Course Name-Managerial Economics
Course Code- OEC 701 ( C )
Topic –Theory of Production
Model Institute of
Engineering & Technology
Course Outcomes
Course Mapping with Program
Description
Outcomes Outcomes
Describe the demand concept as the basis of economic
CO1 activity. 2,3,4,6,7,10,11,12
Articulate the various laws of production in both short
CO2 and long run work for designing the optimum level 2,3,4,7,8,12
output.
Analyze the various types of market structures.
CO3 1,2,3,4,7,8,9,12
Interpret the various pricing methods and strategies.
CO4 1,5,6,8,9,10,11,12
Evaluate the various macroeconomic concepts affecting
CO5 the overall economy and undertake economic analysis. 1,3,5,6,10,11
Course Topic Bloom’s Taxonomy
Outcomes
Articulate the various laws of production in both short
and long run work for designing the optimum level
CO2 output. 2,3,4,7,8,12
Assessment and Evaluation Plan
Assessment Tools
• Q&A
• Discussion
• Evaluation
Lesson Outcomes
Students will be able to understand the concept of Theory of
Production Function.
Some basic Concepts
Meaning of Production
Production means transforming inputs (labour, capital, raw materials,
time etc.) into an output with value added.
Production refers to the process of combining various inputs (such as
labor, raw materials, and capital) to create goods or services that have
value and can be sold in a market. It is the act of transforming resources
into finished products or services that satisfy human needs and wants.
Short Run and Long Run
Production of good involves timer.
The reference to time period involved in production process is an
important concept used in production analysis.
The two reference periods are short run and long run.
Short run is a period during which at least one input is fixed and cannot be
changed, while other inputs can be varied.
Typically, capital (e.g., machinery, land, factories) is considered fixed in the
short run, while labour and raw materials are variable.
Firms can increase or decrease their production levels by adjusting
variable inputs, but they cannot make changes to fixed inputs.
Fixed Inputs: In the short run, certain resources like factory size,
machinery, or land remain constant.
Variable Inputs: Firms can adjust resources like labour and raw materials to
respond to changes in demand or production needs.
For Example: A car manufacturing company may add more workers
(variable input) to increase production in the short run, but the size of its
factory (fixed input) remains unchanged.
Long run is a period during which all inputs are variable, meaning that
firms can change the quantity of all inputs, including capital and labour.
There are no fixed factors in the long run, and firms have the flexibility to
adjust their production capacity by expanding or contracting all resources.
Firms can build new factories, buy more machinery, or change their
production technology.
Example: The same car manufacturing company can build a new factory,
invest in more machines, or change its entire production process in the long
run to increase its output capacity.
All Inputs are Variable: In the long run, firms can fully adjust to changes in
demand by altering both variable and fixed inputs.
Production Function
A production function is a mathematical expression that defines the
maximum amount of output a firm can produce with a given set of inputs
over a specific period. It shows the technological relationship between
physical inputs and outputs.
General Form:
Q=f(L,K,R,T) Where:
Q = Output (Quantity of goods produced)
L= Labour input
K= Capital input
R= Raw materials
T = Technology
Note: The inputs used in production can be broadly classified as labor,
capital, land, materials, and technology.
Types of Production Functions
(a) Short-run Production Function:
In the short run, at least one input is fixed, meaning the firm cannot
adjust it easily.
The firm can only change variable inputs like labour or raw materials.
The primary focus is on how output changes as the firm varies its variable
inputs while holding some inputs constant.
(b) Long-run Production Function:
In the long run, all inputs are variable. Firms can adjust labour, capital,
technology, and other factors as needed.
There are no fixed inputs in the long run.
Cobb-Douglas Production Function
One of the most widely used production functions in economics is the
Cobb-Douglas production function, which represents output as a
product of labour and capital inputs.
Formula:
Where:
Q= Output
A= Total factor productivity (technological efficiency)
L= Labour input
K= Capital input
α\alpha=Output elasticity of labour (percentage change in output due to a
1% change in labour)
β\beta =Output elasticity of capital (percentage change in output due to a
1% change in capital)
Properties:
If α+β=1, there are constant returns to scale.
If α+β>1, there are increasing returns to scale.
If α+β<1, there are decreasing returns to scale.
Total Product (TP)
Definition: Total Product refers to the total quantity of output produced by
a firm using a given quantity of inputs (like labour or capital) over a
specific period of time.
Example: If a factory produces 100 units of goods per day with 5 workers,
the TP is 100 units.
Marginal Product (MP)
Definition: Marginal Product refers to the additional output produced by
using one more unit of input, holding all other inputs constant.
Formula: MP=ΔTP/L
Where ΔTP is the change in total product and ΔL is the change in the quantity of
labour.
Example: If increasing the number of workers from 5 to 6 results in the
Average Product (AP)
Definition: Average Product refers to the average output produced per
unit of input.
Formula: AP=TP/L
Where TP is the total product and L is the number of labour units.
Example: If 5 workers produce 100 units of output, the AP is 100/5=20
units per worker.
Reasons for Negative MP:
a) TP Decreases
b) Disguised Unemployment: Disguised unemployment refers to a situation
where more workers are employed than necessary for a given level of
output, meaning that some workers' contributions to production are
essentially redundant.
Law of Variable Proportion
The Law of Variable Proportion is also known as the Law of
Diminishing Marginal Returns.
The law highlights the relationship between input and output, focusing on
how additional units of a variable factor (e.g., labor) affect total
production.
It is particularly applicable in the short run, where at least one factor is
fixed.
The Law of Variable Proportions states that as more and more units of a
variable factor (such as labour) are combined with a fixed factor (such as
capital or land), the marginal product of the variable factor initially
increases, then starts to decrease, and eventually becomes negative.
If one input is increased while keeping other inputs constant, the resulting
increase in output will follow a three-stage process:
1. Increasing returns,
2. Diminishing returns, and
3. Negative returns.
First Stage (Stage of increasing returns)
Total product increases at an increasing rate up to a certain point and
then increases but at the decreasing rate.
In figure, TP is increasing at the increasing rate up to point A, increasing
at diminishing rate thereafter. TP is maximum at C and D (constant).
MP is increasing up to point G and then it is decreasing.
AP is increasing up to the point H, stable up to point E.
The first stage ends at the point E where AP and MP are equal (i.e. AP =
MP)
Second Stage (Stage of decreasing returns)
In this stage of production, total product continues to increase at the
diminishing rate until it reaches to maximum.
In figure, this stage begins from the point B of TP curve. TP is maximum at
point C and remains stable up to point D.
In this stage AP is continuously decreasing.
MP is also continuously decreasing and becomes zero (Point F of figure)
where second stage ends.
When TP is maximum and constant, MP is zero
Causes of decreasing returns
1. Scarcity of fixed factors
2. Indivisibility of fixed factor
3. Imperfect substitutability of the factor
Third Stage (Stage of negative returns)
This stage begins from the point (point D in figure) in which TP is declining.
AP is also declining but never becomes zero and negative.
When TP declines, MP becomes negative.
Causes of negative returns
1. Inefficient utilization of variable factors
2. Over utilization of fixed factors
3. Complexity of management
Assumptions of the Law
Technology is constant.
Labour is only a variable factor.
At least, one factor of production is fixed.
There must be possibility of varying the proportion of factors of production.
All units of labour are homogeneous
