Production

Function

Dr. Jalandhar Pradhan

 Theory of Production
• Production involves transformation of inputs
such as capital, equipment, labor, and land into
output - goods and services

• In this production process, the manager is

concerned with efficiency in the use of the
inputs
- technical vs. economical efficiency

2
Two Concepts of Efficiency
• Economic efficiency:
– occurs when the cost of producing a
given output is as low as possible

• Technological efficiency:
– occurs when it is not possible to
increase output without increasing
inputs

3
 Production Function
• A production function is purely technical
relation which connects factor inputs &
outputs. It describes the transformation of
factor inputs into outputs at any particular
time period.
Q = f( L,K,R,Ld,T,t)
where
Q = output R= Raw Material
L= Labour Ld = Land
K= Capital T = Technology
t = time

For our current analysis, let’s reduce the

inputs to two, capital (K) and labor (L):
4
Q = f(L, K)
 Production Table
Units of K
Employed Output Quantity (Q)
8 37 60 83 96 107 117 127 128
7 42 64 78 90 101 110 119 120
6 37 52 64 73 82 90 97 104
5 31 47 58 67 75 82 89 95
4 24 39 52 60 67 73 79 85
3 17 29 41 52 58 64 69 73
2 8 18 29 39 47 52 56 52
1 4 8 14 20 27 24 21 17
1 2 3 4 5 6 7 8
Units of L Employed
Same Q can be produced with different
combinations of inputs, e.g. inputs are substitutable
5
in some degree
Short-Run and Long-Run Production

• In the short run some inputs are fixed

and some variable

– e.g. the firm may be able to vary the

amount of labor, but cannot change the
amount of capital

– in the short run we can talk about factor

productivity / law of variable
proportion/law of diminishing returns
6
• In the long run all inputs become
variable
– e.g. the long run is the period in which a
firm can adjust all inputs to changed
conditions
– in the long run we can talk about returns
to scale

7
 Short-Run Changes in Production
Factor Productivity
Units of K
Employed Output Quantity (Q)
8 37 60 83 96 107 117 127 128
7 42 64 78 90 101 110 119 120
6 37 52 64 73 82 90 97 104
5 31 47 58 67 75 82 89 95
4 24 39 52 60 67 73 79 85
3 17 29 41 52 58 64 69 73
2 8 18 29 39 47 52 56 52
1 4 8 14 20 27 24 21 17
1 2 3 4 5 6 7 8
Units of L Employed

How much does the quantity of Q

change, when the quantity of L is 8
increased?
 Long-Run Changes in Production
Returns to Scale

Units of K
Employed Output Quantity (Q)
8 37 60 83 96 107 117 127 128
7 42 64 78 90 101 110 119 120
6 37 52 64 73 82 90 97 104
5 31 47 58 67 75 82 89 95
4 24 39 52 60 67 73 79 85
3 17 29 41 52 58 64 69 73
2 8 18 29 39 47 52 56 52
1 4 8 14 20 27 24 21 17
1 2 3 4 5 6 7 8
Units of L Employed

How much does the quantity of Q change,

when the quantity of both L and K is
increased? 9
Relationship Between Total, Average,
and Marginal Product: Short-Run
Analysis

• Total Product (TP) = total quantity of

output

• Average Product (AP) = total product

per total input

• Marginal Product (MP) = change in

quantity when one additional unit of
input used 10
The Marginal Product of Labor
• The marginal product of labor is the
increase in output obtained by adding 1
unit of labor but holding constant the
inputs of all other factors

Marginal Product of L:
MPL= Q/L (holding K constant)
= Q/L

Average Product of L:
APL= Q/L (holding K constant)
11
 Law of Diminishing Returns
(Diminishing Marginal Product)

The law of diminishing returns states that when more and more
units of a variable input are applied to a given quantity of fixed
inputs, the total output may initially increase at an increasing rate
and then at a constant rate but it will eventually increases at
diminishing rates.
Assumptions. The law of diminishing returns is based on the
following assumptions: (i) the state of technology is given (ii)
labour is homogenous and (iii) input prices are given.

12
 Short-Run Analysis of Total,
Average, and Marginal Product

• If MP > AP then
AP is rising
• If MP < AP then
AP is falling
• MP = AP when
AP is
maximized
• TP maximized
when MP = 0
13
 Three Stages of Production in
Short Run
AP,MP
Stage I Stage II Stage III

APX

•TPL Increases at MPX X

•TPL Increases at
Diminshing rate. • TPL begins to
increasing rate.
•MPL Begins to decline. decline
•MP Increases at
decreasing rate. •TP reaches maximum •MP becomes
level at the end of negative
•AP is increasing stage II, MP = 0.
and reaches its •AP continues to
•APL declines decline 14
maximum at the
end of stage I
Application of Law of Diminishing
Returns:

• It helps in identifying the rational and

irrational stages of operations.
• It gives answers to question –
How much to produce?
What number of workers to apply to a
given fixed inputs so that the output is
maximum?

15
 Production in the Long-Run
– All inputs are now considered to be variable
(both L and K in our case)
– How to determine the optimal combination of
inputs?

To illustrate this case we will use production

isoquants.
An isoquant is a locus of all technically efficient
methods or all possible combinations of inputs
for producing a given level of output.
16
 Production Table
Units
Unitsof
ofKK
Employed
Employed Output Quantity (Q) Isoquant
8 37 60 83 96 107 117 127 128
7 42 64 78 90 101 110 119 120
6 37 52 64 73 82 90 97 104
5 31 47 58 67 75 82 89 95
4 24 39 52 60 67 73 79 85
3 17 29 41 52 58 64 69 73
2 8 18 29 39 47 52 56 52
1 4 8 14 20 27 24 21 17
1 2 3 4 5 6 7 8
Units of
of K
L Employed

17
 Isoquant
Graph of Isoquant

Y
7

0
1 2 3 4 5 6 7 X

18
Marginal Rate of Technical
Substitution MRTS
• The degree of imperfection in
substitutability is measured with
marginal rate of technical
substitution (MRTS- Slope of
Isoquant):

MRTS = L/K

(in this MRTS some of L is removed

from the production and substituted
by K to maintain the same level of
output)
19
 Properties of Isoquants
• Isoquants have a negative slope.

• Isoquants are convex to the origin.

• Isoquants cannot intersect or be tangent to

each other.

• Upper Isoquants represents higher level of

output 20
 Isoquant Map
• Isoquant map is a set
Figure : Isoquant Map
of isoquants
presented on a two Y

dimensional plain.

Capital Y
Each isoquant shows IQ3
IQ4

various combinations IQ1

IQ2

of two inputs that can O Labour X X

be used to produce a
given level of output.

21
 Laws of Returns to Scale
• It explains the behavior of output in response
to a proportional and simultaneous change in
input.
• When a firm increases both the inputs, there
are three technical possibilities –
(i) TP may increase more than proportionately –
Increasing RTS
(ii) TP may increase proportionately – constant
RTS
(iii) TP may increase less than proportionately –
diminishing RTS
22
 Increasing RTS

K
Product Line

3K

3X
2K

2X
K
X

0 L 2L 3L
L
23
 Constant RTS

K
Product Line

3K

3X
2K

2X
K
X

0 L 2L 3L
L
24
 Decreasing RTS

K
Product Line

3K

3X
2K

2X
K
X

0 L 2L 3L
L
25
 Elasticity of Factor Substitution
• () is formally defined as the percentage
change in the capital labour ratios (K/L)
divided by the percentage change in marginal
rate of technical substitution (MRTS), i.e
Percentage change in K/L
()=
Percentage change in MRTS

д(K/L) / (K/L)
()=
д(MRTS) / (MRTS)
26
Equilibrium of the firm: Choice of optimal
combination of factors of prodn
• Assumptions:
1. The goal of the firm is profit maximization
i.e maximization of difference
∏ - Profit
R- Revenue
C-Cost

2. The price of o/p is given, Px

3. The price of factors are given w is the given wage
rate r is given price capital
27
 Single Decision of the firm
(a) Maximize profit ∏, subject to cost
constraint. In this case total cost & prices
are given and maximization of ∏ is if X is
maximised since c & Px are given constant.
∏ = R-C
= P x X-C
(b) Maximise Profit ∏ for a given level of o/p.
Maximisation of ∏ is achieved in this case if
cost c is minimized , given that X & Px are
given constants.
∏= R-C
∏= PxX - C

28
 We will use isoquant map (1) and
isoquant line (2)
Figure : Isoquant Map (1)
Figure : Isoquant Line (2)

K
K

C/r
A
Capital Y

3x
2x
x1
C/W

O L O B L

The cost line is defined by cost equation

C= (r) (k) + (w) (L)
W wage rate r= price of capital service 29
 Case I
Maximization of output subject to
cost constraint

A
Capital

K1 C x3

x2
X1
0 L1 B
Labour

30
 Condition for Equilibrium

• At point of tendency slope of isocost line

(w/r ) = slope of isoquant. (MPL/MPK)
• The isoquants should be convex to origin

31
 Case II
Minimization of cost for given level
of output

K1 e
X

0 L1 L

32
ISOQUANTS AND ISOCOSTS
NEW LOOK AT TECHNOLOGY: ISOQUANTS

TABLE 1 Alternative Combinations of Capital (K) and Labor (L) Required to

Produce 50, 100, and 150 Units of Output
QX = 50 QX = 100 QX = 150
K L K L K L

A 1 8 2 10 3 10
B 2 5 3 6 4 7
C 3 3 4 4 5 5
D 5 2 6 3 7 4
E 8 1 10 2 10 3

33 of 33
 Appendix

Isoquant A graph
that shows all the
combinations of
capital and labor
that can be used
to produce a given
amount of output.

FIGURE 7A.1 Isoquants Showing All Combinations of Capital

and Labor That Can Be Used to Produce 50,
100, and 150 Units of Output
34 of 33
 Appendix
Slope of isoquant:

K MPL

L MPK

marginal rate of
technical substitution
The rate at which a
firm can substitute
capital for labor and
hold output constant.
FIGURE 7A.2 The Slope of an Isoquant Is Equal
to the Ratio of MPL to MPK
35 of 33
 Appendix
FACTOR PRICES
AND INPUT
COMBINATIONS:
ISOCOSTS

isocost line A graph

that shows all the
combinations of
capital and labor
available for a given
total cost.

FIGURE 7A.3 Isocost Lines Showing the

Combinations of Capital and Labor
Available for $5, $6, and $7
36 of 33
 Appendix

FIGURE 7A.4 Isocost Line Showing All

Combinations of Capital and
Labor Available for $25

Slope of isocost line:

K TC / PK PL
 
L TC / PL PK

37 of 33
 Appendix
FINDING THE LEAST-COST TECHNOLOGY WITH
ISOQUANTS AND ISOCOSTS

FIGURE 7A.5 Finding the Least-Cost

Combination of Capital and
Labor to Produce 50 Units of
Output

The firm will choose the combination of inputs

that is least costly. The least costly way to
produce any given level of output is indicated
by the point of tangency between an isocost
line and the isoquant corresponding to that
level of output.

38 of 33
 Appendix

FIGURE 7A.6 Minimizing Cost of FIGURE 7A.7 A Cost Curve Shows the
Production for qX = 50, qX Minimum Cost of
= 100, and qX = 150 Producing Each Level of
39 of 33 Output
 Appendix
THE COST-MINIMIZING EQUILIBRIUM CONDITION

At the point where a line is just tangent to a curve, the two

have the same slope. At each point of tangency, the
following must be true:
MPL PL
slope of isoquant  slope of isocost 
MPK PK

MPL PL
Thus, 
MPK PK

Dividing both sides by PL and multiplying both sides by MPK,

we get
MPL MPK

40 of 33 PL PK
Given the following production function
and input prices, estimate the the
optimum input combination of L and K,
assuming that the firm has only Rs.
6000/- to spend. Additionally, assume
profit maximization as the objective
function of the firm:

Q=LK-80L
PL=60, Pk=30

41