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Chapter 5. The Theory of Production Function
Chapter 5. The Theory of Production Function
Introduction - Production refers to a process by which goods and services are made available to
consumers. In other words, it refers to conversion of raw material into finished goods. And to
produce goods and services firm needs following inputs
1. Labour – skilled and unskilled labour and entrepreneur’s efforts
2. Material – steel, plastic, electricity, water etc
3. Capital – machinery, building, land, inventories and other equipments
One should know that Material is known as non factor inputs and capital and labour
together is known as factor inputs. Therefore, to produce goods firm needs factor inputs and
non-factor inputs.
This relationship between output of a good and its determinants is known by a technical term
called production function
Production function
“It is the technical relationship between factor inputs and output under given technology
and given factor price. It explains in what proportion, factor inputs should be combined to
increase the production”.
But by assuming that a firm needs only two inputs labour (L) and capital (K), the production
function is written as Q = f (L, K)
For example, the production function of wheat can be written as by assuming it needs labour and
tractor Qw = f (L, K)
Therefore, now we can define production function as:
1. It includes only technical efficient inputs that leads to minimum cost of production
All factor inputs and non factor inputs that are used in production process are of two types
a) Variable factors - These factors are those factors which are directly related to the
volume of output and amount of these factors can be changed easily in short run such as
labour, fuel and raw material, electricity supply etc.
b) Fixed factors - These factors are not directly related to the level and volume of
production and amount of this factor can’t be changed in short run like plant and
machinery, land and building etc.
2. Long run production function - It shows the relationship between change in scale of
output due to change in all factors of production. It is also known as “constant proportion
type’ production function since factor proprtions are not changed.
2 1 2:1
2 2 2:2
2 3 2:3
2 4 2:4
2 5 2:5
The production function showing relationship between inputs and output can be explained in
terms of total physical product, average physical product and marginal product.
1. Total Physical Product: It refers to the total volume of goods and services produced
during specified period of time.
TP = ∑ MP or
2. Average Physical Product: It is obtained when we divide total output by the quantities
of a variable factor.
AP = TP / L Here, L = labour i.e., No. of units of variable factor
Relationship between TP, AP, MP with the help of a schedule and graph
The relationship between TP, AP, and MP can be explained with the help of following imaginary
schedule and diagram
1. When with the increase in units of variable factors, MP of additional unit of labour
increases TP rises at increasing rate ( till 3rd unit of output)
2. After a certain level of output (from 4th unit onwards), when MP starts falling, TP starts
increasing at a diminishing rate. When MP becomes 0 (at 6th unit), TP becomes
maximum. Therefore as long as MP remains positive, TP rises.
3. When MP becomes negative (at 7th unit), TP starts falling and AP keeps on falling but
remains positive. Its economic meaning is that additional labour slows down the
production process.
1. When with the increase in units of variable factors, MP of additional unit of labour
increases AP rises at increasing rate ( till 3rd unit of output) but rise in MP > rise in AP.
2. When AP becomes equal to MP (at 4th unit), AP attains its maximum value and becomes
constant.
3. When MP starts falling, AP also falls but fall in MP > fall in AP
4. MP can be zero and negative but AP can never be zero or negative since TP always
remains positive.
Diagrammatically
1. When MP increases, TP increases at increasing rate till point A ( point of inflexion). Both
AP and MP increases but the rate of increase in MP is more than rate of increase in AP
2. When MP curve changes its slope from point of inflexion ( ponit A), TP starts increasing but
at a diminshing rate ( from point A to point H). AP curve keeps on rising and MP curve lies
above it.
3. When MP curve cuts AP curve, AP becomes maximum and constant. Therefore MP curve
can cut AP curve at its maximum point only because as long as AP rises MP lies above it
and when AP falls MP lies below it.
4. After MP = AP both start falling but rate of fall in MP is more than rate of fall in AP
5. When MP = 0, TP becomes maximum and AP falls but remains poistive and TP keeps on
rising at diminishing rate.
6. When MP becomes negative, TP falls. Its economic meaning is that additional labour slows
down the production process.
a) Due to epmployment of varibale factors on fixed factors both AP and MP increases, but
rate of increase in MP is more than that of AP as MP curve lies above AP curve
b) When MP curve cuts AP curve, AP = MP and AP reaches its maximum point and
becomes constant
c) After MP = AP, both MP and AP fall but rate of fall in MP is more then rate of fall in AP
d) MP curve can cut AP curve at its maximum point only because as long as AP rises MP
lies above it and when AP falls MP lies below it.
e) MP can become zero and negative but AP always remains positive.
Introduction - The law of variable proportion was initially called the law of diminishing
returns by Marshall. Marshall applied this law only to agriculture. Joan Robinson, Stigler and
other modern economist called it the law of variable proprtion which could be applied in all
sectors of the economy.
Fixed Variable MP TP
factor factor
(Land)
1 0 - -
2 1 3 3 Increasing
3 2 4 7 return
4 3 5 12
5 4 4 16 Decreasing
6 5 3 19 return
7 6 0 19
8 7 -3 16 Diminishing
return
1. Better utilization of fixed factor – When in the beginning the variable factor is relatively
smaller in quantity, some amount of fixed factor remains unutilized. So, when more and
more units of variable factor are employed on fixed factor, the fuller and efficient utilization
of fixed factor become possible due to which both AP and MP rise of variable factor rises
and TP increases at increasing rate.
1. Breaking of optimum combination – When the optimum combination of fixed and variable
factors is reached, then further increase in the amounts of variable factors lead to decline in
MP. It is because fixed factor becomes inadequate in relation to the quantity of variable
factor and as a result variable factor gets less and less aid from the fixed factor.
2. Imperfect substitution – Factors of production are not perfect substitute of each other.
Therefore, we can’t substitute more and more units of labour in place of capital and vice
versa. Therefore, beyond the optimum limit they become imperfect substitution which leads
to diminishing return
2. Management problem – Use of too much of a variable factor say labour also creates the
problem of effective management. When there are too many workers, it becomes difficult to
manage them. The labourers can avoid the work
4. The period of time in which the plant capacity can be varied is known as:
(a) Short run (b) Long run
(c) Both (a) and (b) (d) Neither (a) nor (b)
5. _____________is the extension of "Law of Diminishing Returns".
(a) Law of Variable Proportions (b) Law of Demand
(c) Law of Equi-marginal utility (d) Law of Diminishing Marginal Utility
6. Law of Variable Proportions is also known as:
(a) Law of Returns (b) Returns to Variable Factor
(c) Law of Returns to Factor (d) All of these
7. The maximum possible output for a firm with two units of labour (L) and ten units of capital
(K), if its production function is given as: 5L + 2K
(a) 0 units (b) 30 units
(c) 200 units (d) 50 units
8. Identify the phase in which TP increases at an increasing rate and MP also increases.
(a) Increasing returns to a factor (b) Diminishing returns to a factor
(c) Negative returns to a factor (d) None of these
9. Which of the following is not a reason for operation of increasing returns to a factor?
(a) Better utilisation of fixed factor (b) Limitation of fixed factor
(c) Increase in efficiency of variable factor (d) Indivisibility of fixed factor
17. Which phase of Law of Variable Proportions has been ruled out on the grounds of technical
inefficiency:
(a) Increasing returns to a factor (b) Diminishing returns to a factor
(c) Negative returns to a factor (d) None of these
18. A rational producer always aims to operate in__________ of Law of Variable Proportions:
(a) 18t Phase (Increasing returns to a factor)
(b) 2nd Phase (Diminishing returns to a factor)
(c) 3rd Phase (Negative returns to a factor)
(d) Either 1st Phase or 2nd Phase
19. In general, most of the production functions measures:
(a) Productivity of factors of production
(b) Economical relation between the factors of production
(c) Technical relation between inputs and output.
(d) None of these
20. Product per unit of labour employed is termed as:
36. The total output generated by the first four units of variable input is 200 units, 350 units, 450
units and 500 units. The marginal product of the third unit of input is:
(a) 50 units (b) 100 units
(c) 150 units (d) 200 units
Ans. 1. (a); 2. (b); 3. (d); 4. (b); 5. (a); 6. (d); 7. (b); 8. (a); 9. (b); 10. (c); 11. (a); 12. (d); 13. (b);
14. (b); 15. (c); 16. (d); 17. (c); 18. (b); 19. (c); 20. (a); 21. (a); 22. (b); 23. (b); 24. (d); 25. (b);
26. (b); 27. (i - c, ii - d, iii - b);
28. (b); 29. (a); 30. (d); 31. (c); 32. (a); 33. (a); 34. (a); 35. (b); 36. (b)