PRODUCTION

FUNCTION
PRODUCTION – Production refers to transformation of inputs into output. For example: To manufacture shoes
(output), we need various inputs like leather, nails, land, labour, capital, services of entrepreneurs etc.

PRODUCTION FUNCTION – Production function is an expression of the technological relation between physical
inputs and output of a good.

Symbolically: Ox = f (i1, i2, i3,…….,in)

{where Ox = output of commodity x; f = functional relationship; i1, i2, …..,in = inputs needed for Ox}

2
Example of Production Function
Suppose a firm is manufacturing chairs with the help of two inputs, say
labour (L) and capital (K). Then, production function can be written as:
Ochairs= f (L, K)

Production function defines the maximum chairs (Ochairs), which can be

produced with the given capital and labour inputs.

If production function is expressed as: 250 = (7L, 2K). It means, 7 units

of labour and 2 units of capital can produce maximum of 250 chairs.

3
SHORT RUN AND LONG RUN
Short run – Short run refers to a period in which output can be changed by changing only variable factor.
In the short run, fixed inputs like plant, machinery, building, etc. cannot be changed. It means, production can be
raised by increasing variable factors, but till the extent of capacity of fixed factors.

For example, if a producer wants to increase output in the short run, then this objective can be achieved by
using more of raw materials and increasing number of workers with the existing factory building, plant and
equipment. One cannot immediately expand factory building, install additional plant and equipment. So, in
the short run, some factors are fixed and some are variable and fixed factors cannot be changed during such a
short span of time.

Long run – Long run refers to a period in which output can be changed by changing all factors of production.
Long run is a period, that is long enough for the firm to adjust all its inputs according to change in the conditions. In
the long run, firm can change its factory size, switch to new techniques of production, purchase new machinery,
etc.

4
DIFFERENCE BETWEEN SHORT RUN AND LONG RUN
Basis Short run Long run

Meaning Short run refers to a period in which Long run refers to a period in which
output can be changed by changing output can be changed by changing
only variable factor. all factors of production.
Classification Factors are classified as variable and All factors are variable in the long
fixed factor in the short run. run.
Price determination Demand is more active in price Both demand and supply play equal
determination as supply cannot be role in price determination as both
increased immediately with increase can be increased.
in demand.

5
VARIABLE FACTORS AND FIXED FACTORS
Variable factors – Variable factors refer to those factors, which can be changed in the short run. For example, raw
material, casual labour, power, fuel, etc.

Fixed factors – Fixed factors refer to those factors, which cannot be changed in the short run. For example, plant
and machinery, building, land, etc.

Difference between variable factors and fixed factors

6
TYPES OF PRODUCTION
FUNCTION
1. Short Run Production Function (variable proportion type) – Short run production function refers to a situation
when output is increased by changing only one input while keeping other inputs unchanged.
As there is change in variable input only, the ratio between different inputs tends to change at different levels of
output.
This relationship is explained by ‘Law of Variable Proportions’.

1. Long Run Production Function (constant proportion type) - Long run production function refers to a situation
when output is increased by increasing all the inputs simultaneously and in the same proportion.
As all inputs are variable in the long run, the ratio between different inputs tend to remain the same at different
levels of output.
This relationship is explained by the ‘Law of Returns to Scale’.
7
Note:
ഥ where Qx = output of good X, L = labour, a variable factor,𝐾=
Short Run Production Function: Qx = f(L, 𝐾), ഥ capital, a fixed
factor.
ഥ
For example: 40x = f(5L, 4𝑲)
ഥ)
45x = f(6L, 4𝑲
In the short run/ short run production function, factor ratio (L: K) must change at different levels of output. This is
because one factor is constant all through the production process. Thus, 𝑘ത = 4 when 5 units of labour are applied to produce
40 units of output or when 6 units of labour are applied to produce 45 units of output. Accordingly, factor ratio shifts from 5:
4 to 6: 4 as the level of output is raised from 40 to 45 units of commodity X. Thus short period production function is called
‘ variable proportions type production function’.

Long Run Production Function: Qx = f(L,K) where K is a variable factor.

For example: 40x = f(5L, 4𝐊)
80x = f(10L, 8K)

In the long period production function, factor ratio remains constant. It is 5: 4 when output = 40 units, and 10: 8 (the same as
5: 4) when output = 80 units. Thus, the long period production function is called ‘constant proportions type production 8
function’.
CONCEPT OF PRODUCT
Product or output refers to the volume of goods produced by a firm or an industry during a specified period of time.

TOTAL PRODUCT (TP) – Total product refers to total quantity of goods produced by a firm during a given period of
time with given number of inputs.

Example: If 10 labours produce 60 kg of rice, then TP is 60 kg.

TP is also known as Total Physical Product (TPP) or Total Return or Total Output.

AVERAGE PRODUCT (AP) – Average product refers to output per unit of variable input.

𝑇𝑜𝑡𝑎𝑙 𝑃𝑟𝑜𝑑𝑢𝑐𝑡 (𝑇𝑃)

𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝑃𝑟𝑜𝑑𝑢𝑐𝑡 (𝐴𝑃) =
𝑈𝑛𝑖𝑡𝑠 𝑜𝑓 𝑣𝑎𝑟𝑖𝑎𝑏𝑙𝑒 𝑓𝑎𝑐𝑡𝑜𝑟 (𝑛)

Example: If TP is 60 kg of rice, produced by 10 labours (variable input), then AP will be 60 / 10 = 6 kg.

AP is also known as ‘Average Physical Product (APP)’ or ‘Average Return’. 9

MARGINAL PRODUCT (MP) – Marginal product refers to addition to total product, when one more unit of variable factor is
employed.
MP n = TP n – TP n-1
Where,
MP n = Marginal product of nth unit of variable factor;
TP n = Total product of n units of variable factor;
TP n – 1 = Total product of (n – 1) units of variable factor;
n = number of units of variable factor.

Example: If 10 labours produce 60 kg of rice and 11 labours produce 67 kg of rice, then MP of

11th labour will be: MP11 = TP11 – TP10 = 67 – 60 = 7 kg

MP is also known as ‘Marginal Physical Product (MPP)’ or ‘Marginal Return’.

One more way to calculate MP:

𝑐ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑇𝑜𝑡𝑎𝑙 𝑃𝑟𝑜𝑑𝑢𝑐𝑡 ∆𝑇𝑃

𝑀𝑃 = =
𝐶ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑢𝑛𝑖𝑡𝑠 𝑜𝑓 𝑣𝑎𝑟𝑖𝑎𝑏𝑙𝑒 𝑓𝑎𝑐𝑡𝑜𝑟 ∆𝑛
10
Again, TP is summation of MP: 𝑻𝑷 = σ 𝑴𝑷
RETURNS TO A FACTOR: LAW OF VARIABLE
PROPORTIONS
Returns to a factor refers to the resultant increase in the total product (return) 11
when only one factor is increased, keeping all other factors fixed. In the short run,
when one input is variable and all other inputs are fixed, the firm’s production
function exhibits the Law of Variable Proportions.

Statement of Law of Variable Proportions:

Law of Variable Proportions (LVP) states that as we increase quantity of only one
input keeping all other inputs fixed, total product (TP) initially increases at an
increasing rate, then at a decreasing rate and finally at a negative rate.
According to the Law of Variable Proportions, the changes
in TP and MP can be classified into following three phases:

Phase I: TP rises at increasing rate.

MP increases.

Phase II: TP rises at decreasing rate.

MP decreases and is positive.

Phase III: TP falls.

MP becomes negative. 12
Assumptions of Law of Variable Proportions
1. It operates in short run, as factors are classified as variable and fixed factor;

2. The law applies to all fixed factors including land;

3. Under Law of Variable Proportions, different units of variable factor can be combined with fixed
factor;

4. This law applies to the field of production only;

5. The effect of change in output due to change in variable factor can be easily determined;

6. It is assumed that, factors of production become imperfect substitutes of each other beyond a
certain limit;

7. The state of technology is assumed to be constant during the operation of this law; 13

8. It is assumed that all variable factors are equally efficient.

Explanation of the Law:
In order to understand the law of variable proportions we take the example of agriculture. Suppose land and
labour are the only two factors of production.

Suppose, a farmer has 1 acre of land (fixed factor) on which he wants to increase the production
of wheat with the help of labour (variable factor). When he employed more and more units of
labour, initially output increased at an increasing rate, then at a decreasing rate and finally, at a
negative rate. The behavior of output is shown in the table below.

14
(i) Phase 1: (Between O to Q) TP increases at an increasing rate and MP also
increases.

(ii) Phase 2: (Between Q to M) TP increases at decreasing rate and MP falls. This

phase ends when MP becomes zero and TP reaches its maximum point.

(iii) Phase 3 (Beyond point M) TP starts decreasing and MP not only falls, but
also becomes negative.

(iv) Point of Inflexion (Point Q) Point ‘Q’ is known as point of inflexion as

curvature of TP curve changes at this point. Till point Q, TP is convex shaped
and beyond point Q, TP becomes concave shaped.

As seen in the given table and figure, when farmer increases the labour on the
same piece of land, then initially TP rises at an increasing rate, then at a
decreasing rate and finally it falls. The resulting relation between input and
output is discussed in three phases:
15
Phase 1: Increasing Returns to a Factor: In the first phase, every additional variable factor adds more and more to the total output.
It means, TP increases at an increasing rate and MP of each variable factor rises.

 It happens because initially quantity of variable input is too small as compared to the fixed input. As production starts, there is efficient use of
the fixed input, which raises the productivity of variable input due to division of labour.

 As seen in the given schedule and diagram, one labour produces 10 units, while two labours produce 30 units. It implies, TP increases at an
increasing rate (till point ‘Q’) and MP rises till it reaches its maximum point ‘P’, which marks the end of first phase.

Phase 2: Diminishing Returns to a Factor: In the second phase, every additional variable factor adds lesser and lesser amount of output. It
Means, TP increases at a diminishing rate and MP falls with increase in variable factor.
That is why, this phase is known as diminishing returns to a factor.

 It happens because after a level of output, pressure on fixed input leads to fall in productivity of the variable input.

 The second phase ends at point ‘S’, when MP is zero and TP is maximum (point ‘M’) at 52 units.

 2nd phase is very crucial as a rational producer will always aim to produce in this phase because TP is maximum and MP of each
variable factor is positive.

Phase 3: Negative Returns to a Factor: In the third phase, (starting from 6 units of labour), the employment of additional variable factor causes
TP to decline. MP now becomes negative. Therefore, this phase is known as negative returns to a factor.
16
 In Fig, the third phase starts after point ‘S’ on MP curve and point ‘M’ on TP curve.

 MP of each variable factor is negative in the 3rd phase. So, no firm would deliberately choose to operate in this phase.
REASONS FOR LAW OF VARIABLE PROPORTIONS
The various reasons for three phases of Law of Variable Proportions are:
Reasons for Increasing Returns to a Factor (Phase I):

1. Fuller utilization of the fixed factor – In the initial stages, fixed factor (such as machine) remains
underutilized. Only by increasing variable factor like, say labour, can we ensure fuller utilization of the
fixed factor. So, initially, more and more units of variable factor adds more and more units to Total
Product. This implies TP increases at an increasing rate and MP also increases.

2. Division of labour and increase in efficiency – Additional application of the variable factor (labour)
enables process – based division of labour. Specialised workers may be used for different processes of
production. This increases efficiency or productivity of the variable factor. Accordingly, MP tends to
increase.

3. Better coordination between the factors – So long as fixed factor remains underutilized, additional
17
application of the variable factor tends to improve the degree of coordination between the fixed and
variable factors. As a result, MP increases and TP increases at an increasing rate.
Reasons for Decreasing Returns to a Factor (Phase II):

1. Fixity of the factor – As more and more units of the variable factor are combined with the fixed factor, the
latter gets excessively utilized. It suffers greater wear and tear and loses its efficiency. Hence, the
diminishing returns.

2. Imperfect factor substitutability - Factors of production are imperfect substitutes of each other. More and
more of labour cannot be continuously used in place of capital. Accordingly, diminishing returns are bound to
set in if only the variable factor is increased to increase output.

3. Poor coordination between the factors – Increasing application of the variable factor ( along with the fixed
factor) eventually disturbs the ideal factor ratio. This results in poor coordination between the fixed and
variable factors. Hence, the diminishing returns.

18
Reasons for Negative Returns to a Factor (Phase III):

1. Limitation of fixed factor – The negative returns to a factor apply because some factors of production
are of fixed nature, which cannot be increased with increase in variable factor in the short run.

2. Poor coordination between variable and fixed factor - When variable factor becomes too excessive in
relation to fixed factor, then they obstruct each other. It leads to poor coordination between variable and
fixed factor. As a result, total output falls instead of rising and marginal product becomes negative.

3. Decrease in efficiency of variable factor – With continuous increase in variable factor, the advantages of
specialization and division of labour start diminishing. It results in inefficiencies of variable factor, which is
another reason for the negative returns to eventually set in.

19
LAW OF DIMINISHING RETURNS
Law of diminishing returns states that when more and more units of a variable factor are employed with the fixed
factor, then marginal product of the variable factor must fall.
This law is also known as Law of Diminishing Marginal Product.

Example:

From the table given above it is clear that a farmer cultivates a small piece of land. He applies some capital and labour to his farm.
When he applies first unit of labour and capital he produces 30 Quintals. The second unit increases to 50 Quintals the extra capital
and labour produces (50 – 30) = 20 quintals.
From the third unit 15 quintals; from 4th and 5th unit 10 quintals and 5 quintals are marginal product. From the study of the table
given above we see that by the introduction of additional capital and labour, the total product increases while the marginal
product decreases. This reduction in the product is only because of the destructive powers of the soil. This trend in agriculture is
called the Law of Diminishing Returns. 20
RELATION BETWEEN TOTAL PRODUCT, MARGINAL PRODUCT AND AVERAGE PRODUCT

Relation between TP and MP:

 As long as TP increases at increasing rate (till point ‘P’), MP also
increases.

 When TP increases at diminishing rate, MP decreases. This

starts happening when 3 units of labour are employed and
continues till 5 units of variable factor.

 When TP reaches its maximum point (point M), MP becomes

zero (point N), i.e. at 5th unit of variable factor.

 When TP starts decreasing, MP becomes negative, i.e. from 6th

unit of variable factor.

21
Relation between MP and AP:

This relationship can be summarised as under:

 As long as MP is more than AP, AP rises, i.e. up

to 2nd unit of variable factor .

 When MP is equal to AP, AP is at its maximum,

i.e. at 3rd unit of variable factor.

 When MP is less than AP, AP falls (from 4th unit

of variable factor).
 Thereafter, both AP and MP fall, but MP
becomes negative, whereas, AP remains
positive. MP falls at a faster rate in comparison
to fall in AP.

22
23