THEORY OF PRODUCTION PRODUCTION: Transformation of input into Output Production function: Expresses the functional relationship between the

quantities of inputs and outputs. Q = (K,L etc.) Laws of Production Short-run Laws of Production Production with one variable input Some factors of production are available in unlimited supply even during the short period. Such factors are called variable factors. In the short-run, therefore, the firms can employ an unlimited quantity of variable factor. In other words, firms can employ in the short run, varying quantities of variable inputs against a given quantity of fixed factors. This kind of change in input combination leads to variation in factor proportions. The laws which brings out the relationship between varying factor proportions and output are therefore known as the Law of Returns to a Variable Input, or what is more popularly known as the Law of Diminishing Returns.

Law of Returns to Variable Input : The Law of diminishing Returns. The law of diminishing return states that when more and more units of a variable input are applied to a given quantity of fixed inputs, the total output may initially increase at an increasing rate and then at a constant rate but it will eventually increase at diminishing rates. Assumptions The law of diminishing returns is based on the following assumptions: (i) the state of technology is given, (ii) labour is homogenous, and (iii) input prices are given. Causes for the operation of the law of diminishing returns 1. wrong combination of inputs 2. scarcity of certain factors 3. imperfect substitutes Long Term Laws of Production Laws of Returns to Scale. The Laws of Returns to Scale 1. Increasing Returns to Scale It is the first stage of production. The marginal output increases in this stage. The increase in efficiency resulting in increased output is due to better utilization of plant or higher degree of specialization. 2. Constant returns to Scale In this stage, total output tends to increase at a rate which is equal to the rate of increase in inputs. i.e., when the inputs are doubled it results in doubling of output. This stage comes in operation when the economies of large scale production is neutralized by the diseconomies of large scale operation. 3. Decreasing returns to scale A proportionate increase in all the inputs in this stage results only in a less than proportionate increase in output. This is because of the diseconomies of large scale production.

The figure 11.6 shows that when a firm uses one unit of labor and one unit of capital, point a, it produces 1 unit of quantity as is shown on the q = 1 isoquant. When the firm doubles its outputs by using 2 units of labor and 2 units of capital, it produces more than double from q = 1 to q = 3. So the production function has increasing returns to scale in this range. Another output from quantity 3 to quantity 6. At the last doubling point c to point d, the production function has decreasing returns to scale. The doubling of output from 4 units of input causes output to increase from 6 to 8 units increases of two units only. Economies of scale 1. Internal Economies a) Technical Economies b) Labour Economies c) Managerial Economies d) Marketing Economies e) Economies in Transport & Storage f) Financial Economies 2. External Economies

Diseconomies of scale The economies of scale will not continue forever. An expansion in size of the firm after certain level will result in diseconomies only. Too much division of labour may bring inefficiency. The increase in number of workers may reduce the efficient use of machines and tools etc. Isoquant Curve The word iso means equal, quant means quantity. Isoquants are equal product curves. An Isoquant curve is locus of points representing various combinations of two inputs capital and labour yielding the same output. An isoquant curve is analogous to an indifference curve, with two points of distinction: (a) an indifference curve is made of two consumer goods while an isoquant curve is mconstructed of two producer goods (labour and capital) and (b) an indifference curve measures utility whereas an isoquant measures output.

Properties of Isoquant (a) Isoquants have a negative slope (b) Isoquants are convex to the origin (c) Isoquants cannot intersect or be tangent to each other (d) Upper isoquant represent higher level of output Optimum combination of Inputs A combination which is most economical or which bears the least cost is the optimum input combination. A least cost input combination can be found out by combining the firms production and cost function. The production function is represented by the isoquant curve and the cost function is represented by the isocost curve. The isocost curve represents the prices of the inputs and the total amount of money that a firm wants to spent on inputs.

An isocost curve represents the same cost for all the different combinations of input.