Production Function

# PRODUCTION FUNCTION

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What is Production Function?
• It is a functional specification that provides the combination of inputs with which a chosen target level of output can be produced. • The graphical representation of long run production function is termed as an Isoquant.
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From Production Function to Cost Function : Long Run Total Cost
• Tangent point between an isoquant and an isocost line gives the least combination of inputs with which the output level corresponding to the isoquant can be produced.

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INPUT Y

A
O SI AN XP E N TH PA

Q3

3 2 1 O C1 C2 C3 Q1

Q2

INPUT X

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IMPLICATION OF THE GRAPH
• It shows the level of output at one least cost combination. • It also shows the total cost of production of output. • OA represents the lowest cost level in which output can be expanded.

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RESULTS OF OA
• OA represents :
– The cost of most efficient combination of input and – The corresponding level of output.

• • These two items of data characterizes the cost function. Hence the cost function can be derived from the expansion path.
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• Cost is dependent on :
– The level of output and – The level of price of the input

• As the price of the input is not under the control of the producer this factor is not explicitly considered and the active determinants of cost turns out to be only the level of output.

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Thus in most general form
C = f (Q)

• •
  

Where, C represents Cost Q represents Output
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The combinations given in the graph correspond to the long run or the short run?
• There is no fixed input • Expansion path starts from the origin indicating that costs vary with output and • It also depicts that if output is zero cost is zero •  Hence the cost function derived from the expansion path is long run in nature.
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COST

LRTC C3 C2 C1 O
OUTPUT

Q1

Q2

Q3

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STEPS TO DERIVE LRTC SCHEDULE • Step 1 :
– Select the level of output (effectively using the isoquant)

• Step 2 :
– Find the optimal (least cost) combination of inputs which correspond to the point of tangency between the isoquant selected in step 1 and the isocost line.
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• Step 3 :
– The point of tangency gives the physical quantity of inputs to be employed. Multiply these with their prices and sum up to get the cost.

• Step 4 :
– This combination of output and cost gives one point on the LRTC curve.

• Step 5 :
– Repeat the above steps for different levels of output.

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