Chapter- 3.

3
Production Function
and Analysis

LR Production Function
(With all inputs variable)
À In the LR, all inputs become variable, i.e.,
the scale of production can be changed.
À The relationships between changes in scale
and changes in Q are described in Returns
to Scale.
À Returns to scale examines the % increase in
output when a firm increases all of its input
by a given %.

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 % change in output
À Returns to Scale = -------------------------
% change in inputs
À When all the inputs are increased in the
same proportions, the proportion between
the different inputs remains unchanged,
refers to as Returns to Scale.
Types of Returns to Scale
À Increasing returns to scale (IRS)
À Constant returns to scale (CRS)
À Diminishing returns to scale (DRS)
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IRS: A proportionate > in all input

quantities results in a greater-than-
proportionate > in output.
CRS: A proportionate > in input quantities
results in the same proportionate > in
output.
DRS: A proportionate > in all input
quantities results in a less-than-
proportionate > in Q.

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 Returns to Scale

Units of Units of Labor Total output Increase in Increase in total

Capital size of firm output

4 20 100
8 40 250 100% 150% IRS

12 60 420 50% 68% IRS

16 80 560 33.3% 33.3% CRS

20 100 672 25% 20% DRS

24 120 780 20% 16% DRS

Explanation of Returns to scale

through IQ curves.
À As Q increases from 10 to 20, 30 ,40 and 50
the factor input combination points shift
from E to F, G, H and I.
À The distance between the combination
points goes on gradually decreasing, OE >
EF > FG > GH > HI, hence IRS.
À The additional inputs required to produce a
proportionate increase in output go on
declining in case of IRS.
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À In case of CRS, OE = EF = FG, proportionate
in inputs yields a proportionate increase in
output.
À In DRS, FG > EF > OE, proportionate
increase in output requires a more than
proportionate increase in inputs.
Managerial Significance of Production
Function
À Enables the management to know in
advance the requirements of factor inputs,
given the state of technology.

À Enables the management to calculate

production chart with one fixed input and
one variable input.
À Enables the management to prepare a chart
of input-out relationship for long run
planning of production, expansion,
replacement, etc.
À Given the input prices, it helps in finding out
the least cost combination of inputs.
À Helps in deciding for larger plant taking
advantage of the scale-economies, there by
reducing per unit cost.
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