (utilities) The isoquants get closer together

Factors behind Increasing Returns to scale


Technical and Managerial Indivisibilities
Higher degree of specialization Dimensional relations

Increasing Returns to Scale


Capital (machine hours)

Increasing Returns: The isoquants move closer together A

4 30 2 10 20

10

Labor (hours)

Returns to Scale
Measuring the relationship between the scale (size) of

a firm and output


2)

Constant returns to scale: output doubles when all inputs are doubled
Size does not affect productivity
May have a large number of producers Isoquants are equidistant apart

Constant Returns to Scale


Capital (machine hours)

Constant Returns: Isoquants are equally spaced 6

30
4 20 2 10 0 5 10 15
Labor (hours)

Returns to Scale
Measuring the relationship between the scale (size) of

a firm and output


3) Decreasing returns to scale: output less than doubles when all inputs are doubled

Decreasing efficiency with large size


Reduction of entrepreneurial abilities Isoquants become farther apart

Factors behind decreasing returns to scale


Manager diseconomies

Budget Line or Iso-cost curve


Cost (C) = K.Pk + L.Pl

Budget Line or Iso-Cost Curve


Y
Capital (K)

N M

Labor (L)

Least-Cost Criteria
It implies that the least cost combination is given by the point where isoquant is tangent to the iso-cost.

K1 p

M
U3
Q

U2
U1

L1

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