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Production

Production refers to the economic process of converting of inputs into outputs. Production uses resources to create a good or service which is suitable for exchange. In other words, production is the act of transforming the inputs into output is called the production process.

Production Function
According to Rojer Miller Production Function is a schedule or mathematical equation that gives a maximum quantity of output than can be produced from specified sets of inputs while techniques of production are given.. There are two production function approaches I.Classical Production Function ii.Neo-Classical Production Function

I .Classical Production Function


It concerned with the short run period, where some or at least one factor of production is kept constant e.g. if any firm keeps the plant or machinery fixed (which is not possible to change in short run) and go on employing the units of labor such possible to change in short run and go on employing. Q = (L)K , Where Q = output, L = and K= capital

Whereas neoclassical production function is concerned with long run period, where all the factors of production are variable, for example if in any period the firm is a position to change its plant and units of labour. The neo-classical function can also be stated as: Q = (L, K) , Where Q = output, L = and In general form: Q=f (L, K, N, TECH), where N= natural resources and TECH = Technology K= capital

Classical Production Function


Classicals are of the view that keeping the other factors constant if we go on employing the units of labour, the total production will increase rates. In other words, the rate of change in total product which is called marginal product may increase, may remain constant and may decrease. Law of Increasing Returns

If marginal product (MP) increase such will demonstrate the situation of law of increasing returns Law of Constant Returns

If MP remains constant such depicts the law of constant returns Law of Decreasing Returns

If MP falls such situation means the law of decreasing returns. Total Product:

(TP=Q) i.e. if a firm produces 50 bicycles by employing 10 labour. Such will represent total product of the firm. Average Product (AP)

AP = TP/L = Q/L = 50/10 = 5 bicycles Marginal Product (MP)

The addition to total output that results from a unit increase in the employment of labour. MP = Q / L = dQ/dL Now these concepts are helpful in understanding the concept of

Law of Variable Proportions


i. ii. iii. iv. In the beginning TP will increase at an increasing rate, hence both AP and MP increase but MP will increase more than AP. (MP > AP) Later on TP will increase at a constant rate, hence both AP and MP will remain constant (MP=AP) Finally, TP will increase at a decreasing rare, hence both AP and MP decrease but MP will decrease more than AP (MP <AP) Afterwards by employing more units of labour TP will reach maximum. Consequently, MP will become zero. Still employing more units of labour means the falling of TP itself and making the MP negative. Q 10 25 45 60 70 75 75 72 63 APL = Q/L 10 12.5 15 15 14 12.5 10.7 9 7 MPL=dQ/dL 10 15 20 15 10 5 0 -3 -9 I MP>AP MP = AP II MP < AP MP = 0 III MP = - ve Stages and relationships

L 1 2 3 4 5 6 7 8 9

The Law of Increasing Returns


The total output is increasing at different rates. In the lower part of the diagram we have AP and MP curves. In the beginning from 1st labour to 3rd labour TP is increasing at an increasing rate. Here both AP and MP increase but MP increases more than AP.

The Law of Diminishing Returns


The production stage which starts from origin and list till AP is maximized is known as production stage I. By employing 5th and 6th labour the TP of the firm increases at a decreasing rate. As a result, both AP an MP fall but MP falls more than AP. This represents the law of diminishing returns.

The Law of Negative Returns


By employing 8th and 9th labour, the TP of the firm itself falls. Here MP becomes negative while AP is still falling. This situate represents the operation of law of negative returns the stage which starts from MP being equal to zero to MP being equal to negative is said to be production stage III.

Short Run
It is a period where a firm can change its variable factors like labour etc while it cannot change its fixed factors like capital etc. Moreover, in short run neither new firms can enter the industry nor the old firms can leave the industry.

Short-Run Cost Concepts:


In short period a firms cost is divided into two parts i.e. fixed and variable costs

Total Fixed Costs (TFC)


During short period, some costs do no change with output. These are called fixed cost. Even if a firm produces nothing (i.e. has zero output) it has to bear the fixed cost. TFC includes the following i. iii. The rent of the building and land. Interest payments of debts ii. iv. Salaries of permanent staff. Fixed taxes, if any e.g. annual license fee.

Variable Cost
It is the cost, which directly varies earth the changes in the level of output. It arises because of variable inputs. If it is a firm produces nothing (has zero output), variable cost will be zero. It includes a. b. c. Cost of raw material Transport Sales commission d. e. f. Wages of labour Electricity, fuel and power charges. Depreciation

Behaviour and Relationship of Costs: Total Total Fixed Cost (TFC) II Total Variable Cost (TVC) III Total Cost (TC) IV AFC + AVC = ATC V VI VII MC VIII Average Cost Marginal Cost

Output Units

0 1 2 3 4 5 6 7

20 20 20 20 20 20 20 20

0 30 50 65 77 95 125 175

20 50 70 85 97 115 145 195

20+ 10 6.6 5 4 3.3 2.8

30 = 25 21.6 19.2 19 20.8 25

50 35 28.2 24.2 23 24.1 27.8

30 20 15 12 18 30 50

Diagram: Below

TC increases continuously at varying Rates. TC = TFC+ TVC AFC goes on decreasing continuously.TFC is a straight line parallel to X axis. It is not affected by the level of output. TVC curve begins from origin and rises steadily as TVC does not change at constant rate. Gradient of TVC is different at different levels of output and its graph is not a straight line. TC curve has the same starting point as TFC but, its shape is similar to TVC. The vertical distance between TC and TVC curves represents TFC. Thus at output level OQ, TVC is QH while TFC is HA. Note: in figure the general shape and inter relationship of AFC, AVC and AC is clear. From point A to M, AC curve is falling and MC is below AC. But after point M, AC starts rising and MC is above AC. AC and MC are equal at the point M where AC is minimum. AFC = TFC /Output Average Variable cost is calculated by the following formula AVC = TVC / Output ATC = TC/output

To describe the relationship between output and cost three measures are used. Total cost (TC), it is sum of fixed and variable cost at each level of output. Average Cost (AC), it is the per unit cost that is AC = TC /Output. Marginal Cost,( MC), it is the addition to total cost by producing an extra unit of output. MC = Change in TC/Change in Q = TC/Q The relation of these costs becomes clear, if we look at the table
Output (Q) 10 11 TC 100 122 AC 10 11 MC 22

Long-Run Costs Concepts


It is a period where a firm can change its fixed as well as variable factors of production. In other words a firm can install new machinery as well as employ more labour, and new firms can enter the industry and old can leave the industry. In the long-run there is no difference between fixed and variable costs. Long-Run Average Cost (LAC) If we divide long run total cost by the units of the good produced we get LAC. LAC = LTC / Q

Long-Run total costs (LTC) If we multiply the LAC by the units of the good produced we get LTC. LTC = LAC X Q

Q LAC LTC LMC

4 10 40 6.10

5 9

6 8.30

7 8 56

8 8.20 65.6

9 9 81

10 10

11 11.30

12 13 156 31.70

15 13 11.30 15 26 33.90 11 7.90

45 49.80 5 4.80

100 124.30 19 24.30

6.20 9.60 15.40

Curves: LTC and LMC and LAC As long-run consists of so many short-run periods, accordingly, LAC will come into being by joining different minimum short-run average costs (SACs). Long-run Average Cost Curve: It is a curve which shows minimum average costs of different levels of output in the long- run when the firm can change both the labour and capital.