BDT – Module 3 - PRODUCTION FUNCTION

PRODUCTION FUNCTION: Meaning of production function, law of variable proportions,

Iso-quants, economic region of production, and determination of optimum factor combinations.

Production Function: Production is the backbone of any economy and the lifeblood of
businesses. But have you ever wondered how companies figure out the most feasible and
profitable way to manufacture products, or services? This is where production functions come
into play.

In this study, we’ll talk about production functions , components of production functions, types
of production functions, and their crucial role in economic and business decision-making.

What is the Production Function?

Production function is basically a function that explains the relationship or interconnection

between inputs and outputs in a company’s production process. Or, in a layman’s language, it is
a mathematical representation/equation of how various factors of production (inputs) come
together to produce a certain level of output. The concept of production functions is super
important for understanding and optimizing the production process.

Components of Production Function

 The Law of Diminishing Marginal Returns: A cardinal tenet underpinning production functions is the
Law of Diminishing Marginal Returns. This principle asserts that as the input of one factor (e.g., labour)
increases while keeping other inputs constant, the incremental output produced by each supplementary
unit of that factor will ultimately diminish. This outcome arises from other inputs' finite capacity and
production procedures' intricacy.
 Constant Returns to Scale: In specific scenarios, production functions exhibit constant returns to scale,
implying that when all inputs are expanded proportionally, output increases at an identical rate. In such
instances, the production function adopts the form Q = aL + bK + cT + dO, with a, b, c, and d as
constants.
 Isoquants : Isoquants serve as graphical depictions of production functions, elucidating all the mixtures
of inputs capable of yielding a given output level. They are analogous to indifference curves in
consumer theory and aid firms in making choices regarding resource allocation.
 Technology and Efficiency: Technology's role is pivotal within production functions. Technological
advancements can induce shifts in the production function, empowering firms to generate more output
with the same inputs or the same output with fewer inputs. Technology is an exogenous factor
influencing the production process.

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 Economies of Scale: Economies of scale transpire when a company garners cost savings as it expands
production. This phenomenon can be mirrored in the production function, where the cost per unit of
output decreases as production levels escalate.
 Short-Run vs. Long-Run: Production functions are frequently scrutinized in both the short run and the
long run. In the short run, at least one input is regarded as fixed, whereas in the long run, all inputs are
malleable. This distinction allows for a more comprehensive comprehension of production dynamics
across diverse timeframes.

Production Function Formula

The production function formula serves as a fundamental element in economic analysis, demonstrating the
connection between input factors and the generation of goods and services within the production process. It
offers a mathematical representation of this connection and plays a vital role in comprehending and enhancing
production. The general structure of the production function can be articulated as follows:

Q = f(L, K, T, O)

Where:

Q represents the volume of output generated.

L signifies the amount of labour engaged.
K denotes the quantity of capital (e.g., machinery, structures, equipment) utilized.
T represents technology, which can augment or diminish production efficiency.
O stands for other factors influencing production, including natural resources, managerial expertise, and
organizational structure.
The production function elucidates how diverse combinations of inputs (L, K, T, O) result in varying output
levels (Q). It is used to evaluate the influence of factors like labour and capital on production, appraise the
efficiency of resource utilization, and facilitate well-informed determinations regarding resource allocation. A
profound understanding of the production function formula is of utmost significance for businesses,
policymakers, and economists, as it aids in streamlining production procedures and evaluating economic
efficiency.

Types of Production Functions

Production functions are a cornerstone of economic analysis, and they can be classified into different types
based on timeframes and the adaptability of input factors. The primary categories of production functions are
short-run and long-run production functions. Here, we will explore these two types, their characteristics, and the
critical distinctions between them.

1. Short-Run Production Function

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Definition: The short-run production function elucidates the connection between output quantity (Q) and at least
one input factor, typically labour (L) while keeping other inputs like capital (K) and technology (T) constant.
Characteristics:
 Fixed Inputs: In the short run, at least one input remains fixed, meaning firms can't readily alter
their capital, machinery, or other long-term assets. For instance, a factory may be constrained by its
existing machinery and unable to quickly expand production capacity.
 Variable Inputs: The variable input, usually labour, can be modified in response to changes in
production requirements. Firms can hire more workers or reduce the workforce based on fluctuations
in demand.
 Law of Diminishing Returns : The short-run production function adheres to the law of diminishing
marginal returns. As more units of the variable input are added, the additional output will eventually
decrease due to the constraint of fixed inputs.
 Cost Considerations: In the short run, firms must make resource allocation decisions considering
variable and fixed costs. Variable costs, like labour, can be adjusted relatively quickly, while fixed
costs, such as capital expenditures, remain unchangeable in the short run.
2. Long-Run Production Function
Definition: The long-run production function illustrates the relationship between output quantity (Q) and all
input factors, including labour (L), capital (K), technology (T), and other factors (O), all of which are adjustable
for optimal production.
Characteristics:
 Variable Inputs: In the long run, all inputs are variable. Firms possess the flexibility to modify the
quantities of labour, capital, technology, and other factors to attain the most efficient production
levels.
 No Fixed Inputs: Unlike the short run, there are no fixed inputs in the long run. Firms can
strategically change production facilities, expand or reduce the labour force, invest in new
technologies, or alter their organizational structure.
 Economies of Scale: The long-run production function empowers firms to explore the concept of
economies of scale, where increasing production scale results in proportionally greater output and
efficiency, leading to cost savings. This notion significantly influences production strategies in the
long run.

Differences between Short-Run and Long-Run Production Functions

1. Time Horizon: The most apparent distinction between short-run and long-run production functions is
the time horizon. The short-run has a fixed period with at least one unalterable input, while the long run
encompasses an extended timeframe where all inputs are variable.
2. Flexibility of Inputs: In the short run, firms can only adjust the quantity of the variable input, typically
labour, while keeping other inputs fixed. In the long run, firms can adapt all input quantities, including
labour, capital, technology, and other factors, to achieve optimal production levels.

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3. Law of Diminishing Returns: The law of diminishing returns primarily applies to the short run due to
the presence of at least one fixed input. In the long run, where all inputs are variable, firms can optimize
production processes to mitigate diminishing returns.
4. Cost Considerations: In the short run, firms must make decisions regarding resource allocation,
accounting for both variable and fixed costs. Fixed costs, like capital expenditures, are unchangeable in
the short run. In the long run, firms can make decisions considering the cost implications of adjusting all
input factors, potentially resulting in cost savings and greater efficiency.
5. Economies of Scale: The concept of economies of scale, not directly linked to the short run, becomes
relevant in the long run. Firms can explore opportunities to increase production scale and achieve cost
savings by adjusting all input factors.

Classification of Production Function:

It can be classified on the basis of the substitutability of the inputs by other inputs:

1. Fixed Proportion Production Function

2. Variable Proportion Production Function
3. Linear Homogeneous Production Function
4. Cobb. Douglas Production Function
5. Constant Elasticity of Substitution

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1. Fixed Proportion Production Function

Definition: The Fixed Proportion Production Function, also known as a Leontief
Production Function implies that fixed factors of production such as land, labor, raw materials
are used to produce a fixed quantity of an output and these production factors cannot be
substituted for the other factors.

2. Variable Proportion Production Function

Definition: The Variable Proportion Production Function implies that the ratio in which
the factors of production such as labor and capital are used is not fixed, and it is variable. Also,
the different combinations of factors can be used to produce the given quantity, thus, one factor
can be substituted for the other.

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3. Linear Homogeneous Production Function

Definition: The Linear Homogeneous Production Function implies that with the
proportionate change in all the factors of production, the output also increases in the same
proportion. Such as, if the input factors are doubled the output also gets doubled. This is also
known as constant returns to a scale.

The production function is said to be homogeneous when the elasticity of substitution is equal
to one. The linear homogeneous production function can be used in the empirical studies
because it can be handled wisely. That is why it is widely used in linear programming and
input-output analysis. This production function can be shown symbolically:

nP = f(nK, nL)

Where, n = number of times

nP = number of times the output is increased
nK= number of times the capital is increased
nL = number of times the labor is increased

Thus, with the increase in labor and capital by “n” times the output also increases in the same
proportion. The concept of linear homogeneous production function can be further
comprehended through the illustration given below:

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4. Cobb. Douglas Production Function

Definition: The Cobb-Douglas Production Function, given by Charles W. Cobb and

Paul H. Douglas is a linear homogeneous production function, which implies, that the
factors of production can be substituted for one another up to a certain extent only.
With the proportionate increase in the input factors, the output also increases in the same
proportion. Thus, there are constant returns to a scale. In Cobb-Douglas production function,
only two input factors, labor, and capital are taken into the consideration, and the elasticity of
substitution is equal to one. It is also assumed that, if any, of the inputs, is zero, the output is
also zero.

Likewise, in the linear homogeneous production function, the expansion path generated by the
cobb-Douglas function is also a straight line passing through the origin. The CD function can be
expressed as follows: Q = ALαKβ

Where, Q = output
A = positive constant
K = capital employed
L = Labor employed
α and β = positive fractions shows the elasticity coefficients of outputs for inputs labor and
capital, respectively.
Β = 1-α

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This algebraic form of Cobb-Douglas function can be changed in a log linear form, with the
help of regression analysis:

Log Q = log A + α log L + β log K

The homogeneity of the Cobb-Douglas production function can be checked by adding the
values of α and β. If the sum of these parameters is equal to one, then it shows that the
production function is linearly homogeneous, and there are constant returns to a scale. If the
sum of these parameters is less or more than one, then there is a decreasing and increasing
returns to a scale respectively.

Law of Variable Proportion: Meaning, Assumptions, Phases and

Reasons for Variable Proportions

The Law of Variable Proportions is a crucial concept in production theory, providing insights into how varying
one input affects overall production. It underscores the importance of optimal resource utilization and helps in
making informed decisions about input levels to achieve desired production outcomes.

What is the Law of Variable Proportions?

The Law of Variable Proportions, also known as the Law of Diminishing Returns, is a fundamental principle in
economics that describes how the output of a production process changes as the quantity of one input varies
while other inputs are kept constant. This law is applicable in the short run, where at least one factor of
production (such as capital) is fixed.

Returns to Factor: Law of Variable Proportion

Returns to a Factor refer to the rise in the total product that results from increasing just one factor while
holding the other factors constant. The production of the firm displays the Law of Variable Proportions in the
short term when one input is variable, and the other inputs are fixed.

Statement of Law of Variable Proportion

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The Law of Variable Proportions states that as we increase the quantity of only one input while keeping other
inputs fixed, the total product increases initially at an increasing rate, then at a decreasing rate, and finally at a
negative rate.

As per the law of variable proportions, the changes in TP and MP can be categorized into three phases:
Phase 1: TP rises at an increasing rate, and MP increases.
Phase 2: TP rises at a decreasing rate, MP decreases and is positive.
Phase 3: TP falls, and MP becomes negative.

Assumptions of the Law of Variable Proportion

 It operates in the short run because the factors are categorised as variable and fixed.
 The law is applicable to all fixed factors, including land.
 The law of variable proportions allows for the combination of several variable units with fixed factors.
 This law primarily applies to the production sector.
 It is simple to calculate the impact of a change in output caused by a change in variable factors.
 It is considered that after a certain point, factors of production become imperfect substitutes for one
another.
 In order for this law to function, it is assumed that the state of technology would remain constant.
 All variable factors are thought to be equally effective.

Example of Law of Variable Proportion

Let's say a farmer has 1 acre of land (i.e., fixed factor) and wants to use labour (i.e., variable factor) to improve
the production of rice there. The output increased initially at an increasing rate, then at a decreasing rate, and
finally at a negative rate as he employed more and more units of labour. The below table displays the output
behaviour in this case.

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Phases of Law of Variable Proportion

Phase I: Increasing Returns to a Factor (TP increases at an increasing rate)

In the initial stage, each additional variable component raises the total production by an increasing amount. This
indicates that each variable's MP rises and that TP rises at an increasing rate.

 It occurs as a result of the initial variable input quantity being too small in comparison to the fixed input.
Due to the division of labour, efficient use of the fixed input during manufacturing increases the
productivity of the variable input.
 One labour generates 5 units, as shown in the schedule and diagram, whereas two labours produce 20
units. It means that MP rises until it reaches its maximum point at point P, which signifies the end of the
first phase, while TP rises at an increasing rate (up to point Q).
Point of Inflexion: A point from where the slope of TP curve changes is known as point of inflexion. Till the
point of inflexion, TP increases at an increasing rate, and from this point downwards, it increases at a
diminishing rate.
Phase II: Decreasing Returns to a Factor (TP increases at a decreasing rate)
Every extra variable in the second phase increases the output by a less and smaller amount. This indicates that
when the variable factor increases, MP decreases, and TP rises at a decreasing rate. This stage is known as the
diminishing returns to a factor.

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 This occurs as a result of pressure on fixed inputs that results in a decline in variable input productivity
after a certain level of output.
 When MP is zero (point S), and TP is at its maximum (point M) at 40 units, the second phase comes to
an end.
 The second phase is highly important because a rational producer will always try to produce during this
time because MP and TP are both positive for each variable factor.

Phase III: Negative Returns to a Factor (TP falls)

The third phase shows a decline in TP due to the use of more variable factors. MP has now become negative. As
a result, this stage is referred to as negative returns to a factor.

 It occurs when the amount of variable input exceeds the fixed input by a great difference, which causes
TP to decrease.
 The third phase in the above graph begins after points S on the MP curve and M on the TP curve.
 In the third phase, MP for each variable factor is negative. Therefore, no company would deliberately
decide to operate at this phase.

Reasons for Variable Proportion

The reasons for the three phases of the law of variable proportions are:

A. Reasons for Increasing Returns to a Factor (Phase I)

The operation of increasing returns to a factor is carried out for three key reasons:

1. More Effective Use of Fixed Factor: In the initial stage, a number of fixed factors are available,
while there aren't enough variable factors. The fixed factor is therefore not completely utilised. The
fixed factor is better used, and output increases at an increasing rate when the variable factors are
increased and combined with fixed factors.
2. Increased Efficiency of Variable Factor: The variable factors must be increased and combined with
the fixed factor, in order to use the former more efficiently. Besides, there is a high degree of
specialisation and increased cooperation among the different units of the variable factors.
3. Fixed Factor Indivisibility: In general, fixed factors that are integrated with variable factors are not
divisible. It means that these elements cannot be divided into smaller parts. As more units of the variable
components are given, the utilisation of the fixed factor improves after an investment has been made in
an indivisible fixed factor. As long as the ideal level of variable and fixed factor combination is attained,
increasing returns is applicable.

B. Reasons for Decreasing Returns to a Factor (Phase II)

The occurrence of diminishing returns to a factor is due to these three key reasons:

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1. Optimum Combination of Factors: There is only one optimal combination between a variable and a
fixed factor where the overall product is maximum. The marginal return of the variable factor begins to
decrease after the fixed factor has been utilised to its fullest potential. For instance, if a machine (fixed
factor) is being used to its full potential with 4 workers, adding a fifth worker will only slightly improve
TP, and MP will begin to decline.
2. Over-utilization of Resources: The fixed component finally reaches its limits and begins to produce
diminishing returns as one continues increasing the variable factor.
3. Imperfect Substitutes: Fixed and variable factors are imperfect substitutes for one another, which
results in diminishing returns to a factor. There is an extent to which one factor of production can be
substituted for another. For instance, until a certain point, capital may be used in place of labour or
labour may be used in place of capital. Beyond a certain point, they start to lag behind each other and
produce declining returns.

C. Reasons for Negative Returns to a Factor (Phase III)

The occurrence of negative returns to a factor is due to these three major reasons:
1. Limitation of Fixed Factor: The reason why some production factors have negative returns is that
they are fixed in nature and cannot be raised in the short run together with an increase in the variable
factor.
2. Lack of Coordination: When the variable factor dominates the fixed factor, they interfere with one
another. It causes a lack of coordination between the fixed and the variable factor. As a result, total
output falls rather than rises, and the marginal product becomes negative.
3. Decrease in Efficiency of Variable Factor: The benefits of specialisation and the division of
labour begin to diminish as variable factors continue to increase. It causes inefficiencies of variable
factors, which is another element that finally leads to negative returns.

Isoquant

What is Isoquant Curve?

Isoquant Curve: A technical relation that shows how inputs are converted into output is depicted by an
isoquant curve. It shows the optimum combinations of factor inputs with the help of prices of factor inputs and
their quantities that are used to produce the same output.
The term ISO implies equal and quant means quantity or output.
For example, for producing 100 calendars, 90 units of capital and 10 units of labour are used.
Isoquant curves are also called as equal product curves or production indifference curves.

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The term Iso-quant or Iso-product is composed of two words, Iso = equal, quant = quantity or product = output.

Thus it means equal quantity or equal product. Different factors are needed to produce a good. These factors
may be substituted for one another.

Isoquant Curve Definition

 An isoquant is a curve showing all possible combinations of inputs physically capable of producing a
given level of output: Ferguson
 An isoquant curve may be defined as a curve showing the possible combinations of two variable factors
that can be used to produce the same total product: Peterson
 “The Iso-product curves show the different combinations of two resources with which a firm can produce equal
amount of product.” Bilas “
 Iso-product curve shows the different input combinations that will produce a given output.” Samuelson

Assumptions Of Isoquant Curve:

The main assumptions of Iso-quant curves are as follows:
1. Two Factors of Production: Only two factors are used to produce a commodity.
2. Divisible Factor: Factors of production can be divided into small parts.
3. Constant Technique: Technique of production is constant or is known before hand.
4. Possibility of Technical Substitution: The substitution between the two factors is technically possible. That is,
production function is of „variable proportion‟ type rather than fixed proportion.
5. Efficient Combinations: Under the given technique, factors of production can be used with maximum efficiency.

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Figure 1 shows the isoquant curve of different labour capital combinations that help in producing 150
tonnes of output:

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Properties of Isoquant Curve

Some of the properties of isoquant curve are as follows:

 Isoquant curves slope downwards

 Isoquant curves are convex to origin
 Isoquant curves cannot intersect each other
 Higher the isoquant the higher the output
 No iso-quant curve touches either of the axis, X or Y.
 Iso-quant curves need not be parallel to each other
 Each iso-quant curve is oval shaped

1. Isoquant curves slope downwards

 Isoquants slope downward from left to right.
 This means that as one input (e.g., labor) increases, the other input (e.g., capital) must decrease to
maintain the same level of output.
 The slope of an isoquant represents the Marginal Rate of Technical Substitution (MRTS), which is the
rate at which one input can be substituted for another while holding output constant.

2. Isoquant curves are convex to origin

 Isoquants are typically convex to the origin.
 This shape reflects the diminishing MRTS as one input is substituted for another.
 For example, as more labor is used and less capital is used, the rate at which capital can be substituted
for labor diminishes.

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3. Isoquant curves cannot intersect each other

 Isoquant curves never intersect each other.
 If they did, it would imply that the same input combinations could yield different levels of output, which
is impossible.

4. Higher the isoquant the higher the output

 An isoquant further away from the origin (higher up and to the right) represents a higher level of
output.
 This means that more input combinations are required to produce that higher output level.

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5. No iso-quant curve touches either of the axis, X or Y.

 If it does so, then the rate of technical substitution would be void since it will show that a single
factor is producing the given level of output without any units of other factor being employed.
 As per the figure, if an iso-quant curve IQ2 touches the X axis, this means no units of labor are
employed, and only capital is required to produce the given level of output, which is not correct.

6. Iso-quant curves need not be parallel to each other

 Iso-quant curves need not be parallel to each other because the rate of technical substitution
between the factors may vary in all the iso-quant curves.

7. Each iso-quant curve is oval shaped, which enables a firm to identify the most efficient factor of
production.

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Types of Iso-quant Curves

The iso-quant curves can be classified on the basis of the substitutability of factors of production. These are:

1. Linear Iso-quant Curve: This curve shows the perfect substitutability between the factors of
production. This means that any quantity can be produced either employing only capital or only labor or
through “n” number of combinations between these two.

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2. Right Angle Iso-quant Curve: This is one of the types of iso-quant curves, where there is a strict
complementarity with no substitution between the factors of production. According to this, there is only
one method of production to produce any one commodity. This curve is also known as Leontief Iso-
quant, input-output isoquant and is a right angled curve.

3. Kinked iso-quant Curve: This curve assumes, that there is a limited substitutability between the factors
of production. This shows that substitution of factors can be seen at the kinks since there are a few
processes to produce any one commodity. Kinked iso-quant curve is also known as activity analysis
programming iso-quant or linear programming iso-quant.

4. Convex Iso-quant Curve: In this types of iso-quant curves, the factors can be substituted for each other
but up to a certain extent. This curve is smooth and convex to the origin.

Thus, the classification of the iso-quant curve can be done on the basis of the number of labor units that can be
substituted for capital and vice-versa, so as to have the same level of production.

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The Economic Region of Production

The economic region of production represents the area where producers can operate efficiently by combining
inputs in optimal proportions. This critical concept in microeconomics identifies where additional resources
genuinely contribute to increased output, helping businesses avoid wasteful production practices. Ridge lines
serve as important boundaries of this region, marking where the marginal productivity of inputs becomes zero
and further resource allocation becomes economically irrational.

What is the economic region of production?

The economic region of production refers to the area on an isoquant map where it makes economic sense for a
firm to operate. Within this region, both inputs contribute positively to production, and using resources is
technically efficient. Outside this region, production becomes inefficient as adding more of one input while
holding the other constant either doesn’t increase output or actually decreases it.

This region is bounded by what economists call “ridge lines” – mathematical boundaries that separate rational
production decisions from irrational ones. Understanding this concept helps firms avoid wasting resources and
maximize their production efficiency.

Economic Regions

The economic region of production shows the combinations of factors at a certain cost that make economic
sense. Areas outside the economic region of production mean that at least one of the inputs has negative
marginal productivity. This region is marked by what are called ridge lines, which are simply the boundaries
beyond which one of the two factors is being overused. Therefore, outside the economic region of production,
there is clear inefficiency, and the company would be better off using less of one of the two factors, bringing
costs down whilst maintaining equal production output. Graphically:

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Operating within this region matters for several reasons:

 Cost minimization: Firms can produce their desired output at the lowest possible cost.
 Resource optimization: Resources aren’t wasted on inputs that don’t contribute to additional output.
 Competitive advantage: Efficient firms can offer products at lower prices or generate higher profits
than inefficient competitors.
 Sustainability: Using resources efficiently aligns with environmental and social responsibility goals.

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Optimum Factor Combination

Definition:
In the long run, all factors of production can be varied. The profit maximization firm will choose the least cost
combination of factors to produce at any given level of output. The least cost combination or the optimum
factor combination refers to the combination of factors with which a firm can produce a specific quantity of
output at the lowest possible cost.

Explanation:

There are two methods of explaining the optimum combination of factor:

(i) The marginal product approach.

(ii) The isoquant / isocost approach.

These two approaches are now explained in brief:

1. The Marginal Product Approach

In the long run, a firm can vary the amounts of factors which it uses for the production of goods. It can choose
what technique of production to use, what design of factory to build, what type of machinery to buy. The profit
maximization will obviously want to use that mix of factors of combination which is least costly to it. In search
of higher profits, a firm substitutes the factor whose gain is higher than the other. When the last rupee spent on
each factor brings equal revenue, the profit of the firm is maximized. When a firm uses different factors of
production or least cost combination or the optimum combination of factors is achieved when:

Formula:

In the above equation a, b, c, n are different factors of production. Mpp is the marginal physical product. A firm
compares the Mpp / P ratios with that of another. A firm will reduce its cost by using more of those factors with
a high Mpp / P ratios and less of those with a low Mpp/Pratio until they all become equal.

(ii) The Isoquant / Isocost Approach:

The least cost combination of-factors or producer's equilibrium is now explained with the help of iso-product
curves and isocosts. The optimum factors combination or the least cost combination refers to the combination of
factors with which a firm can produce a specific quantity of output at the lowest possible cost.

As we know, there are a number of combinations of factors which can yield a given level of output. The
producer has to choose, one combination out of these which yields a given level of output with least possible

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outlay. The least cost combination of factors for any level of output is that where the iso-product curve is
tangent to an isocost curve. The analysis of producers equilibrium is based on the following assumptions.

Assumptions of Optimum Factor Combination:

The main assumptions on which this analysis is based areas under:

(a) There are two factors X and Y in the combinations.

(b) All the units of factor X are homogeneous and so is the case with units of factor Y.
(c) The prices of factors X and Y are given and constants.
(d) The total money outlay is also given.
(e) In the factor market, it is the perfect completion which prevails. Under the conditions assumed above, the
producer is in equilibrium, when the following two conditions are fulfilled.

(1) The isoquant must be convert to the origin.

(2) The slope of the Isoquant must be equal to the slope of isocost line.

Diagram/Figure:

The least cost combination of factors is now explained with the help of figure

Here the isocost line CD is tangent to the iso-product curve 400 units at point Q. The firm employs OC units of
factor Y and OD units of factor X to produce 400 units of output. This is the optimum output which the firm can

Prepared By: Mr. Diwakar B – Assistant Professor – SMDC- Ballari Page 23

 BDT – Module 3 - PRODUCTION FUNCTION

get from the cost outlay of Q. In this figure any point below Q on the price line AB is desirable as it shows
lower cost, but it is not attainable for producing 400 units of output. As regards points RS above Q on isocost
lines GH, EF, they show higher cost.

These are beyond the reach of the producer with CD outlay. Hence point Q is the least cost point. It is the point
which is the least cost factor combination for producing 400 units of output with OC units of factor Y and OD
units of factor X. Point Q is the equilibrium of the producer.

At this point, the slope of the isoquants equal to the slope of the isocost line. The MRT of the two inputs equals
their price ratio.

Thus we find that at point Q, the two conditions of producer's, equilibrium in the choice of factor combinations,
are satisfied.

(1) The isoquant (IP) is convex the origin.

(2) At point Q, the slope of the isoquant ΔY / ΔX (MTYSxy) is equal to the slope of the isocost in Px / Py. The
producer gets the optimum output at least cost factor combination.

Prepared By: Mr. Diwakar B – Assistant Professor – SMDC- Ballari Page 24