Production Analysis
Production
What is Production?
Production refers to the technical
transformation of inputs into outputs.
What is Factor Input?
A Factor input is defined as any good or
service which contributes to the production of
an output.
Production function describes the
relationship between inputs and output
Inputs
Output
Production
What are the Factors of Production?
Four Factors of Production
Land-It is immobile in nature. It is inelastic in
supply
Labor-Can be skilled or unskilled
Capital- Machinery, building, equipment's, tools
Entrepreneur – Decision makers who used to take
risk and whose main aim is to increase the value
of the firm and making profit
Two More
Intermediate Inputs, Say Steel for Example
Technology
Production
Technology: Crucial In Production
Adjustment
Example: Italian Tire maker, Pirelli Developed a
New Technology Called MIRS (Modular
Integrated Robotized System) which can Produce
Tire in 72 minutes instead of Six Days Earlier it
Used to take .
Production
Technology is Necessary But not Ultimate
Careful and Efficient Management
Related to
Making the Right Choice at Right Time
Entreprene
Simplifying and Reorganizing Production ur
Producing Qualitative Products
Example: General Motors Failure with New
Technology i.e. Automation of Plants with
Robots
Classification of Production Function
Very short run (VSR)
all factors( labor and capital) are fixed (remains
unchanged).
Short run (SR)
Capital is fixed and labor is variable.
Long run (LR)
Both capital and labor are variable.
Production function in the Very short run(VSR)
Assumptions:
only two factors are involved capital & labour
Capital Fixed
Fixedfactor
factor
Fixed
Fixed
Factor
Factor
In VSR output can not be increased.
Production function in the short run(SR)
Assumptions:
only two factors are involved capital & labour
Capital Variable
Variablefactor
factor
Fixed
Fixed
Factor
Factor
In SR output can be increased by employing more
labour only.
Production function in the long run(LR)
Assumptions:
only two factors are involved capital & labour
Capital Variable
Variablefactor
factor
VariableFactor
VariableFactor
In LR production can be increased by employing
more labour and capital
It is important to distinguish between short run and long run when analyzing
production. Short run refers to the time period in which the quantities of one or
more factors of production can not be changed. In other words, it refers to the time
period during which at least one input is fixed. In short run, capital is fixed and
labour is variable. On the other hand, long run refers to the time period during
which all inputs are variable. More clearly in the long run both labour and capital
are variable.
The length of the long run depends on nature of the industry. For ex- in order to
establish a dry cleaning industry long run might be one month, the short run might
be less than a week whereas, in order to establish a power plant long run might be
10 years and the short run might be 5 years. In the short run, a firm can increase
output by using more of the variable input ( labor and raw materials) together with
fixed inputs( plant and equipment). In the long run, technology usually improves,
so that more output can be obtained from a given quantity of input. There is no
specific time period such as one year, 5 years, 10 years, 20 years that separates the
short run from the long run. Rather one must distinguish them by case by case
basis.
Production Function Can be Represented
By
Q = F(L , K)
Q is output. K is capital and L is labour. The maximum
amount of output that can be produced with K units of capital
and L units of labor if all the inputs are efficiently Used.
If more labours are used compared to capital to produce
output, then it is known as labour intensive techniques.
On the other hand, if more capital is used compared to labour
to produce output, then it is known as capital-intensive
technique.
Total Product (TP), Marginal Product (MP), and Average Produc
(AP).
Possible
in LR
only
Note: In short run labour is variable and capital is fixed
Average Product
Units of inputs
It is defined as the output per unit of factor inputs
Three variables are defined to measure the output:
____________________:
Total product (TP) is the whole amount of output
produced by all the factors employed. In Short run
labour is variable input and capital is fixed input.
Average product (AP) is the total output per unit
____________________:
of inputs.
____________________:
Marginal product (MP) the change in output
resulting from employing an additional unit of the
variable factor.
TP = Q TP Q TP Q
AP
L L MP
L L 1 L L 1
Law of Variable Proportion
or
Law of Diminishing Return
or
Short run Production Function
What does the Law Say?
It Tells us the behavior of the Output as the quantity of one
factor is increased keeping the quantity of other factors fixed.
The law of variable proportions is as follows: “If a producer
increases the units of a variable factor (i.e labour) while
keeping other factors fixed(Capital), then initially the total
product increases at an increasing rate, then it increases at a
diminishing rate, and finally starts declining.”
Derivation of the law:
With a given amount of fixed factors, when one
worker is employed, he can use only some of the fixed
factors each time.
When more workers are employed, they can specialize
and raise the productivity. (Both MP & AP ).
However, after all the fixed factors have been
efficiently used, additional workers can help the
preceding workers only. Hence MP which will finally
drag down AP (and even TP).
Assumptions
The Sate of Technology is assumed to be
Given and Unchanged
There must be some inputs whose quantity is
kept fixed
Possibility varying the Proportions
Three Stages of LVP
Stage 1: Increasing Return to factor
Stage 2: Diminishing Return to
factor
Stage 3: Negative Return to factor
Stage 1: Increasing Return to Factor
TP increases at an increasing rate. MP & AP
Increases.
Stage 1 ends when AP reaches maximum and
where AP=MP
Stage 1: Increasing Return to Factor
Reason: Fixed Factor is Abundant in Comparison to
Variable one. So better utilization of fixed factor takes
place with the increase in amount of variable factor.
Stage 2: Diminishing Return to Factor
Stage 2: Diminishing Return to Factor
Reason: Increasing utilization of Fixed factor and
Variable Factor is getting less and Less aid from
the Fixed factor.
Stage 3: Negative Return to Factor
Since MP is negative, TP diminishes from the Max.
Here AP also declines but AP cant be Zero.
Since MP is negative, no producer will prefer this stage.
Reason: Variable Factor is too high relative to the
Fixed factor. Impairs the Efficiency of the Fixed
Factor. Too Many Cooks Spoil the Broth
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