THEORY OF PRODUCTION

Inputs in economics are known as factors of production these can be classified under 2 heads:

1.

Fixed factors :- fixed factors of production are those whose factor inputs cannot be changed at different levels of output in the short period. Eg: land, machinery etc. Variable Factor :- Variable factor inputs are those whose quantity will differ at different levels output. Eg : Labour, Raw material etc. There are 2 time periods under which production takes place.

2.

1)

Short Run : Some factor inputs are fixed while others are variable. The production in short run can be increased only by increasing. Quantity of variable factors. Long Run : All factors of production become variable the distinction between fixed & variable factor become irrelevant. the production in long run. can be increased by increasing all the factors of production. Production in economics is defined as transformation of input into output. Production includes physical goods & services both. Production function means relation ship between inputs used & resulting output. There are 2 types of production function

2)

1) Short Run Production function: It refers to production in the
short run where some factors remain fix & other is variable. In short run. product increases when more units of variable factors are used with the fixed factors. This is known as returns to a variable factors or law of variable proportions

2) Long Run Production function: It refers to production in a
time period when all factors are variable. The effects of the changes in all the inputs on total output is called returns to scale or Long Run Production function. CONEPTS OF PRODUCT

1)

Total product / Total physical product :- It is defined as the total quantity & services produced by a firm with the given inputs during a specified period of time or total product is sum total of output of each unit of variable factor used in the process of production. Thus

MP decreases but remains positive 3. AP = TP Variabl e Factor 0 1 2 3 4 5 6 7 8 TP AP TP L 0 4 5 6 6 5.6 20 20 – 4 = 16 L 2.8 (20 – 28) .is a net addition to total product when one more unit of variable factors employed MP = TPn.TPn-1 MP = ∆TP ∆L Average. 2. When TP is maximum & constant MP is O (zero) 4. MP is negative . MP also increases.6 4. When TP begins to fall. When TP increases at increasing rate.is the per unit production of the variable factors i.e. product :.8 2 MP TPn – TPn-1 0 4 6 (10 . When TP starts increasing at decreasing rate.2) 3) TP = Sum of MPs TP = AP X n Marginal Product :.4(16 – 20) Fixed Factor (Land) 10 10 10 10 10 10 10 10 10 0 4 10 18 24 28 28 Relationship between TP & MP 1.4) 8 (18 -10) 6 (24 -18) 4 (28 .24) 0 (28 – 28) .

When MP equals to AP. When MP is greater than AP. AP = TP & MP = ∆TP L ∆L 2.Relationship between AP & MP 1. AP rises but MP rises at faster pace. AP falls but MP falls at higher rate. AP is constant 4. When MP is less than AP. 3. Both AP & MP cures are derived from TP since. Y T A Total product TP Point of inflexion M O X L1 L2 L3 Unit of labour Stage I Stage II Stage III .

Diminishing Return :. M A AP O L1 L2 L3 Units of labour MP X Law of variable proportions or Returns to factor It states that as more & more units of a variable factor are applied to a given quantity of a fixed factor the total product may increase at an increasing rate initially but eventually it will increase at a diminishing rate. One factor of production is variable & others are fixed. The law applies only in the short run. Increasing returns :.In this stage. TP increase at increasing rate & later at the diminishing rate.TP increases at a diminishing rate till it reaches at maximum point & then becomes constant . All units of variable factor are homogeneous. Factor proportions can he changed. AP increases & reaches at its maximum MP initially increases then starts decreasing but continues to remain above AP 2. 2. 4. 5. There are 3 stages of law of Variable proportions 1.P. State of technology is given & remains the same. 3. Assumptions 1.Average and M.

Accordingly marginal productivity tends to rise.Continuous increase in application of variable factor along with fixed factors beyond a point crosses the limit of ideal factor ratio. initially additional unit of variable factors add more to the total output (ii) Specialization of Labour :. Negative Returns :.When there are too many workers they may shift the responsibility to others & it becomes difficult for the management to coordinate with them. Thus the output also decreases.When more & more variable factors are added to a given quantity of fixed factor it will lead to over crowding & due to this MP of the Labours decreases & it goes into negative (ii) Management Problems :.Factors of production are imperfect substitutes of each other. for eg. More & more of Labour. Q. The Labours avoid doing work.Additional application of Variable factor causes process based division of Labour that raises the efficiency of factors. (ii) Disturbing the optimum proportion :. All these things lead to decrease in efficiency of Laboures. Diminishing return to a factor:- (i) Imperfect factor substitutability :. 1. Cannot be continuously used in place of additional capital. In which stage should a producer operate? .TP begins to fall AP continues to fall but remains positive MP becomes negative Causes of 3 stages of Law of variable proportion . 4. hence. Negative returns to a factor :- (i) Overcrowding :. 3. Accordingly diminishing returns to variable factor becomes inevitable. This results in poor co-ordination between the fixed & variable factors which causes diminishing return to a factor. Increasing return to a factor:- (i) Fuller utilization of fixed factor : In the initial stages Fixed factor remain under utilized its fuller utilization starts with the more application of variable factor. 3.AP continues to fall MP decreases & finally becomes zero (o).

the main reasons for the operation of the different forms of returns to scale are found in economies & diseconomies of scale Economies of Scale . The 1st & 3rd stages are called stages of economic absurdity hence a rational producer would like to operate in 2 nd stage because it is the stage where AP & MP of variable factor are declining but remain positive Thus this is the best stage to work. He will not stay in Ist stage because it is the stage of increasing returns under no circumstances he will also not operate under 3rd stage where the total product starts decreasing. There are 3 aspects of returns to scale (i) Increasing returns to scale – occurs when a given percentage increase in all factor inputs in the same ratio causes proportionately greater increase in output : Scale of production Output 1 Machine + 2 Laboures 100 Kgs 2 machine + 4 Laboures 250 Kgs (ii) Constant returns to scale :.When a percentage increase in all factor inputs in the same ratio causes proportionately lesser increase in output is known as diminishing returns to scale Scale of production Output 1 Machine + 2 Laboures 100 Kgs 2 machine + 4 Laboures 150 Kgs Causes for the operation of Law :. It is applicable in the long run.A rational producer would always prefer to operate in the 2nnd stage. Returns to Scale It refers to a situation in which we study the behavior of output when all the factor inputs are varied in the same proportion.Under this percentage increase in all factor inputs in the same proportion causes equal percentage increase an output Scale of production Output 1 Machine + 2 Laboures 100 Kgs 2 machine + 4 Laboures 200 Kgs (iii) Diminishing returns to scale :. In long period production of a commodity can be increased by increasing all the factors in the same proportions. If all the factors increase in same proportion the scale of production increases & the corresponding behavior of output is studied as returns to scale.

Rise in input prices. & Labour inefficiency.These disadvantages are firm specific & are not shared by other firms in industry technical economies Eg : managerial diseconomies. Economies are of 2 types (i) Internal economies :.these are the disadvantages which are industry specific which are experienced by all the firms in the industry due to increase in scale of production. Some specific factors responsible for returns to scale 1.In this situation economies are neutralized by diseconomies. economies of info.As a result of increase in the scale of production division of Labour becomes possible. (i) Causes of increasing return to scale Indivisibility :. (ii) Specialization :. (i) Internal diseconomies :.Some factor of production cannot be divided hence they cannot be purchased in parts. These are internal became they are not shared by other firms in the industry Eg : Technical economies.economies of concentration. It increases the efficiency of factor inputs & the volume of output also increase.It refers to the situation in which increasing the scale of production. Eg :. Labour economies of purchase & sale. (ii) External diseconomies :. (ii) External Economies :. Constant returns to scale :. 2. costlier transport. Reduces the per unit of cost of production or raises output per unit of factor inputs. Diseconomies are also of 2 types. higher wager. When scale increases these indivisible factors of production become more efficient & they are more efficiently utilized by the Labours which increases the volume of output. Eg :. Diminishing returns to scale occurs due to the diseconomies of scale which means the disadvantages experienced by the production units after increasing the scale of production beyond the maximum limit. Causes of constant return to scale . Economies to scale are responsible for increasing returns to scale.These are the economies which are industries specific the are available to all the firms in the industry when the scale of operation of the industry as a whole expands. economies of disintegration. financial economies & economies of risk. It is clear that the constant returns to scale operates when the total output increases in the same proportion as an increase in the quantity of factor inputs.Which are firm specific These are available to that particular firm in the industry which seeks to increase its level of output by way of increasing the scale of production.

Difference between retune to a variable factor & returns to scale (write on your own) 1. It decrease. Which decrease the efficiency of it & output also decreases. Scale of production 5. Stages .With the increase in scale of production over utilization of natural resources takes place. There may be a point when the abilities & skills of the entrepreneur may be fully utilized. its efficiency thus cost of production increases.It may occur in certain productive activities where factor of production are perfectly divisible. (ii) Exhaustibility of natural resources :.(i) Limits to economies of scale :– economies of scale are not indefinitely available as the scale of production expands a point is reached when economies of scale are counter balanced by the diseconomies of scale. Factor proportions 4. Meaning 2. Causes of diminishing returns to scale (i) Entrepreneur is a fixed factor :.with the increase in scale of production. Eg : Double the output by setting up of two plants 3. Time period 3. Thus the output increases in the same ratio as the input (ii) Divisibility of inputs :.

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