COMILLA UNIVERSITY

Department of Accounting & Information Systems

Course Title: Micro Economics
Course Code: 122
Term Paper on
“Theory of Production”

SUBMITTED TO:
Dr. Mohammed Belal Uddin
Professor,
Department of Accounting &
Information Systems
Comilla University

SUBMITTED BY:
Mahrun Nacha
(ID No: 12106033)
Department of AIS
Comilla University
On behalf of “Group-F”

DATE OF SUBMISSION: 23 October 2022

Letter Of Transmittal
October 23, 2022
Dr. Mohammed Belal Uddin
Professor,
Department of Accounting & Information Systems,
Comilla University, Comilla

Subject: Prayer for granting our term paper on “Theory of production”

Dear Sir,
With due respect and humble submission, we would like here to state that, we are student of
BBA program (15th Batch), session 2020-2021 of Department of Accounting & Information
Systems, Comilla University. We are delighting to submit here with a copy of term paper
report for your kind evaluation and appreciation.

This report is about " Theory of production " Term Paper we have found the study to be
quite interesting, beneficial, and knowledgeable and it has been a blissful and instructive
experience for us to prepare this report.

For your kind consideration we would like to mention that there might be some errors and
mistakes due to limitations of our knowledge. We hope that you will forgive us considering
that we are still learner and in the process of learning.

Thanking for your time and reviews. We sincerely hope that this term Paper report will get
your approval. We would be glad to furnish you with clarifications, if required.

Sincerely yours,
Mahrun Nacha
(ID No: 12106033)

On behalf of Group-F

Acknowledgement
The Performance of term paper its accomplishment successfully is quite impossible except
someone who can sincerely and constructively assist us to make this term paper and thus we
would like to specially extend thanks to our honorable course teacher Dr. Mohammed Belal
Uddin for his support, valuable insights, and suggestions regarding the preparation of term
paper to its completion. It is a great pleasure in submitting the term paper on “Theory of
production " under the course "Micro Economics." We are truly grateful to our respective
sir who made a chance for us to have the knowledge about this. We hope in future we will get
his assistance to make such kind of study and we also hope we will get his solitude
indications and valuable advice. At last, we would like to thank almighty Allah for answering
our prayers and giving us the strength, courage, and patience to finish this task within
responsible time

Group Members
SL NO. NAME ID NO.

1. Mahrun Nacha (Leader) 12106033

2. Asikur Rahman Fahim 12106001

3. Juthi Akter 12106006

4. Sayedul Islam 12106007

5. Doli Mazumder 12106013

6. Wasib Haider Chowdhury 12106023

7. Riayj Ahmed 12106027

8. Atikur Rahman Arif 12106029

9. Jubayer Mohammad 12106041

10. Mst. Rizu Akther 12106057

11. Md Shamim Ahmed 12006062

 Table of Content
Content no Content Page no

1. Define the theory of production and short 02

run production function
2. Total production curve and law of 03-05
variable properties
3. Long run production function and 06-07
isoquant and its properties
4. Average production and marginal 08
production relationship
5. Return to scales and cost function 09-10

6. Iso cost and its properties and economic 11-12

efficiency
7. Producer equilibrium thought isoquant an 13-14
iso cost curve
8. Output maximization vs cost 15
minimization
9. Efficiency in production and derivation of 16-17
production possibility form
10 Cobb, Douglas production function 18-19

11 Elasticity of substitution 20

12 Reference 21
 Define the Theory of production

Theory of production
In economics, an effort to explain the principles by which a business firm decides
how much of each commodifying, that it sells (its outputs or products) it will Produce and
how much of each kind of labor, raw material, fixed capital, good etc. The theory involves
some of the most fundamental principles of economics.

Short run production function

The short run production function defines the relationship between one variable factor
and the output. The law of return to a factor explains such a production function. The short
run production function is one in which at least is one factor of production is thought to be
fixed in supply, it cannot be increased or decreased, and the rest of the factors are variable in
nature. In general, the firm’s capital inputs are assumed as fixed and the production level can
be changed by changing the quantity of other input such as labor, raw material, and capital.
Short run production function: -The short run is a time period where at least one factor of
production is in fixed supply. A business has chosen its scale of production and sticks with
this in the short run. We assume that the quantity of plant and machinating is fixed, and that
production can be attended by changing variable inputs such as labor, raw material and
energy.

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 Total Production Curve

Introduction: The total production curve represents the total amount of output that
enterprises can manufacture within a provided amount of labor. As and when the amount of
labor changes, the total output changes. Total product is also called the sum of marginal
products.

Graphical Representation:

Explanation:
We quantify the units of labor along with the horizontal axis and the output along with the
vertical axis. TP curve increases at an increasing rate up to point A. It increases at a
decreasing rate up to point B. It is maximum from point B to C. Beyond point C, it starts to
decline.

Law of variable properties

Law of variable proportions is called short run production function. Law of variable
proportions is developed by classical economist to explain the behavior of agricultural output.
According to P A Samuelson, “An increase in some inputs relative to other fixed inputs will,
in a given state of technology, cause output to increase, but after a point extra output resulting
from the same additions of extra inputs will become less and less”
Assumption: There are 3 basic assumptions, such as-
1) The state of technology remains unchanged.

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 2) The various inputs employed in production some at least must be get in constant.
3) The low of variable proportion is clearly based upon the possibility of verging
proportion in production.

It describes the production function with one variable factor while the quantity of other factor
of production is fixed. It describes the input output relation in a situation when the output is
increase by increase the quantity of one input, keeping the other inputs constant.

Numerical Example:
Units of variable Total Product (TP) Average Marginal Product (MP)
factor (L) Product (AP) {MP = % change in TP/ %
AP = TP/L change in Labor}
1 8 8 8
2 22 11 12
3 39 13 17
4 52 13 13
5 60 12 8
6 66 11 6
7 70 10 4
8 72 9 2
9 72 8 0
10 70 7 -2
11 66 6 -4

Graphical Representation:

L0 L1 L2

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Explanation:

Stage-I (Efficient Utilization of Labor)

1. Up to point F, MP is increase and positive and after that point decaling and TP is
increasing.

2. After point F, TP is increasing in diminishing rate and through stage-I.

3. AP is continuously increasing, and rises is maximum where MP and AP is equal.

4. This stage is increasing return to scale.

Stage-II (Decreasing efficiency of labor)

1. TP is increasing and diminishing and at reaches at maximum level.

2. MP is declining and become zero.

3. AP is declining.

4. This stage is decreasing return to scale.

Stage-III
1. TP is decreasing continuously.

2. MP is negative and below the x-axis.

3. AP is also declining and still positive.

4. This stage is negative return to scale.

So, stage-II is economically important and efficient because this stage TP is increasing, and
AP is greater than MP which is still positive.

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 Long-run Production Function / Equal product curve / Iso- product
curve - Isoquants and its Properties:

Long-run Production Function

An equal product curve represents all combinations of inputs which are capable of
producing the same level of output.
Since an equal product curve represents those combinations which will allow the production
of an equal quantity of output the producer would be indifferent between them.
Long run : q= f ( K, L)

Combinations Factor (X) Factor (Y)

A 5 9
B 10 6
C 15 4
D 20 3

Iso-quants and its properties

Iso-quant: An isoquant is a curve that shows all
the combinations of inputs that yield the
same level of output. An isoquant includes all
the technically efficient methods for producing
a given level of output.

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Properties of Isoquants:
 Slope downward to the right: Since the Isoquant curve shows an equal amount of
production at its different point the producer
must have to give up 1 input to use more of another
input in order to maintain the same level of
output.

 Convex to origin: An isoquant must always be

convex to the origin. This is because of the
operation of the principle of diminishing marginal rate
of technical substitution. MRTS is the rate at which marginal unit of an input can be
substituted for another input making the level of output remain the same.

 Isoquants need not be parallel: The shape of an

isoquant depends upon the marginal rate of technical substitution. Since the rate of
substitution between two factors need not necessarily be the same in all the isoquant

 No isoquant can touch either axis: If an isoquant

touches the X-axis it would mean that the commodity can be produced with OL units of

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Point K on the Y- axis implies that the
commodity can be produced with OK units
of capital and without any unit of labor.
However, this is wrong because the firm
cannot produce a commodity with one
factor alone.
Relationship between average product and marginal product:

Marginal product focuses on the changes between production totals and the quantity of
resources. Average product shows output at a specific level of input. The peak of the average
product curve is the point at which the marginal product curve and average product curve
intersect. For the points below (to the left of) this point, the marginal product of the extra
input is higher than the average product. For example, if adding another worker increases
output by more than the average product of the total labor force, then the marginal product of
the new worker will raise the average product amount. Thus, the average product curve must
be below the marginal product curve.

Similarly, if the new worker adds less product than the average product amount, the average
product curve will be above the marginal product curve (for all points to the right of the point
of intersection of the two curves). At the point of intersection, the additional worker produces
the same as the average product of the total workforce; there will be no change. The marginal

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product curve may fall to zero, showing that an additional worker will have no impact on
production; for example, if there is no more space left to work in, or if machines are working
at 100% capacity and all raw materials have been used up.

Return to Scale

The Return to Scale refers to the changes in output as

all factors change by the same proportion. Return to
Scale relates to the behavior of total output of all inputs
are varied and is a long run concert.
Return to Scale are of the following three types -
1. Increasing Return to Scale: An increasing return to scale occurs when the output
increases by a larger proportion than the increase in inputs during the production
process. Increasing returns to scale if (for any constant a greater than 1)
F(aK,aL)>aF(K,L)

2. Constant Return to Scale: A constant return to scale means that the proportionate
increase in input is exactly equal to the increase in output.The for Constant returns to
scale if (for any constant a greater than 0) F(aK,aL)=aF(K, L) (Function F is
homogeneous of degree 1)

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 3. Decreasing Return to Scale: A decreasing Return to Scale occurs when the
proportion of output is less than the desired increasing input during the production
process. The formula for Decreasing returns to scale if (for any constant a greater than
1) F(aK,aL)<aF(K,L)

 Causes of Increasing Return to Scale:

Return to Scale technical or managerial issue. Advanced industrial technology is the
existence of mass production methods over large sections of industry.
 Causes of Decreasing Return to Scale:
The most common causes are diminishing returns to management. The management is
responsible for the coordination of the activities of the various sections of the firm.

Derivation of Cost Functions from Production Functions

A cost function is a function of input prices and output quantity whose value is the cost of
making that output given those input prices, often applied through the use of the cost curve
by companies to minimize cost and maximize production efficiency.
Costs are derived functions. They are derived from the technological relationships implied by
the production function.
We will first show how to derive graphically the cost
curves from the production function. Subsequently we
will derive mathematically the total-cost function from a
Cobb-Douglas production function.

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Graphical Derivation of Cost Curves from the Production Function:
The total cost curve is determined by the locus of points of tangency of successive iso-cost
lines with higher isoquants.
Assumptions for our example:
a) Given production function (that is, constant technology) with constant returns to
scale.

b) Given prices of factors

w = 20p per man hour

r = 20p per machine hour

Iso cost and its properties and economic efficiency

Iso Cost line

In economics, an isocost line shows all combinations of inputs which cost the same total
amount [1]. It means iso cost line shows various combinations of labor and capital that the
firm can buy for a given factor prices. Iso cost line also depends on the prices of the factor
and the amount of money which a farm wants to spend. Iso cost line represents two things the
prices of productive factors and the total amount of money which a firm wants to spend.
Slope of Iso cost -line
With the change in the factor prices the slope of iso cost line will change. If the price of labor
falls the firm could buy more labor and the line will shift away from the origin. The slope
depends on the prices of factors of production and the amount of money which the firm
spends on the factors. When the amount of money spent by the firm changes, the isocost line
may shift but its slope remains the same. A change in factor price makes changes in the slope
of isocost lines as shown in figure 1.[2]

For example: a producer wants to spend TK. 300 on the factors of production, namely L and
K. The price of L in the market is TK. 3 per unit and price of K is TK. 5 per unit.

CapitalFact

Eor K

A
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 (60)

0
B D F Labor
(100)
Factor L

Figure-1: Iso-cost Line

As shown in Figure-1, if the producer spends the whole amount of money to purchase L, then
he/she can purchase 100 units of L, which is represented by OB. On the other hand, if the
producer purchases K with the whole amount, then he/she would be able to get 60 units,
which is represented by OA. If points A and B are joined on L and K axes respectively, a
straight line is obtained, which is called iso-cost line. All the combinations of L and K that lie
on this line, would have the same amount of cost that is TK. 300. Similarly, other iso-cost
lines can be plotted by taking cost more than TK. 300. In case the producer is willing to
spend more amount of money on production factors.

Properties of iso-cost:

1.It shows the combination of factors which cost the same total amount.

2.From the two factors only one factor can be used.

3.Every point of the iso-cost slope shows the same amount of cost.

4.Iso-cost curve depends on two different things the price of production factor and the total
amount of money which a firm wants to spend.

Economic efficiency of isocost

Iso-cost is process by which producer can produce maximum level of output from minimum
cost. This iso-cost helps producer to decide the best combination for their benefit. The
producer firstly finds the best combination of factor for production, then they try to find the
cost of those factor to ensure maximum profit at minimum cost.

The isocost line is combined with the isoquant map to determine the optimal production point
at any given level of output. Specifically, the point of tangency between any isoquant and an
isocost line gives the lowest-cost combination of inputs that can produce the level of output
associated with that isoquant.

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So, iso-cost is economically efficient because it gives the maximum profit from minimum
factor cost.

Producer equilibrium thought isoquant an iso cost curve

Producer’s Equilibrium

The value of all assets used for production is limited. Hence, the producer has to use
such a combination of inputs as would provide him with maximum output and profits. This
optimum level of production, also called producer’s equilibrium, is achieved when maximum
output is derived from minimum costs.

In order to achieve this, producers first have to classify their resources into different
combinations. Each combination would provide production in different quantities. The
combination that provides the highest amount of produce at the least amount of costs is the
optimum level of production.
In order to find out producer’s equilibrium, we first need to understand isoquant curves and
iso-cost lines. These two concepts help us calculate optimum production.

Isoquant Curves:
These lines represent various input combinations which produce the same levels of output.
The producer can choose any of these combinations available to him because their outputs are
always the same. Thus, we can also call them equal–product curves or production
indifference curves.
Just like indifference curves, isoquants are also negatively-sloping and convex in shape. They
never intersect with each other. When there are more curves than one, the curve on the right
represents greater output and curves on the left show less output.
Consider the table below. It shows four combinations, i.e. A, B, C and D, which produce
varying levels of output.

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 Factor combinations Units of Labor Units of Capital

A 5 9
B 10 6
C 15 4
D 20 3

Plotting these figures on a graph provides us with this curve (Figure 1):

The X-axis shows units of labour, while the Y-axis represents units of capital. Points A, B, C
and D are combinations of factors on which IQ is the level of output, i.e. 100 units. IQ1 and
IQ2 represent greater potential output.

Isocost Lines:
Isocost lines represent combinations of two factors that can be bought with different
outlays. In other words, it shows how we can spend money on two different factors to
produce maximum output. These lines are also called budget lines or budget constraint lines.
Let’s assume that a farmer has Rs. 1,000 to spend on labour costs and ploughs for farming.
The cost of one such plough and wage per labourer is Rs. 100. Considering his total outlay of
Rs. 1,000, he can spend that money in the following combinations:

10 20 30 40 50 60 70 80 90 10
Ploughs 0
0 0 0 0 0 0 0 0 0 00
10 90 80 70 60 50 40 30 20 10
Labor 0
00 0 0 0 0 0 0 0 0 0

The farmer, in this case, can either spend the entire sum of
Rs. 1,000 on just ploughs by buying 10 of them. Similarly,
he can also spend it all on labour by employing 10
labourers. He can even purchase both, labour and
ploughs using different combinations as shown above.
The total outlay of Rs. 1,000 will remain the same. Hence,
the isocost line will remain straight as shown below:

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The x-axis represents units of ploughs, and Y-
axis would show units of labour. Output levels are
shown by a straight line because they remain
constant.

Output maximization vs cost minimization

Output maximization
Definition: Profit is maximized at the level
of output where the cost of producing an
additional unit of output (MC) equals the revenue
that would be received from that additional unit
of output (MR)
Theory: A manager maximizes profit when
the value of the last unit of product (marginal
revenue) equals the cost of producing the last
unit of production (marginal cost).
Maximum profit is the level of output where
MC equals MR

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Formula: The profit-maximizing choice for a perfectly competitive firm will occur at the
level of output where marginal revenue is equal to marginal cost—that is, where MR = MC.

Cost minimization
Definition: Cost minimization is the process of reducing expenditures on unnecessary or
inefficient processes. These changes in spending can be slight or drastic, but any level of
reduction in costs will likely have a dramatic effect on maximizing profits
Theory: Cost minimization simply implies that firms are maximizing their productivity or
using the lowest cost amount of inputs to produce a specific output. In the short run firms
have fixed inputs, like capital, giving them less flexibility than in the long run.

Formula: In the cost minimization formula, the marginal product of labor divided by the
wage rate equals the marginal product of capital divided by the rental price of capital.
Efficiency in production and derivation of production possibility form

Production efficiency
Production efficiency is an economic term describing a level at which an economy or entity
can no longer produce additional amounts of a good without lowering the production level
of another product. This happens when production is reportedly occurring along a
production possibility frontier (PPF).
Production efficiency may also be referred to as
productive efficiency. Productive efficiency
similarly means that an entity is operating at
maximum capacity.

KEY TAKEAWAYS

1. Economic production efficiency refers to a level at

which an entity has reached maximum capacity.

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 2. The concept of economic production efficiency centers around the charting of a
production possibility frontier.
3. Analysts can also measure various types of production efficiency by using the equation:
Output Rate ÷ Standard Output Rate x 100.
Understanding Production Efficiency
In economics, the concept of production efficiency centers around the charting of a
production possibility frontier. Economists and operational analysts will typically also
consider some other financial factors, such as capacity utilization and cost-return efficiency
when studying economic operational efficiency.
In general, economic production efficiency refers to a level of maximum capacity in which
all resources are being fully utilized to generate the most cost-efficient product possible. At
maximum production efficiency, an entity cannot produce any additional units without
drastically altering its production process. The company will seek to gain added capacity
capabilities through lowering the production of another product.
The Federal Reserve provides a monthly report on industrial production and capacity
utilization, which can be helpful in understanding production efficiency for the
manufacturing, mining, electric, and gas utilities sectors. Analysis of production efficiency
also involves a close look at costs. Generally, economic production efficiency simultaneously
suggests that products within scope are being created at their lowest average total cost. From
this perspective, economies of scale and cost-return efficiency measures are also analyzed.
Overall, maximum production efficiency can be difficult to attain. As such, economies and
many individual entities aim to find a good balance between the use of resources, the rate of
production, and the quality of the goods being produced without necessarily maxing out
production at full capacity. Operational managers must keep in mind that when maximum
production efficiency has been reached, it is not possible to produce more goods without
drastically altering portfolio production.

Production Possibility Frontier

The production possibility frontier is central to the economic concept of production
efficiency. Theoretically, variables are charted along the x- and y-axis showing maximum
production levels that can be achieved through simultaneous production. Maximum economic
production efficiency, therefore, includes all of the points along the production possibility
frontier curve.

The PPF curve shows the maximum production level for each good. If an economy or entity
cannot make more of a good without lowering the production of another good, then a
maximum level of production has been reached. Production–Possibility Frontier: Butter &
Guns

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Measuring Efficiency
In addition to operating based on a
PPF, analysis of production efficiency
can also take other forms. Analysts can
measure efficiency by dividing output over a
standard output rate and multiplying by
100 to get a percentage. This
calculation can be used to analyze the
efficiency of a single employee, groups of employees, or sections of an economy at large.
The formula looks like this: Efficiency= Output Rate ÷ Standard Output Rate × 100. The
standard output rate is a rate of maximum performance, or the maximum volume of work
produced per unit of time using a standard method. When maximum production efficiency is
achieved for any sample under analysis then production efficiency will be at 100%. If an
economy is producing efficiently, then it will have a production efficiency of 100%.

Production Efficiency and the Service Industry---

The concepts of production efficiency typically apply to manufacturing but can also be used
within the service industry. To perform a service, resources are required, such as the use of
human capital and time, even if no other supplies are required. In these cases, efficiency can
be measured by the ability to complete a particular task or goal in the shortest amount of time
Cobb-Douglas Production Function
with an optimized level of quality output.

In economics, the Cobb–Douglas production function is a particular functional form of the

production function, widely used to represent the technological relationship between the
amounts of two or more inputs (particularly physical capital and labor) and the amount of
output that can be produced by those inputs. The Cobb–Douglas form was developed and
tested against statistical evidence by Charles Cobb and Paul Douglas between 1927 and 1947.

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According to Douglas, the functional form itself was developed earlier by Philip Wick steed.
Cobb-Douglas production function reflects the relationships between its inputs – namely
physical capital and labor – and the amount of output produced. It’s a means for calculating
the impact of changes in the inputs, the relevant efficiencies, and the yields of a production
activity. Here’s the basic form of the Cobb-Douglas production function:

Basic formula:
In this formula, Y is the quantity produced from the inputs L and K. L is the amount of labor
expended, which is typically expressed in hours. K represents the amount of physical capital

input, such as the number of hours for a particular machine, operation, or perhaps factory. A,
which appears as a lower-case c in some versions of this formula, represents the total factor
productivity (TFP) that measures the change in output that isn’t the result of the inputs.
Typically, this change in TFP is the result of an improvement in efficiency or technology.
The Greek characters alpha and beta reflect the output elasticity of the inputs. Output
elasticity is the change in the output that results from a change in either labor or physical
capital

Marginal Product:
Another concept associated with the Cobb-Douglas production function is marginal product,
which is the change in the output that results from one additional unit of a single production
factor with all other factors held constant. Or, as the economists say, ceteris parabis, which
means ‘all other things equal.’ Marginal product is measured in physical units, which is why
it is also called marginal physical product.
For example, consider a company called Wee Bee Toys. When there are no workers in the
factory, there is no output even though physical capital is present. When a single worker
shows up, three units are produced per labor hour. When two workers come in, output
increases to five units per hour.

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The addition of the labor of the second worker results in two more units per hour, or a
marginal product of two. Because the marginal product is directly related to the increase in
labor, this is also called the marginal product of labor. Had the increase in output been a
result of new technology or physical capital, the change would be marginal product of capital.

Returns to Scale
In a production function, the amount of output can change as a result of changes in the input
amounts. Returns to scale measures the change in output that results from a proportional
change to the inputs.
A constant return to scale (CRS) is when the change in output is proportional to the changes
in the inputs. If output increases from a proportional change to the inputs, we have an
increasing return to scale (IRS). A reduction in the output from a proportional change is a
decreasing return to scale (DRS).

The factors that most affect the outcome of the returns to scale calculation are the output
elasticity of the inputs. The alpha (a) and beta (b) factors in the Cobb-Douglas production
function can be used to predict the result of the returns to scale.

Elasticity of substitution

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Elasticity of substitution is the measure of the extent to which one input
substitute for another input. Elasticity of substitution is the elasticity of the ratio
of two inputs to a production function with respect to the ratio to their marginal
products.
Higher production due to high elasticity of substitution Leeds to higher
economy growth. If elasticity of substitution is low, firm is inelastic to reduce
factor cost of capital.
Elasticity of substitution production function implies that any change in the
input factors, results in the constant change in the output.

% change∈X 2 / X
ex =
1

% change∈MRS X 1 X 2
d ( x2 / x ) MRS x 1 x 2
e 1= 1
.
d ( MRS x 1 x 2 ) ( x 2/ x 1 )

Conclusion:

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The paper has analyzed in a general framework of the analysis, using, however, only simple
models, some of the outstanding features of modern industrial economies, that is,
commodities are produced by means of commodities and fixed capital goods play an
important part in the production process. It has been shown that the framework elaborated
allows a discussion of the intricate problem of the choice of technique and a consistent
determination of the dependent variables under consideration: one of the distributive
variables (the rate of profits or, alternatively, the real wage rate) and relative prices. It has
also been shown that problems such as different patterns of utilization of plants and
equipment can easily be analyzed in the present framework. The paper is designed to provide
the basis for an analysis that takes production seriously.

Reference
1. https://www.economicsdiscussion.net
2. https://www.toppr.com/guides/business-economics/laws-of-production/product
3. https://www.investopedia.com
4. https://www.studocu.com
5. https://www.researchgate.net
6. https://en.wikipedia.org
7. https://www.economicshelp.org
8. https://www.toppr.com

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