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Theoryofproduction
- 1. ECONOMICS Theory of Production Shortrevision series
- 2. Production Production meanstransforming inputs (labor, machines, raw materials etc.) into an output. The production process does not necessarily involve physical conversion of raw materials in to tangible goods, it also includes conversion of intangible inputs to intangibles outputs. E.g., layer, doctor, social workers etc. An input is good or service that goes into the process of production and output is any good or service that comes out of production process.
- 3. Fixed and VariableInputs A fixed input is one whose supply is inelastic in the short run. A variable input is defined as one whose supply in the short run is elastic, e.g. labor, raw materials etc. A fixed input remains fixed up to a certain level of output whereas a variable input changes with change in output.
- 4. Production Function Afirm has two types of production function: 1. Short run production function 2. Long run production function
- 5. Short Run Production It refers to a period of time in which the supply of certain inputs (e.g., plant, building, machines, etc) are fixed or inelastic. Thus an increase in production during this period is possible only by increasing the variable input.
- 6. Long Run Production It refers to a period of time I which supply of all the input is elastic, but not enough to permit a change in technology. In the long run, the availability of even fixed factor increases. Thus in the long run, production of coomodity can be increased by employing more of both, variable and fixed inputs.
- 7. Production Function Productionfunction is defined as the transformation of physical input in to physical output where output is a function of input. It can be expressed algebraically as; Q = f (K, L etc.) Where, Q = the quantity of output produced during a particular period K, L etc. are the factors of production f = function of pr depends on.
- 8. Production Function Assumptions The production functions are based on certain assumptions: 1. Perfect divisibility of both inputs and output 2. Limited substitution of one factor for the others 3. Constant technology 4. Inelastic supply of fixed factors in the short run
- 9. Factors of Production The classic economic resources include land, labor and capital. Entrepreneurship is also considered an economic resource because individuals are responsible for creating businesses and moving economic resources in the business environment. These economic resources are also called the factors of production.
- 10. Land Land isthe economic resource encompassing natural resources found within a nation. Nations must carefully use their land resource by creating a mix of natural and industrial uses. Using land for industrial purposes allows nations to improve the production processes for turning natural resources into consumer goods.
- 11. Labor Labor representsthe human capital available to transform raw or national resources into consumer goods. It is a flexible resource as workers can be allocated to different areas of the economy for producing consumer goods or services. It can also be improved through training or educating workers.
- 12. Capital Capital canrepresent the monetary resources companies use to purchase natural resources, land and other capital goods. Capital also represents the major physical assets (e.g., buildings, production facilities, equipment, vehicles and other similar items) individuals and companies use when producing goods or services.
- 13. Entrepreneurship It isalso considered a factor of production since someone must complete the managerial functions of gathering, allocating and distributing economic resources or consumer products to individuals and other businesses in the economy.
- 14. The Law ofProduction In the short run, input-output relations are studied with one variable input, while other inputs are held constant. The law of production under these assumptions are called “The Laws of Variable Production”. In the long run input output relations are studied assuming all the input to be variable. The long-run input output relations are studied under Laws of Returns to Scale.
- 15. Law of DiminishingReturns (Law of Variable Proportions)… The law which brings out the relationship between varying factor properties and output are known as the law of variable proportion. The variation in inputs lead to a disproportionate increase in output more and more units of variable factor when applied cause an increase in output but after a point the extra output will grow less and less. The law which brings out this tendency in production is known as Law of Diminishing Returns.
- 16. Continue… The lawof diminishing returns levels that any attempt to increase output by increasing only one factor finally faces diminishing returns. The law states that when some factors remain constant, more and more units of a variable factors are introduced the production may increase initially at an increasing rate; but after a point it increases only at diminishing rate. Land and capital remain fixed in the short- term whereas labor shows a variable nature.
- 17. Continue… The followingtable explains the operation of the Law of Diminishing Returns: No. of Workers Total Product (TP) Average Product (AP) Marginal Product (MP) 1 10 10 10 2 22 11 12 3 36 12 14 4 52 13 16 5 66 13.2 14 6 76 12.7 10 7 82 11.7 6 8 85 10.5 3 9 85 9.05 0 10 83 8.3 (-2)
- 18. Continue… Average productis the product for one unit of labor, arrived by dividing the total product by number of workers. Marginal product is the additional product resulting term additional labor, calculated by dividing the change in total product by the change in the number of workers. From table we can see that the total output increases at the increasing rate till the employment of the 4th worker. Any additional labor employed beyond the 4th labor clearly faces the operation of the Law of Diminishing returns.
- 19. Continue… The graphicalrepresentation of the table is as below:
- 20. Continue… The lawof diminishing returns operation at three stages. At the first stage, total product, marginal product, average product increases at an increasing rate. this stage continues up to the point where AP is equal to MP. At the second stage, the TP continues to increase but at a diminishing rate. As the MP at this stage starts falling, the AP also declines. This stage ends where TP become maximum and MP becomes zero.
- 21. Continue… The marginalproduct becomes negative in the third stage. Total product also declines. The average product continues to decline in the third stage.
- 22. Assumptions of Lawof Diminishing Returns The Law of Diminishing Returns is based on the following assumptions: 1. The production technology remains unchanged. 2. The variable factor is homogeneous. 3. Any one factor is constant. 4. The fixed factor remains constant.
- 23. Law of Returnsto Scale Returns to scale is the rate at which output increases in response to proportional increases in all inputs. The increase in output may be proportionate, more than proportionate or less than proportionate.
- 24. Increasing Returns toScale Proportionate increase in all factor of production results in a more than proportionate increase in output. Increasing Returns => Output > Input Example : Output Input 100 Unit = 3L + 3K 200 Unit = 5L + 5K 300 Unit = 6L + 6K Where L = labor and K=capital (in unit)
- 25. Constant Returns toscale When all inputs are increased by a certain percentage, the output increases by the same percentage, the production function is said to exhibit constant returns to scale. Constant Returns => Output = Input Example : Output Input 100 Unit = 3L + 3K 200 Unit = 6L + 6K 300 Unit = 9L + 9K where L = labor and K=capital(in unit)
- 26. Diminishing Returns toScale The term ‘diminishing’(Decreasing) returns to scale where output increases in a smaller proportion than the increase in all inputs. Diminishing Returns => Output < Input Example : Output Input 100 Unit = 3L + 3K 200 Unit = 7L + 7K 300 Unit = 12L + 12K Where L = labor and K=capital(in unit)
- 27. Economies of Scale The factors which cause the operation of the laws of returns to scale are grouped under economies and diseconomies of scale. Increasing returns to scale operates because of economies of scale and decreasing returns to scale operates because of diseconomies of scale where economies and diseconomies arise simultaneously.
- 28. Continue… When afirm increases all the factor of production it enjoys the same advantages of economies of production. The economies of scale are classified as: 1. Internal economies 2. External economies
- 29. Internal Economies ofScale Internal economies are those which arise from the explanation of the plant-size of the firm. Internal economies of scale may be classified as: 1. Economies in production 2. Economies in marketing 3. Economies in management 4. Economies in transport and storage
- 30. Economies in Production It arises from 1. Technological advantages 2. Advantages of division of labor and specialization
- 31. Economies in Marketing It facilitates through: 1. Large scale purchase of inputs 2. Advertisement economies 3. Economies in large scale distribution 4. Other large-scale economies
- 32. Managerial Economies Itachieves through: 1. Specialization in management 2. Mechanization of managerial fucntion
- 33. Economies in Transportand Storage Economies in transportation and storage costs arise from fuller utilization of transport and storage facilities.
- 34. External Economies ofScale External economies to large size firms arise from the discounts available to it due to 1. Large scale purchase of raw materials 2. Large scale acquisition of external finance at low interest 3. Lower advertising rate from advertising media 4. Concessional transport charge on bulk transport 5. Lower wage rates if large scale firm is monopolistic employer of certain kind of specialized labor.
- 35. Continue… External economiesof scale are strictly based on experience of large-scale firms or well managed small scale firms. Economies of scale will not continue for ever. Expansion in the size of the firms beyond a particular limit, too much specialization, inefficient supervision, improper labor relations etc will lead to diseconomies of scale.
- 36.