Production Function

Production refers to transformation of inputs into outputs. There exists some

relation between inputs and outputs of a firm. In Economics, such a relationship
is known as production function. Production function is an expression of the
technological relation between physical inputs and outputs of a good. A
production function can be an equation, table or graph showing a maximum
amount of a commodity that a firm can produce from a given set of inputs during
a period of time.

The concept of production function describes the ways in which a firm uses its
factors of production and combines them to produce different level of outputs. It
shows the minimum set of inputs required to produce a given level of output or it
shows the maximum level of output that can be produced with the given level of
inputs. Production function can be symbolically written as,

OX = f (i1, i2, i3 …….in)

Where,

OX = Output of commodity X
f = Functional relation
i1, i2, i3 …….in = Inputs needed for OX

Suppose a firm is manufacturing chairs by using two inputs -labour and capital.
The production function can be written as,

OChairs = f(L,K)

The concept of production function defines the maximum number of chairs which
can be produced with the given labour and capital. If the production function is
given as 250 = (7L,2K), it means that 7 units of labour and 2 units of capital can
produce a maximum of 250 chairs.

A production function either specifies the maximum outputs that can be produced
with the given amount of inputs or the minimum inputs required to produce a
given level of output. It establishes a technical relationship between inputs and
outputs. The production function only includes technically efficient methods of
production and no rational consumer will use inefficient methods.

Short Run and Long Run Production Function

Before we move on to short run and long run production function, we need to first
take a look at the two types of factors of production – variable factors and fixed
factors.

1. Variable Factors – Variable factors refer to those factors which can be

changed in the short run. They vary directly with the level of output. As
output increases, requirement for variable factors also rises and vice
versa. Variable factors are not required in case of zero output. For
example, raw material, casual labour, power, fuel etc.
2. Fixed Factors – Fixed factors refer to those factors which cannot be
changed in the short run. The quantity of fixed factors remain the same in
the short run irrespective of the level of output. They do not change
whether the level of output rises, falls or becomes zero. For example, plant
and machinery, building, land etc.
Let us now understand what is meant by short run and long run production
function.

Short Run Production Function

Short run refers to a period in which output can be changed by changing only
variable factors. In the short run, fixed factors like plant, machinery, building etc.
cannot be changed. Therefore production can be raised only by increasing
variable factors, but till the extent of the capacity of the fixed factors.

For example, if a producer wants to increase output in the short run, he can do
so by using more raw materials or increasing the number of workers with the
existing factory building, plant and equipment. One cannot immediately expand
factory building, additional plant and equipment. So, in the short run, some
factors are fixed and some are variable and fixed factors cannot be changed
during such a short span of time.

The period of short run is not a fixed time span. The period is a rather functional
concept, which depends on production conditions. It varies from firm to firm and
industry to industry.
The short run production function studies the effect on output due to change in
variable inputs, assuming that there is no change in other factors. As there is
change in variable input only, the ratio between different inputs tends to change
at different levels of output.

Long Run Production Function

Long run refers to a time period in which output can be changed by changing all
factors of production. In long run, there are no fixed factors as all factors can be
varied. Long run is a period long enough for the firm to adjust all its inputs
according to change in the conditions. In the long run, a firm can change its
factory size, switch to new techniques of production, purchase new machinery
etc. All factors are variable in the long run.

Therefore, if a producer wants to increase his output in the long run, he can do
so by changing any of the factors of production, including factory building, plants
machinery etc.

The long run production function studies the effect on output due to change in all
the factors inputs. As all inputs are variable in the long run, the ratio between
different inputs tend to remain the same at different levels of output.

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Product or output refers to the volume of goods produced by a firm or an industry

during a specified period of time. The concept of product can be considered from
three different angles – Total Product, Marginal Product, Average Product.

Total Product (TP)

Total Product (TP) refers to the total quantity of goods produced by a firm during
a given period of time with the given number of inputs. For example, if 10
labourers produce 60 kg of rice, then the TP is 60 kg. In the short run a firm can
expand TP by increasing only the variable factors. However, in the long run, TP
can be raised by increasing both fixed and variable factors. TP is also known as
‘Total Physical Product (TPP)’ or ‘Total Return’ or ‘Total Output’.

Marginal Product (MP)

Marginal Product (MP) refers to the addition to TP, when one more unit variable
factor is employed. MP can be written as,

MPn = TPn – TPn-1

Where,
MPn = MP of nth unit of variable factor
TPn = TP of n units of variable factor
TPn-1 = TP of (n-1) units of variable factor
n = number of units of variable factor

For example, if 10 labourers make 60 kg of rice and 11 labourers make 67 kg of

rice, then MP of the 11th labour will be

MP11 = TP11 – TP10

MP11 = 67-60 = 7 kg

We now know that MP is the change in TP when one more unit of variable factor
is employed. However, when change in variable factor is greater than one unit,
then MP can be calculated as,

MP = Change in TP/ Change in units of Variable Factor

MP = ΔTP/Δn

Suppose 2 labourers produce 60 units and 5 labourers produce 90 units, then

MP will be,

MP = 90-60/5-2 = 30/3 = 10 units

Average Product (AP)

Average product (AP) refers to output per unit variable input. For example, if TP
is 60 kg of rice, produced by 10 labourers (variable input), then AP will be 60/10
= 6 kg.

AP is obtained by dividing TP by number of units of variable output. AP can be

written as,
AP = TP/Units of variable factor (n)

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In the short run, the output is affected due to change in variable input, assuming
no change in other factors. As there is change in variable input only, the ratio
between different inputs tends to change at different levels of output. This
relationship is explained by Law of Variable proportions. Before we move on to
the law of variable proportions, let us take a look at what is meant by returns to a
factor.

Law of Variable Proportions

Returns to a Factor
Returns to a factor refers to the resultant increase in the total product (return)
when only one factor is increased, keeping all other factors fixed. In the short run,
when one input is variable and all other inputs are fixed, the firm’s production
function exhibits the law of variable proportions. The law of variable proportions
is one of the most important laws of production. It shows the nature of the rate of
change in output due to a change in only one variable factor of production.

Statement of Law of variable

Proportions
Statement of Law of Variable Proportions states that as we increase
quantity of only one input keeping other inputs fixed, total product (TP)
initially increases at an increasing rate, then at a decreasing rate and finally
at a negative rate.

According to the Law of Variable Proportions, the changes and behaviour of TP

and MP can be classified into three phases. Let us understand each phase with
the help of a diagram.
Phase I – Increasing Returns to Factor
In the first phase every additional unit of variable factor adds more and more to
the total product. TP increases at an increasing rate and MP of each variable
factor rises. As seen in the diagram, TP increases at an increasing rate till point
A and MP rises till it reaches point B. This is because, in this phase the fixed
factors are too large and the variable factors are few. Therefore adding more and
more units of variable factors leads to better utilisation of the fixed factors and
thus TP increases at an increasing rate.

Phase II – Diminishing Returns to a Factor

In the next phase, every additional unit of variable factor contributes lesser and
lesser to the total output. TP increases at a diminishing rate and MP of each
variable factor decreases. In the diagram, TP rises till it is maximum at point M
and MP decreases till it is zero at point S. When TP is maximum, MP is zero.
Diminishing returns occur in this phase because, the optimum use of fixed factor
has already been made after which the marginal return of variable factors start to
diminish. Another contributing reason is that fixed factors and variable factors are
imperfect substitutes for one another.

Phase III – Negative Returns to a Factor

In the third phase, the additional units of variable factor cause the TP to decline
and MP becomes negative. Thus, this phase is known as negative returns to a
factor. The third phase starts after point M on the TP curve and point S on the
MP curve. In this phase MP of each variable factor is negative. This is because
of the limitation of fixed factors, poor coordination between variable and fixed
factors and decrease in efficiency of variable factor.
Assumptions of Law of Variable Proportions
1. It operates in the short run, as factors are classified as variable and fixed.
2. The law applies to all fixed factors including land.
3. Different units of different variable factors can be combined with fixed
factor.
4. This law applies to the field of production only.
5. The effect of change in output due to change in variable factor can be
easily pin-pointed.
6. Factors of production are imperfect substitutes of each other beyond a
certain limit.
7. The level of technology is constant.
8. All variable factors are assumed to be equally efficient.
Phase Operation
A rational producer will always prefer to operate in the second phase of the law
of variable proportions. In Phase I every additional unit of variable factor gives
increasing amount of output. This means that more profits can be made and the
producer increases production with more units of variable factor.

In the third phase of the law of variable proportions, marginal product of

additional units of variable factors is negative and the total product is declining.
This means that the producer will lose profits. Therefore, no rational consumer
will choose to operate in this phase. This concludes that a produce will aim to
operate in the second phase as TP is maximum and MP is positive

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There is a unique relationship between total product (TP) and marginal

product (MP) and between marginal product (MP) and average product
(AP). It is very important to understand the relationship between these

concepts in order to understand the process behind production by firms.

Relationship between Total Product

and Marginal Product
The relationship between TP and MP is explained through the Law of Variable
Proportions. As long as the the TP increases at an increasing rate, the MP also
increases. This goes on till MP reaches maximum. When TP increases at a
diminishing rate, MP declines. This continues till the point where TP is at its
highest. When TP reaches its maximum point, MP becomes zero. This concept
can be better understood with the help of the following schedule and diagram.

As you can see in the graph, TP increases at an increasing rate till point P, the
point of inflextion, and till that point (i.e. the 2nd unit of variable factor), MP
increases. Then, as the TP start increasing at a diminishing rate till point M when
TP is maximum., the MP keeps declining and reaches zero at point N. This
happens at the 6th unit of variable factor. After this point, the TP start decreasing
and MP becomes negative, which can be seen when the 7th unit of variable
factor is employed.

Relationship between Marginal Product

and Average Product
The marginal product (MP) and average product (AP) initially increase and then
decrease due to the operation of the Law of Diminishing Marginal Returns. As
long as MP is higher than AP, AP increases. At the highest point of AP, i.e. when
AP is at its maximum, MP is equal to AP. When MP becomes lesser than AP, AP
also starts to fall. Thereafter, both AP and MP fall, but MP becomes negative and
AP remains positive. Also, MP falls at a faster rate as compared to AP. This can
be better understood with the help of the following schedule and diagram.
As seen in the above given graph, as long as MP is more than AP, AP rises, i.e.
till the 2nd unit of variable factor. When MP and AP become equal at the 3rd unit,
AP is at its highest. When MP becomes less than AP, from the 4th unit of
variable factor, AP falls. After that, both MP and AP fall but the curve of MP is
steeper than that of AP, and AP remains positive while MP becomes negative.