UNIT III

PRODUCTION FUNCTION
Production Function– Meaning – Assumption – Isoquants – MRS - Producer’s Equilibrium -
Laws of Production - Laws of Variable Proportion – Laws of Returns to Scale.

Introduction to Production function:

Do you ever consider the origins of the goods you purchase at the market, such as
journals, pens and pencils, clothing, cereal, milk, fruits, veggies, etc? Customers are
a segment of the market who buy goods and services to satisfy their needs. A
producer or firm combines a variety of inputs, such as land, labour, capital,
entrepreneurship, and other inputs, such as raw materials and fuel, to generate the
products and services that customers want. It is interesting to know that, factually
humans can neither produce a physical product nor can they destroy it. All we can
do is change its form. The act of producing something involves contributing or
generating something beneficial. Any procedure that makes a product more useful is
referred to as production.

What is Production?

Production is a process that a business uses to turn inputs into outputs. It is the
procedure of producing goods and providing services with the aid of inputs or
production factors in order to satisfy hu man needs. In other terms, production is a
general term for the "transformation of inputs into output" when value is added. Input
is anything that is utilised in the creation of a commodity. For instance, the use of
machinery, raw materials, labor, and other things are inputs in the production of a car.
The relationship between a commodity's inputs and outputs depends on its
technological status since new technolo gy enables producers to create more with the
same amount of inputs or the same amount of output with fewer inputs.

Fixed and Variable Factors

Fixed factors are those production inputs whose quantity can not be changed with the
change in output. For instance, it is not possible to change a large amount of land,
equipment, etc., to produce more output.

Contrarily, variable production factors are those whose amount is easily influenced by
changes in output level. For instance, we may quickly alter the labour force to boost
or lower productivity.
Level and Scale of Production

Any company's level of output rises when it increases production by boosting the
amount of one-factor input while maintaining the quantity of the other factor inputs.
However, the scale of production increases when a firm raises production by
concurrently and proportionately growing the quantity of all the production elements.

Definition of the Production Function

The physical link between inputs and outputs is referred to as the production function
in economics. In another way, a production function is a mathematical relationship
involving inputs and output that enables the maximum output to be created with a
specific set of input factors and technological capabilities at a specific time, such as
real estate, labour capital, and entrepreneurship.

Production function can be stated as

Qx = f (L, K)

Suppose there are two-factor inputs: labour (L) and capital (K). Qx is the quantity of
output of commodity x, f is the function, L I s the unit of labour and k is the unit capital.
According to this, the amount of output depends on the labour and capital inputs
utilised in manufacturing.

Here, there are two things to think about. First, the production function must be taken
into account in relation to a specific time frame, such as a short term and a long period.
Second, the state of technology affects how well manufacturing functions. It's vital to
remember that a production function merely depicts the physical relationship and has
no financial value.

Short Run and Long Run Production Function

The term "short run" describes a period of time during which a company does not have
enough time to grow the scale of output. Only by raising the amount of a variable
element and utilising the fixed factors that are already in place can it raise the output
level.

The term "lo ng run," on the other hand, corresponds to the amount of time over which
businesses can raise the size of their output by raising the quantity of all of their inputs
concurrently and in an identical ratio.

Short Run Production Function

A short run production function is one that illustrates the variation in output when only
one factor is altered while the other stays the same. In the production
function example given above, labour (L) is the variable factor that can be altered to
affect the level of output. The second factor, capital (K), is a constant that cannot be
altered. The "Law of Variable Proportion or Returns to a Factor" serves as the
foundational principle for the short run production function.

An agricultural company, for instance, has 10 labour units and six acres of land. Here,
labour is the variable factor, whereas land is the constant factor. On its property
(constant factor), the company uses a single unit of labour ( variable factor) at first.
The land-labour ratio is therefore 6 to 1. The land-labour ratio changes to a 6: 2 or 3:
1 ratio if the company uses two units of labour.

Long Run Production Function

When all the production elements can be altered concurrently and in the same ratio,
the output is examined using a long run production function. Therefore, throughout
time, the size of the business can change depending on whether the production
elements are multiplied or diminished.

For instance, the builder can construct new buildings or expand existing buildings,
purchase more new machinery and equipment, open additional production unit
branches, purchase additional land to increase the firm's size, hire additional skilled
workers, modify production and managerial technology, etc.

Over a lengthy period of time, all manufacturing inputs or resources are variable. The
producer can build new structures or enlarge existing ones, buy new and more
machinery and equipment, set up more production unit branches, purchase additional
land to increase the firm's size, employ more and more skilled personnel, alter
production and managerial technologies, and so on.

Types of Production function

Depending on how much one input can be substituted for another, there are
many types o f production functions.

1.Cobb Douglas Production Function

Charles W. Cobb and Paul H. Douglas, two American economists, developed the
Cobb Douglas production function to examine the relationship between input and
output. The Cobb-Douglas production function is the kind of production function that
allows for some substitution of one input by other sources. For instance, capital and
labour can be substituted for one another, but only to a certain extent. This is how the
Cobb Douglas production function can be represented mathematically:

Q = AK^a L^b ( here, A is a positive constant, and a and b are positive fractions )

2.Leontief Production Function

The W. Wassily Leontif-developed Leontief production function uses a set ratio of
inputs with no sustainability between them. It means that the Leontief production
function exists if the input-output ratio is free of the production scale. It presumes that
the production factors are strictly complementary. The fixed proportion production
function is another name for the Leontief production function. The following is an
expression for this production function:

q = min (z1/a , z2/b)

3.CES Production Function

Constant Elasticity Substitution is referred to as CES. The output is constantly
changing as a result of changes in the production's input, as seen by the CES
production function. It is expressed as :

Q = A [aK^–β (1–a) L^–β] ^–1/β

Features of Production Function

The following are the primary features of production function: -

Sustainability
Because of substitutability, any output's quantity can fluctuate while other elements
remain constant, even if only by a small amount.

Complementary
As a result, a producer may combine the input factors to make the output. The output
cannot be generated if any input is null in quantity.

Specificity
In order to produce a given product, for instance, raw materials, skilled labour, tools,
and equipment may be used. All of these production-related characteristics can be
used to create other goods. Thus they are not entirely specialised.

Production Period
Any kind of product production takes time. Production is only conceivable over the
long term. The variation in input amount is what causes the variance in total output in
the production function. A single input's volume might be reachable in a brief amount
of time.

ISOQUANT CURVE

 An isoquant curve is a concave line plotted on a graph, showing all of the various
combinations of two inputs that result in the same amount of output.

 Most typically, an isoquant shows combinations of capital and labor and the technological
trade-off between the two.

 The isoquant curve assists companies and businesses in making adjustments to their
manufacturing operations, to produce the most goods at the most minimal cost.

 The isoquant curve demonstrates the principle of the marginal rate of technical
substitution, which shows the rate at which you can substitute one input for another, without
changing the level of resulting output.

 Isoquant curves all share seven basic properties, including the fact that they cannot be
tangent or intersect one another, they tend to slope downward, and ones representing higher
output are place d higher and to the right.

What Is an Isoquant Curve?

An isoquant curve is a concave-shaped line on a graph, used in the study

of microeconomics, that charts all the factors, or inputs, that produce a specified
level of output. This graph is used as a metric for the influence that the inputs—most
commonly, capital and labor—have on the obtainable level of output or production.

The isoquant curve assists companies and businesses in making adjustments to

inputs to maximize production, and thus profits.
Understanding an Isoquant Curve

The term "isoquant," broken down in Latin, means “equal quantity,” with “iso”
meaning equal and “quant” meaning quantity. Essentially, the curve represents a
consistent amount of output. The isoquant is known, alternatively, as an equal
product curve or a production indifference curve. It may also be called an iso-
product curve.

Most typically, an isoquant shows combinations of capital and labor, and the
technological tradeoff between the two—how much capital would be required to
replace a unit of labor at a certain production point to generate the same output.
Labor is often placed along the X-axis of the isoquant graph, and capital along the
Y-axis.

Due to the law of diminishing returns—the economic theory that predicts that after
some optimal level of production capacity is reached, adding other factors will
actually result in smaller increases in output—an isoquant curve usually has a
concave shape . The exact slope of the isoquant curve on the graph shows the
rate at which a giv en input, either labor or capital, can be substituted for the other
while keeping the same output level.

For example, in the graph below, Factor K represents capital, and Factor L stands
for labor. The curve shows that when a firm moves down from point (a) to point (b)
and it uses one additional unit of labor, the firm can give up four units of capital (K)
and yet remain on the same isoquant at point (b). If the firm hires another unit of
labor and moves from point (b) to (c), the firm can reduce its use of capital (K)
by three units but remain on the same isoquant.
The Properties of an Isoquant Curve

Property 1: An isoquant curve slopes downward, or is negatively sloped.

This means that the same level of production only occurs when increasing units of
input are offset with lesser units of another input factor. This property falls in line
with the principle of the Marginal Rate of Technical Substitution (MRTS). As an
example, the same level of output could be achieved by a company when capital
inputs increase, but labor inputs decrease.

Property 2: An isoquant curve, because of the MRTS effect, is convex to its

origin.
This indicates that factors of production may be substituted with one another. The
increase in one factor, however, must still be used in conjunction with the decrease
of another input factor.

Property 3: Isoquant curves cannot be tangent or intersect one another.

Curves that intersect are incorrect and produce results that are invalid, as a
common factor combination on each of the curves will reveal the same level of
output, which is not possible.

Property 4: Isoquant curves in the upper portions of the chart yield higher
outputs.
This is because, at a higher curve, factors of production are more heavily employed.
Either more capital or more labor input factors result in a greater level of production.

Property 5: An isoquant curve should not touch the X or Y axis on the graph.
If it does, the rate of technical substitution is void, as it will indicate that one factor is
responsible for producing the given level of output without the involvement of any
other input factors.

Property 6: Isoquant curves do not have to be parallel to one another.

The rate of technical substitution between factors may have variations.

Property 7: Isoquant curves are oval-shaped.

This allows firms to determine the most efficient factors of production.

THE MARGINAL RATE OF TECHNICAL SUBSTITUTION (MRTS):

Meaning: The rate at which one input can be substituted for another
along an isoquant is called the marginal rate of technical substitution
(MRTS), defined as:
MRTSL for K = – ∆K/∆L
where K is capital, L is labour and ∆ denotes any change. The minus sign is added in
order to make MRTS a positive number, since ∆K/∆L, the slope of the isoquant, is
negative.

For any movement along an isoquant, the MRTS equals the ratio of the marginal
products of the two inputs.
To prove this, suppose the use of L increases by 3 units and K by 5. If, in
this stage, the MPL is 4 units of Q per unit of L and that of K is 2 units of Q
per unit of K, the resulting change in output (Q) is:

∆Q = (4 x 3) + (2 x 5) = 22

This means that when L and K are allowed to vary slightly, the change in Q resulting
from the change in the two inputs is the marginal product of L times the amount of
change in L plus the marginal product of K times its change.

As a general rule:
∆Q = MPL. ∆L + MPK. ∆K.

What Is the Marginal Rate of Technical Substitution – MRTS?

The marginal rate of technical substitution (MRTS) is an economic theory that

illustrates the rate at which one factor must decrease so that the same level of
productivity can be maintained when another factor is increased.

The MRTS reflects the give-and-take between factors, such as capital and labor, that
allow a firm to maintain a constant output. MRTS differs from the marginal rate of
substitution (MRS) because MRTS is focused on producer equilibrium and MRS is
focused on consumer equilibrium.
Principle of Marginal Rate of Technical Substitution
Marginal rate of technical substitution is based on the principle that the rate by which a
producer substitutes input of a factor for another decreases more and more with every
successive substitution.

If we assume labor (L) and capital (K) to be the two inputs of a production process, the principle
of MRTS states that the value of MRTSL,K decreases with subsequent substitution of labor for
capital. And, this diminishing rate of MRTS is also apparent from the table 1 given above.
Initially, when the producer moved from combination A to combination B, the rate of MRTS
was calculated to be 4. When the producer moved to combination C, the rate of MRTS fell and
became 3. In the same way, with each successive addition of constant unit of labor, the MRTS
were calculated to be 3, then 2 and finally, 1.

Clearly, the marginal rate of technical substitution has diminished more and more as the
producer kept on substituting input of labor for capital.

Causes of Diminishing Marginal Rate of Technical Substitution

Marginal rate of technical substitution is diminishing due to following reasons.

Imperfect substitutability of the factors

Two factors cannot substitute each other perfectly because they have their own uses in the
production process.

Besides, if the factors could perfectly substitute each other, increase or decrease in either of
the factors won’t bring any changes in the marginal rate of technical substitution.
Inadequacy of the factor
Substituting one factor for the other continuously causes scarcity of the factor being replaced.
As a result, the factor being tradeoff won’t be able to make as much contribution as it should
have for the efficient production.
 PRODUCER EQUILIBRIUM

Producer's equilibrium refers to a situation where profits are maximised, i.e., the
difference between total revenue and total cost is maximised, or in cases losses,
the difference is minimised, so as to minimise losses.