MODULE 3

PRODUCTION ANALYSIS
1. What do you mean by production?
It is the process of creation of utility or value. Production is the transformation of resources
into commodities over time and space. Inputs like land,labour ,capital , organization are
transformed into output for satisfying human wants
2. What do you mean by Production Function?
The functional relationship that exists between inputs and outputs of a firm is called
production function. The functional relationship under the given technology between physical
rates of input and output of a firm per unit of time. Physical inputs are the factors of the
production such as land ,labour, capital and organization. Physical outputs are the quantity of
goods produced. Production function shows the maximum quantity of output that can be
produced during a particular period with a certain quantity of inputs under the prevailing state
of technology.
This can be expressed in the form of an equation
Q=f(L,L1,C,M,T)
Where Q- stands for output
L- denotes land employed in the production
L1-denotes labour used in the production
C- implies capital invested in production
M-stands for management exercised for production
T- technology employed in production
f-signifies the ‘function’

3. What are the managerial uses of production function?

• Helps in decision making
• To find out the least cost combination
• Helps in increasing production
• Substituting costly inputs
• Cost control and cost reduction
4. Explain Cobb-Douglas Production Function
The production function formulated by C W Cobb and Paul H Douglas of
USA is popularly known as Cobb-Douglas production function
 Where Q=output
L=units of labour input
C=units of capital inputs
K=constant which represents the state of technology or productivity of the
system
a=positive fraction expressing the proportion between inputs

• According to Cobb-Douglas production function the marginal product of labour

decreases as the amount of labour input increases and it increases as the amount of
capital increases.In the same way marginal product of capital decreases as the amount
capital input increases
• Cobb – Duglas production function has originated from the study of production
function of the manaufacturing industries in USA.Since this production function is a
general form of statistical equation ,it applies to the whole of the United States
manufacturing industries and not to any particular industry or firm.Their study reveals
a unit of output needs .75 units of labour and .25 unit of capital.The value of k =1.01

It means that for any given amount of United States national production 75% of that
product is attributable to labour input and 25% to capital inputs.
• The Cobb –Douglas production function establishes the proportion of distribution of
output between labourers and capitalists

5. Explain economies and diseconomies of scale (Previous QP)

Economies of scale refers to the benefits of large scale operation .When a firm expands
its size or increases the scale of operation the average cost of production decreases and
it ultimately leads to profit maximization
• Economies of scale are grouped into 2-internal and external economies
1.Internal economies
o Associated with the size of business. It is inherent in the techniques of production and
other allied activities of a firm
o Six kinds of internal economies
1.Technical economies
These are benefits from the use of most modern machines and equipment.
Mechanisation helps mass production leading to cost reduction and improvement of quality
2.labour economies
These are economies on employment of large number of employees. Number of
workers of a firm increases with the expansion of scale of operation. This leads to
division of labour and specialization
3.managerial economies
 Large firms can afford to employ well qualifies specialists to head different
functional departments like production , fibnance ,marketing . The ultimate result is
that it increases efficiency and reduces loss due to ignorance, delay and inexperience
4.commercial economies
Refers to economies in purchase and sales. Also known as economies in
transport and storage. Large firms can make bulk purchase of materials at favouable
terms. Bulk buying reduces cost of transportation. These firms are unaffected by
temporary price fluctuations
5.financial economies
A large firm gets liberal credit facilities from suppliers of materials. It can
borrow money very easily from banks and other financial institutions on the security of
its assets at cheap rates.it may issue debentures and receive public deposits. A large
firm enjoys benefit of lowest cost of capital
6.Risk bearing economies
A large firm can withstand temporary set backs with its large resources.it can
withhold sales during the period of depression and create demand for the product by
manipulating controllable demand determinants. It can diversify product ,market and
supply
2.External economies
It refers to benefits common to all the firms located in a particular area
• Improvement in transportation and communication facilities
• Improvement I n power supply
• Establishment of firms for supply of raw materials
• Development of facilities for service and repairs
• Development of banking system and increase credit facilities
• Growth of marketing and advertising agencies
• Establishment of trade associations and dissemination of information connected
to trade and industry
• Establishment of technical institutions and training centers
Diseconomies of scale
• The loss due to the increase in the scale of operation
• For example diseconomies of scale occur when the number of workers are more than
optimum . Here the facility available for work will be low and the supervision will be
difficult . The labour productivity decreases and the cost of production increases as a
result profit declines
• Diseconomies of scale also occur due to external factors like over crowding of firms in
the area. This causes bottleneck in transportation , power failures ,marketing difficulties
, accommodation problems etc. These problems result in increase in cost of production
and decrease in profit
6. What do you mean by TP,AP,MP / Explain different concepts of product
(Previous QP)
1.Total Product(T.P) or Total Physical Product(TPP)
Total product is the total physical output corresponding to each set of input
2.Average Product(A.P)or Average Physical Product(APP) (Previous QP)
 Average product is the output produced per unit of the variable factor input employed
AP= Total Product(TP)/No of variable factor units(n)
3.Marginal Product(MP)or Marginal Physical Product(MPP)
Marginal Product is the addition to the total product .It is the addition to the total
product from the use of an additional unit of variable factor employed.Variable factor is the
factor input which is varied at various levels of product

7.Explain Law of Diminishing Returns or Law of Variable Proportion(Previous QP)

o It is one of the fundamental laws of economics. The law explains the input out put
relation when the output is increased by putting more and more units of one variable
input
o The law states that when additional units of a variable factor are applied to the fixed
factors of production ,after a certain point ,each successive unit of the variable factor
brings forth a less than proportionate increase in the total output
o It means that addition of each variable input causes an an increase in the total output
beyond a certain point at a diminishing rate
o According to Mrs .Joan Robinson the law of diminishing returns states that with a fixed
amount of any factor of production ,successive increase in the amount of other factors
will, after a point yield diminishing increment of the product
o With the successive addition of a variable input ,the total product increases ,while after
a certain point ,both the average product and marginal product go on decreasing
8.Explain Law of Returns to Scale(Previous QP)
• The law that deals with production function in the long run is called law of returns to
scale
• In the long run it is possible to vary all inputs. The law explains how a simultaneous
and proportionate increase in all the inputs affects the total output
• Law of returns to scale has 3 phases depending on the magnitude of effect on output
due to simultaneous change in all inputs. The increase in output may be proportionate ,
or more than proportionate or less than proportionate
• If the increase in output is more than proportionate to the increase in input it is
increasing returns to scale . If the increase in output is proportionate to increase in input
,then it is constant returns to scale . If the increase in output is less than proportionate
to increase in input it is diminishing returns to scale
1.Increasing Returns to Scale
Means output is more than proportionate to the increase in input. Increasing returns
refers to increase in productivity. It occurs when the increase in output is more than
proportionate to the increase in all factors of production in the same ratio
For example increase of all factors of production by 50% leads to more than 50%
increase in output
Increasing returns to scale also leads to increase in average product and marginal
product
 Factors Total Product Average Marginal
combination Product product
1 15 15 (15)
2 36 18 21
3 63 21 27

2.Constant Returns to Scale

• It means increase in output is proportionate to increase in input .Constant returns to
scale implies no change in productivity ie ; production increases proportionate to the
increase in the input factors without any change in their composition
• It is the second phase of operation of the law of returns to the scale and it sets in as
soon as the first phase ie; the increasing returns to sacle ,ends
• When constant returns to scale occurs ,the average product and marginal product
continues to be the same and the total product changes proportionately

Factors Total Average Marginal

combination(units) Product Product Product
1 90 90 (90)
2 180 90 90
3 270 90 90

▪ Constant returns to scale operates only for a short period.This comes into operation
when economies of scale are neutralized by the diseconomies of scale
3.Diminishing Returns to Scale
▪ Diminishing returns to scale means increase in output is less than proportionate to
increase in inputs
▪ Denotes decrease in productivity
▪ Here the total product increases but at a diminishing rate.It means that proportionate
increase in all inputs results in less than proportionate increases in output
Factor Total Average Marginal
combination(units) Product Product product
1 144 144 (144)
2 264 132 120
3 366 122 102

▪ When diminishing returns to scale operates the average product and marginal product
decrease with each successive addition of input factors in the same proportion .
However the total product goes on decreasing .This tendency will not last long
▪ After a particular stage the addition of each batch of input reduces both the total product
and average product and marginal product becomes negative
▪ Diminishing returns to scale is attributed to the diseconomies of large scale production
. It is because when a firm expands beyond limits the management becomes difficult
.Such firms are often exposed to problems like material shortage ,frequent power
failures etc

9.Explain graphically the concept of Isoquant? (Previous QP)

▪ An isoquant is a contour line drawn through the set of points at which the same quantity
of output is produced while changing the quantities of two or more inputs
▪ The term isoquants is derived from the terms ”iso” and “quant” and it means equal
quantity
▪ An isoquant curve shows all possible combinations of two inputs ,capital and labour
,which can produce a particular quantity of output

Combination Factor Factor Output(units)

C(units) L(units)
A 10 10 100

B 8 15 100

C 6 22 100

D 4 32 100
10.Explain Properties /Characteristics of Isoquants (Previous QP)
1.Isoquants slope downwards
The downward slope of isoquants from left to right shows that an increase in the
employment of one factor of production causes a decreases in the employment of the
other factor of production . For example an increase in the capital input reduces the
labour input , if the level of output remains the same
2.Isoquants never intersect
The isoquants cannot cut each other .This is because a particular combination of inputs
cannot produce different levels of output. Higher level of output needs larger
combinations of inputs and vice versa . If the isoquants intersect it means that the same
input combination can produce different quantities of output with the same techniques
of production . This is impossible and unrealistic
3.Isoquants are convex to the origin
Isoquants are convex to the origin because of the operation of the law of diminishing
marginal rate of technical substitution . Marginal Rate of Technical Substitution
(MRTS) is the rate at which one input factor is substituted by another input factor in
order to get the same output . The slope of isoquants indicated the rate of substitution
between the two inputs
11. What do you mean by Optimum Combinations of Inputs/Least Cost input
combination
A certain quantity of output can be produced with different input combinations .The
cost of each combination varies and only one of the combinations gives the minimum.
The combination which is most economical or which bears the least cost is the
‘optimum input combination’. The optimum input combination to produce a given
output level is given by the point of tangency of the isoquant to an isocost line
12.Explain the concept of Optimum firm(Previous QP)
Optimum firm is that firm which fully utilizes its scale of operation and produces optimum
output with the minimum cost per unit of production. Optimum firm will have the most efficient
size. In the short run a firm would build the scale of plant and operate it at a point where the
average cost is at its minimum. This is the optimum level of production for the firm. In the long
run all inputs are variable and the firm can build larger plant size or use smaller plants to deal
with changed demand for the product. The point at which per unit cost is minimum ,will be the
optimum level of production. At this point the firm will have the most efficient size in the long
run
13. Explain Role of Law of Diminishing Returns in Decision Making(Previous QP)
1. It shows production function at different stages of production and at different
combination of various input factors like fixed factors and variable factors
2. It helps to know the optimum level of production and optimum combination of inputs
.At this stage the marginal product and average product will be same
3. It facilitates the adoption of marginality principle .The principle underlines the need for
cost benefit analysis before taking business decisions
14.Why two Isoquants never intersect which each other? (Previous QP)
The isoquants cannot cut each other .This is because a particular combination of inputs
cannot produce different levels of output. Higher level of output needs larger combinations of
inputs and vice versa . If the isoquants intersect it means that the same input combination can
produce different quantities of output with the same techniques of production . This is
impossible and unrealistic
15. State the assumptions of Law of diminishing returns (Previous QP)
1.Only one factor is varying
The law assumes that only factor is varying while others are keeping constant .This is
dome inorder to find the effect of a particular variable input on the output
2.Homogeneous
The law assumes that all units of the variable factor are homogeneous ie they are
identical in size or productivity
3.Measured in physical units
The law of diminishing marginal returns assumes that the product is measured in
physical units
4.No change in technology
The law of diminishing returns operates only under a given state of technology.The law
assumes that there is no change in technology
5.Indivisible fixed input
The law assumes that the capacity of fixed input cannot be divided and used for
other production
6.Short run situation
The law of diminishing returns assumes a short run situation