NATIONAL INSTITUTE OF TECHNOLOGY SIKKIM

Ravangla Campus
Barfung Block, Ravangla Sub Division, South Sikkim-737139
Department of Mechanical Engineering
Engineering Economics (HS15101)

Module: 2 Lecture No: 9

Learning Objectives

 To discuss the basic concept of production theory.

 To describe various factors of production.
 To explain the equal product curves or isoquants.
 To explain the marginal rate of technical substitution.

Important & Relevant Questions

 Discuss the various factors of production function.

 Define equal product curve and explain what do you mean by marginal rate of technical
substitution.

Evaluation Questions

 What are fixed factor and variable factor of production?

 What is equal product curve or isoquant?
 What is the difference between indifference curves and equal product curves?
 What is the difference between short-run and long-run production system?
 What is marginal rate of technical substitution?

References

 Gregory. N. Mankiw, “Principles of Microeconomics”, Cengage Learning, 7th Edition,

2013.
 Rudiger Dornbusch and Stanley Fischer, “Macroeconomics”, McGraw-Hill Europe.
11th Edition, 2011.
 Lipsey and Chrystal, “Economics”, Oxford University Press, 13th Edition, 2015.
 Riggs, Bedworth and Randhwa, “Engineering Economics”, McGraw Hill Education
India.
 NATIONAL INSTITUTE OF TECHNOLOGY SIKKIM
Ravangla Campus
Barfung Block, Ravangla Sub Division, South Sikkim-737139
Department of Mechanical Engineering
Engineering Economics (HS15101)

In present scenario, one of the key concerns of the business managers is to achieve optimum
efficiency in production or minimizing cost for a given output. In competitive market, a firm
can survive only if it is able to produce goods and services at a competitive cost. Hence,
business managers should make an effort to minimize the cost of production or maximize
output for a given level of inputs. There are some basic questions which managers are
confronted with while endeavoring to minimize the production cost. These are:
1. How does output change with the increase in quantity of inputs?
2. How can production be optimized to achieve reduction in cost?
3. How does technology helps in minimizing the cost of production?
4. How to achieve the least cost combination of inputs for a given output?
The theory of production seeks to explain answer to these questions with the help of economic
models that are built under hypothetical conditions. The production theory provides various
tools and methods to analyze relationship between input and output which provide directions
to find solutions to practical business problems.
Basic concepts of Production Theory
 Production
In economics, the transformation of resources (men, material, time and so on) into a
different & more useful commodity through a process is called production. In general, the
production function is limited to only ‘manufacturing’ in which inputs (labour, machine,
raw material, time & so on) are transformed into an output.
In economics sense, there are different forms of production other than manufacturing.
When a commodity is transferred from one place to another for consuming in the
production process is production. For eg. When sand is transferred from the river bank to
construction site by the sand dealer, this activity, too, is production. When a commodity is
stored for future consumption or sale, this is also called production.
It is not necessary that only physical conversion of inputs into tangible goods take place in
production process. Some types of production involves conversion of an intangible input
into intangible output. For e.g. both input and output are intangible in the production of
medical, legal, social and consultancy services.
 Fixed and variable factors of production
A variety of goods and services are used by a firm in the process of production called factors
of production or inputs such as land, labour, raw material, plant and machinery, factory
premises, tools and equipment etc. These factors of production can be classified into two
parts:
1. Fixed factors
2. Variable factors
Fixed factor is one whose quantity remains the same irrespective of the level of output. Its
quantity cannot be readily changed in the short run. On the other hand, a variable factor
is one whose quantity changes with the changes in the level of output. In the short run, a
 NATIONAL INSTITUTE OF TECHNOLOGY SIKKIM
Ravangla Campus
Barfung Block, Ravangla Sub Division, South Sikkim-737139
Department of Mechanical Engineering
Engineering Economics (HS15101)

larger quantity can be employed by the users of such factors. For example: a firm wants to
increase the production of books from 1000 to 2000 daily. To do so, it will need more
factors of production. But, there are some factors whose supply cannot be increased
immediately e.g. printing press, building etc. Therefore, the firm will have to use those
factors whose quantity can be increased immediately such as labour, raw material etc. In
the given example, printing press and building are fixed factors of production, labour and
raw material are variable factors of production.
 Short and long run
Short run refers to that time period in which supply of certain factors is fixed i.e. it cannot
be increased or decreased. For e.g. plant, machinery, building etc. Therefore, a firm can
increase the production of a commodity in the short run, by increasing the use of variable
factors such as labor and raw materials.
Long run refers to that time period in which supply of all factors i.e. fixed and variable is
elastic, but not sufficient to allow a change in technology. In the long run, no factor is a
fixed factor, all factors are variable. Therefore, a firm can increase the production of a
commodity in the long run by increasing the use of both variable and fixed factors of
production.
There is another term ‘very long run’ used by economists which refers to that time period
in which technology of production can also be changed. The production function also
changes in the very long time period.
Factors of production
The factors of production are the resources that are used by people to produce goods and
services. Economists divide the factors of production into four categories: land, labor, capital,
and entrepreneurship.
 Land
The first factor of production is the land, but this includes any natural resource used to
produce goods and services. This includes not just land, but anything that comes from the
land. Some common land or natural resources are water, oil, copper, natural gas, coal, and
forests. Land resources are the raw materials in the production process. These resources
can be renewable, such as forests, or nonrenewable such as oil or natural gas. The income
that resource owners earn in return for land resources is called rent.
 Labour
The second factor of production is the labour. Laboor is the effort that people contribute to
the production of goods and services. Labour resources include the work done by the waiter
who brings your food at a local restaurant as well as the engineer who designed the bus that
transports you to school. It includes an artist's creation of a painting as well as the work of
the pilot flying the airplane overhead. If you have ever been paid for a job, you have
contributed labour resources to the production of goods or services. The income earned by
labour resources is called wages and is the largest source of income for most people.
 NATIONAL INSTITUTE OF TECHNOLOGY SIKKIM
Ravangla Campus
Barfung Block, Ravangla Sub Division, South Sikkim-737139
Department of Mechanical Engineering
Engineering Economics (HS15101)

 Capital
The third factor of production is the capital. Capital is referred to the machinery, tools and
buildings which are used by humans to produce goods and services. Some common
examples of capital include hammers, forklifts, conveyer belts, computers, and delivery
vans. Capital differs based on the worker and the type of work being done. For example, a
doctor may use a stethoscope and an examination room to provide medical services. A
teacher may use textbooks, desks, and a whiteboard to produce education services.
 Entrepreneurship
The fourth factor of production is the entrepreneurship. An entrepreneur is a person who
combines the other factors of production - land, labour, and capital - to earn a profit. The
most successful entrepreneurs are innovators who find new ways to produce goods and
services or who develop new goods and services to bring to market. Without the
entrepreneur combining land, labour, and capital in new ways, many of the innovations we
see around us would not exist. Think of the entrepreneurship of Henry Ford or Bill Gates.
Entrepreneurs are a vital engine of economic growth helping to build some of the largest
firms in the world as well as some of the small businesses in your neighborhood.
Entrepreneurs thrive in economies where they have the freedom to start businesses and buy
resources freely. The payment to entrepreneurship is profit.
There might be question of why money is not considered as a factor of production? Money is
not capital as economists define capital, because it is not a productive resource. While money
can be used to buy capital, it is the capital good (things such as machinery and tools) that is
used to produce goods and services.
Equal Product Curves or Isoquants
Equal-product curves are similar to the indifference curves of the theory of consumer’s
behaviour. An equal-product curve represents all those input combinations which are capable
of producing the same level of output. The equal-product curves are thus contour lines which
trace the loci of equal outputs. These equal-product curves are also known as isoquants
(meaning equal quantities) and iso-product curves. Since the equal-product curve represents
those combinations of inputs which will be capable of producing an equal quantity of output,
the producer would be indifferent between them as such. Therefore, another name which is
often given to the equal-product curves is production-indifference curve.
The concept of equal-product curves can be easily understood from the following Table 1. It is
presumed that two factors, i.e., Factor X and Factor Y are being employed to produce a
product.
 NATIONAL INSTITUTE OF TECHNOLOGY SIKKIM
Ravangla Campus
Barfung Block, Ravangla Sub Division, South Sikkim-737139
Department of Mechanical Engineering
Engineering Economics (HS15101)

Table 1: Various factor combinations to produce a given level of output

Factor combination Factor X Factor Y
A 1 12
B 2 8
C 3 5
D 4 3
E 5 2
Each of the factor combinations A, B, C, D and E produces the same level of output, say, 20
units. To start with, factor combination A consisting of 1 unit of Factor X and 12 units of Factor
Y produces the given 20 units of output. Similarly, combination B consisting of 2 units of X
and 8 units of Y, combination G consisting of 3 units of X and 5 units of Y, combination D
consisting of 4 units of X and 3 units of Y, and combination E consisting of 5 units of X and 2
units of Y are capable of producing the same amount (20 units) of output. We have plotted all
these combinations and by joining them we obtain the equal-product curve showing that every
combination represented on it can produce 20 units of output (Figure 1).

Figure 1: Equal product curve

Though equal product curves are similar to the indifference curves of the theory of consumer’s
behaviour, yet there is one important difference between the two. An indifference curve
represents all those combinations of two goods which provide the same satisfaction or utility
to a consumer but no attempt is made to specify the level of satisfaction or utility it stands for.
This is so because the measurement of satisfaction or utility in unambiguous terms is not
possible. That is why we usually label indifference curves by ordinal numbers as I, II, III, etc.,
indicating that a higher indifference curve represents a higher level of satisfaction than a lower
one, but the information as to by how much one level of satisfaction is greater than another is
 NATIONAL INSTITUTE OF TECHNOLOGY SIKKIM
Ravangla Campus
Barfung Block, Ravangla Sub Division, South Sikkim-737139
Department of Mechanical Engineering
Engineering Economics (HS15101)

not provided. On the other hand, we can label equal product curves in the physical units of
output without any difficulty. Production of a good being a physical phenomenon lends itself
easily to absolute measurement in physical units. Since each equal product curve represents
specified level of production, it is possible to say by how much one equal-product curve
indicates greater or less production than another. In Figure 2, an equal-product map or isoquant
map have been drawn with a set of four equal product curves which represent 20 units, 40 units,
60 units and 80 units of output respectively. Then, from this set of equal-product curves it is
very easy to judge by how much production level on one equal-product curve is greater or less
than on another.

Figure 2: Equal product map

 Marginal Rate of Technical Substitution (MRTS)
Marginal rate of technical substitution (MRTS) in the theory of production is similar to the
concept of marginal rate of substitution in the indifference curve analysis of consumer’s
demand. Marginal rate of technical substitution indicates the rate at which factors can be
substituted at the margin without altering the level of output. More precisely, marginal rate
of technical substitution of Factor X for Factor Y may be defined as the amount of Factor
Y which can be replaced by one unit of Factor X, the level of output remaining unchanged.
The concept of marginal rate of technical substitution can be easily understood from the
following table (Table 2).
Table 2: Marginal rate of technical substitution
Factor combination Factor X Factor Y MRTS of X for Y
A 1 12 -
B 2 8 4
C 3 5 3
D 4 3 2
E 5 2 1
 NATIONAL INSTITUTE OF TECHNOLOGY SIKKIM
Ravangla Campus
Barfung Block, Ravangla Sub Division, South Sikkim-737139
Department of Mechanical Engineering
Engineering Economics (HS15101)

Each of the input combinations A, B, C, D and E yields the same level of output. Moving
down the table from combination A to combination B, 4 units of Y are replaced by 1 unit
of X in the production process without any change in the level of output. Therefore, the
marginal rate of technical substitution is 4 at this stage switching from input combination
B to input combination C involves the replacement of 3 units of Factor Y by an additional
unit of Factor X, output remaining the same. Thus, the marginal rate of technical
substitution is now 3. Likewise, marginal rate of technical substitution between factor
combinations C and D is 2, and between factor combinations D and E is 1.
The marginal rate of technical substitution at a point on the equal product curve can be
known from the slope of the equal product curve at that point. Consider a small movement
down the equal product curve P1 from G to H in Figure 2, where a small amount of factor
Y, say ΔY, is replaced by an amount of factor X, say ΔX without any loss of output. The
slope of the isoproduct curve P1 at point G is therefore equal to (ΔY / ΔX). Thus, marginal
rate of technical substitution = slope = ΔY / ΔX.
An important point to be noted about the marginal rate of technical substitution is that it is
equal to the ratio of the marginal physical products of two factors. Since, by definition,
output remains constant on the equal product curve, the loss in physical output from a small
reduction in Factor Y will be equal to the gain in physical output from a small increment in
Factor X. The loss in output is equal to the marginal physical product of Factor Y (MPy)
multiplied by the amount of reduction in Y (ΔY). The gain in output is equal to the marginal
physical product of factor X (MPx) multiplied by the increasement in X (ΔX).