Current News

Indian economy may not see V-shaped recovery:

Kevin Sneader, Managing Partner, McKinsey & Co
Implication of this news
Take–away of today’s lecture
Production function with two variable
inputs
 Learning Outcome

• To identify the different factors of production

available to produce output

• To analyse the combination of factors available

 Production Function with Two Variable Inputs

Capital Labour
▪ All inputs are variable in long run (Rs. crore) (’00 units)
▪ Only two inputs are used 40 6
28 7
18 8
12 9
8 10
▪ Represented as:

Q = f ( L, K )
45
40
Capital (Rs. Crore)

35
30
25
20
15
10
5
0
6 7 8 9 10
Labour ('00 units)
What is Isoquant?
•Shows combination of two inputs that can
produce the same level of output.

• Shows economic region of production,

which is negatively sloped.
 Characteristics of Isoquants

▪ Downward sloping
▪ Convex to the origin
▪ A higher isoquant represents a higher output
▪ Two isoquants do not intersect
 Special Shapes of Isoquants
Capital Capital

Q3
Q2
Q1
Q1 Q2 Q3
O O
Labour Labour

Linear isoquants Right angled isoquants

• Perfect substitutability • Capital is a perfect complement

between two factors for labour
• Isoquants are downward • Non existence of any
substitutability between the two
sloping straight lines factors
• Constant MRTS
Polling question
• The production function incorporates the
technically efficient method of .............

a. production.

b. process

c. function
d. All of these
Iso-Cost Line
 Iso-cost Line

Isocost lines represent all combinations of

two inputs that a firm can purchase with
the same total cost.
• Iso-cost line is also known as
a)Factor Price Line
b)Outlay Line
c) Firm’s Budget
C = wL + rK
Diagram
Slope of Iso-cost line= Ratio of input prices = w/r
Polling question
• In the long run, all factors of production are
a. Variable
b. Fixed
c. Materials
d. Rented
 Producer’s Equilibrium

• Two conditions must be satisfied:

a)IQ must be convex to the origin

b)Slope of IQ= Slope of Iso-cost line

 Expansion Path

• It is the line formed by joining the tangency points

between various isocost lines and the
corresponding highest attainable isoquants.
 Returns to Scale

Production Function Q = f(L, K)

Q = f(hL, hK)

If  = h, then f has constant returns to scale.

If  > h, then f has increasing returns to scale.
If  < h, then f has decreasing returns to
scale.
 SCALE OF PRODUCTION

INCREASING RETURNS TO SCALE

❖ All the factors of production are increased in a given
proportion, output would increase by a greater proportion.
Capital

When labour and capital are doubled

(100 units to 200 units), output
increases from 20 units to 60 units,
which is more than double.

200
The causes of increasing returns
IQ = 60 to scale are specialization,
100%
technical economies,
> 100%
100 managerial economies which
IQ =20
are also known as economies
Labour of scale.
100 200
100%
 CONSTANT RETURNS TO SCALE
❖ All the factors of production are increased in a given
proportion, output would increase by same proportion.
Capital

When labour and capital are doubled

(100 units to 200 units), output
increases from 20 units to 40 units.

200
IQ = 40
100%

100%
100
IQ =20

Labour
100 200

100%
 DECREASING RETURNS TO SCALE
❖ All the factors of production are increased in a given
proportion, output would increase by a smaller proportion.
Capital

When labour and capital are doubled

(100 units to 200 units), output
increases from 20 units to 30 units,
which is less than double.

200
The causes of decreasing
IQ = 30 returns to scale are internal
100%
and external diseconomies
100 of scale.
< 100%
IQ =20

Labour
100 200

100%
Polling question
• Factors of production are
a) inputs and outputs.
b) outputs only
c) inputs only
d) the minimum set of inputs that can produce a
certain fixed quantity of output.