Ch 05: Production Function

Contents

 Introduction
 Classification of Factors
 Time Dimension
 Production Function
a) Meaning
b) Types
 Concept of Product
 Returns to a Factor: Law of Variable Proportions
 Reasons for Law of Variable Proportions
 Law of Diminishing Returns
 Relationship between TP and MP
 Relationship between AP and MP

Introduction

A producer performs very important function of converting inputs into output, which is defined as
transformation of inputs into output. In single term, this is called production.

Production means any process that transforms one commodity into another i.e., transformation of
inputs into output.

Classification of Factors

a) Fixed Factors
 These refer to those factors whose quantity cannot be changed in the short run.
 Costs of fixed factors do not vary directly with output i.e. these do not change, whether
the level of output increase, decreases or become zero.
 E.g. plant and machinery, building, land etc.
b) Variable Factors
 These refer to those factors whose quantity can be changed in the short run.
 Costs of variable factors vary directly with output i.e. these increases when output
increases, decreases when output decreases and are zero when there is no output.
 E.g. raw material, transport, communication etc.

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Time Dimension

a) Short run
Short run refers to a period in which output can be changed by changing only variable factors.
If a producer wants to increase output in short run, he can increase by increasing raw materials
or by increasing number of workers.
b) Long run
Long run refers to a period in which output can be changed by changing all the factors of
production. In long run firm can change its factory size, switch to new technique. Here if the
producer wants to increase the production, he can increase the production by purchasing plant
and machinery.

Production Function

a) Meaning
Production function refers the functional relationship between inputs and outputs.
q = f (x1, x2)
It means that by using x1 amount of factor 1 and x2 amount of factor 2, we can produce ‘q’
amount of the commodity.
For example, if q = f(x1, x2)
1240M = f (5L , 6K)
It says that maximum 1240 units of commodity ‘M’ can be produced by using 5 units of labour
and 6 units of capital.
b) Types
1. Short run production function
Short run production function refers to the situation when output is increased by changing
only one input while keeping other inputs unchanged.
2. Long run production function
Long run production function refers to the situation when output is increased by increasing
all the inputs simultaneously and in the same proportion.

Concepts of Production

1) Total Product (TP)

Total product refers to total quantity of goods produced by a firm during a given period of time
with given number of inputs.
e.g. if 10 labors produce 100 kg of rice, then TP is 100 kg.
2) Average Product (AP)
Average product refers to output per unit of variable input.
𝑇𝑜𝑡𝑎𝑙 𝑃𝑟𝑜𝑑𝑢𝑐𝑡
AP =
𝑈𝑛𝑖𝑡𝑠 𝑜𝑓 𝑣𝑎𝑟𝑖𝑎𝑏𝑙𝑒 𝐹𝑎𝑐𝑡𝑜𝑟

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 e.g. if 10 labors produce 70 kg of rice,
70
AP = = 7.
10
3) Marginal Product (MP)
Marginal Product refers to addition to total product, when one more unit of variable factor is
employed.
MPn = TPn – TPn-1
Eg. If 10 labours make 60 kg of rice and 11 labours make 67 kg of rice, then MP of 11th labour
will be 7 kg.

Law of Variable Proportions

The theory states that “As we increase the quantity of only one input (variable) keeping other factor
constant (fixed), then the total product initially increases at an increasing rate, than at decreasing rate
and finally at a negative rate”.

In other words, as we employ more and more units of variable factor with the given fixed factor. The
proportion between variable factor and output changes in such a way that the resulting output (MP)
at first increases, then diminishes and finally becomes zero or negative.

Assumptions

1) This theory is related to short run production function

2) There are 2 factors of production (both fixed and variable)
3) Technology remains constant
4) This law applies in the field of production only

Fixed Factor Variable Factor (labour) TP MP Phase

(Land in acres)

1 1 10 10 Increasing at
increasing rate/
1 2 30 20 Increasing Returns
to factor

1 3 45 15 Increasing at
Decreasing Rate/
1 4 52 7 Diminishing
1 5 52 0 Returns to factor

1 6 48 -4 Negative Returns

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Phase 1: Increasing return

This is the first stage of production in which marginal product increases so total product increases.

Phase 2: Diminishing return

In this stage the marginal product start decreasing so the total product increases but at slow speed.
When the MP becomes zero, TP is at maximum.

This happens because after a level of output, pressure on fixed inputs leads to fall in productivity of
the variable input.

Phase 3: Negative returns

This the last stage of production in which total product declines due to negative marginal product.

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Reasons for Law of Variable Proportions

1. Reasons for Increasing returns to factor (Phase 1)

a) Better utilization of fixed factor:
Initially, the fixed factor is much excessive in relation to the variable factor. So, when the
producer employs more and more units of variable input with the given fixed factor. Then
the fixed factor gets efficiently utilized to give maximum output.
b) Better co-ordination between the factors:
As we increase more and more units of variable factor with the given fixed factor then the
co-ordination between fixed and variable factor will improve.
c) Increases the efficiency of labour:
The unit of labour is increased by the producer with the given fixed units of land. So that
the competition among the labour increases and gives maximum possible output in the first
stage of production.
2. Reasons for diminishing returns to factor (Phase 2)
a) Fixity of the factor
The theory is based on short run production function. So, when we increase more and more
units of variable factor with the given fixed factor then the MP will go on diminishing, due
to limited amount of fixed factor.
b) Imperfect substitute of the factors
Fixed and variable factors are imperfect substitute of one another. There is a limit to the
extent of which one factor is substituted for another factor of production.
3. Reasons for Negative returns to factor (Phase 3)
a) Limitation of Fixed Factor
The negative returns to a factor apply because some factors of production are fixed in
nature, which can’t be increased with increase in variable factor in the short run.
b) Poor coordination between the factors
When variable factor becomes too excessive in relation to the fixed factor, then they
obstruct each other.
c) Decrease in efficiency of variable factor
With continuous increase in variable factor, the advantages of specialization and division of
labour start diminishing. It increases the inefficiency of variable factor.

Law of Diminishing Returns

Law of diminishing returns states that when more and more units of variable factor are employed
with fixed factor, then marginal product of the variable factor must fall. It means that marginal
returns diminish when proportion between variable and fixed factors increases. This law is also known
as Law of Diminishing Marginal Product.

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Fixed Factor Variable Factor TP MP AP

1 1 12 12 12

1 2 22 10 11

1 3 30 8 10

1 4 36 6 9

1 5 40 4 8

Relationship between TP and MP

1. As long as TP increases at increasing rate, MP also increases

 This relation can be seen till 3 units of variable factor employed.
 In diagram it can be seen till point A (TP) and B (MP).
2. When TP increases at diminishing rate, MP falls positively
 This relation can be seen from 3rd unit to 7th unit of labour employed.
 In diagram it can be seen from A to C (TP) and B to D (MP).
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 3. When TP becomes maximum and constant, MP becomes zero.
 This is seen at 7th unit
 This relation can be seen at point C (TP) and point D (MP)
4. When TP decreases, MP becomes negative.
 This relation can be seen from 7th to 9th unit of variable factor
 In diagram this relation can be seen after point C (TP) and after point D (MP)

Relationship between AP and MP

1. When MP is more than AP (MP>AP), AP rises.

 This relation can be seen from 1st to 3rd unit of variable factor employed.
 In diagram this relation can be seen from 0 to A (MP) and 0 to B (AP)
2. When MP is equal to AP (AP=MP), AP is at its maximum and constant.
 This relation can be seen at 4th unit of variable factor employed.
 In diagram this relation can be seen at point C.
3. When MP is less than AP (MP<AP), AP falls.
 This relation can be seen from 4th unit to 9th unit of variable factor employed.
 In diagram, this relation can be seen after point C.
4. MP can be positive, zero and negative but AP is always positive.
5. Both MP and AP are calculated from TP.

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