Production Analysis

• Production is a function of land, labour, capital and

organisation.
• The managers will have to procure the right level of these
factors based on factors like diminishing marginal returns,
economies of large scale operations, law of return, scales
etc., with a view of maximizing the output with minimum
cost so as to earn larger profit to the firm/ industry.
Production
• Production is an important economic activity which satisfies the
wants and needs of the people.
• Production function brings out the relationship between inputs
used and the resulting output.
• A firm is an entity that combines and processes resources in
order to produce output that will satisfy the consumer’s needs.
• The firm has to decide as to how much to produce and how
much input factors (labour and capital) to employ to produce
efficiently.
• Factors of production include resource inputs used to produce
goods and services. Economist categorize input factors into four
major categories such as land, labour, capital and organization.
Production function
• Production Function indicates the maximum amount of
commodity ‘Y’ to be produced from various combinations of
input factors.
• It decides on the maximum output to be produced from a given
level of input, and how much minimum input can be used to get
the desired level of output.
• The production function assumes that the state of technology is
fixed.
• If there is a change in technology then there would be change in
production function.
• Q = f (Land, Labour, Capital, Organization)
• Q = f (L, L, C, O)
• The production manager’s responsibility is that of identifying the
right combination of inputs for the decided quantity of output.
• As a manager, he has to know the price of the input factors and
the budget allocation of the organization.
• The major objective of any business organization is maximizing
the output with minimum cost.
• To achieve the maximum output the firm has to utilize the input
factors efficiently. In the long run, without increasing the fixed
factors it is not possible to achieve the goal.
• Therefore, it is necessary to understand the relationship
between the input and output in any production process in the
short and long run.
Cobb Douglas Production Function
• This is a function that defines the maximum amount of output
that can be produced with a given level of inputs.
• Let us assume that all input factors of production can be
grouped into two categories such as labour (L) and capital (K).
• The general equilibrium for the production function is Q = f (K,
L) There are various functional forms available to describe
production.
• In general Cobb-Douglas production function (Quadratic
equation) is widely used
• Q = A Kα Lβ
• Q = the maximum rate of output for a given rate of capital (K)
and labour (L).
Short Run & Long run Production Functions
• In the short run, some inputs (land, capital) are fixed in quantity.
• The output depends on how much of other variable inputs are used.
• For example if we change the variable input namely (labour) the
production function shows how much output changes when more
labour is used.
• In the long run all input factors are variable.
• The producer can appoint more workers, purchase more machines
and use more raw materials. Initially output per worker will increase
up to an extent.
• This is known as the Law of Diminishing Returns or the Law of
Variable Proportion.
• To understand the law of diminishing returns it is essential to know
the basic concepts of production.
Measures of Productivity
• Total production (TP): the maximum level of output that can
be produced with a given amount of input.
• Average Production (AP): output produced per unit of input
AP = Q/L
• Marginal Production (MP): the change in total output
produced by the last unit of an input
• Marginal production of labour = Δ Q / Δ L (i.e. change in the
quantity produced to a given change in the labour)
• Marginal production of capital = Δ Q / Δ K (i.e. change in the
quantity produced to a given change in the capital)
The Law of Diminishing Returns
• In the combination of input factors when one particular factor is
increased continuously without changing other factors the output will
increase in a diminishing manner.
• There is a limit to the extent to which one factor of production can be
substituted for another.
• The total production increases up to an extent and it gets saturated or
there won’t be any change in the output due to the addition of the
input factor and further it leads to negative impact on the output.
• That means the marginal production declines up to an extent and it
reaches zero and becomes negative.
• The point at which the MP becomes zero is the maximum output of
the firm with the given set of input factors. This law is applicable in all
human activities and business activities.
• For example with two sewing machines and two tailors, a firm can produce
a maximum of 14 pairs of curtains per day. The machines are used only from
9 AM to 5 PM and the machines lie idle from 5 pm onwards.
• Therefore the firm appoints 2 more tailors for the second shift and the
production goes up to 28 units.
• Then adding two more labour to assist these people will increase the output
to 30 units.
• When the firm appoints two more people, then there won’t be any change
in their production because their Marginal productivity is zero.
• There is no addition in the total production. That means there is no use of
appointing two more tailors.
• Therefore, there is a limit for output from a fixed input factors but in the
long run purchase of one more sewing machine alone will help the firm to
increase the production more than 30 units.
The Law of Returns To Scale
• In the long run the fixed inputs like machinery, building and
other factors will change along with the variable factors like
labour, raw material etc. With the equal percentage of
increase in input factors various combinations of returns
occur in an organization.
• Returns to scale: the change in percentage output resulting
from a percentage change in all the factors of production.
They are increasing, constant and diminishing returns to scale.
• Increasing returns to scale may arise: if the output of a firm
increases more than in proportionate to an increase in all
inputs.
• Constant returns to scale: when all inputs are increased by a
certain percentage the output increases by the same
percentage.
• Diminishing returns to scale: when output increases in a
smaller proportion than the increase in inputs it is known as
diminishing return to scale.
• In economics, the production function with one variable input
is illustrated with the well known law of variable proportions.
• It shows the input-output relationship or production function
with one factor variable while other factors of production are
kept constant.
• To understand a production function with two variable
inputs, it is necessary know the concept iso-quant or iso-
product curve.
ISO-Quant and Iso-cost
• To understand the production function with two variable
inputs, iso-quant curve is used.
• These curves show the various combinations of two variable
inputs resulting in the same level of output.
• The shape of an Iso-quant reflects the ease with which a
producer can substitute among inputs while maintaining the
same level of output.
• Iso-cost: different combination of inputs that can be
purchased at a given expenditure level.
Managerial Uses of Production Function

• Production functions are logical and useful.

• Production analysis can be used as aids in decision making
because they can give guidance to obtain the maximum
output from a given set of inputs and how to obtain a given
output from the minimum aggregation of inputs.
• The complex production functions with large numbers of
inputs and outputs are analyzed with the help of computer
based programmes