Production Function

“The theory of production consists of how the producer, given the state of technology
combines various inputs to produce a definite amount of output in an economically efficient
manner.” - Ferguson

Production is a process of combining various inputs to produce an output for consumption.

Production theory is necessary for the business for the business for taking decisions on what
should be sale of each commodity and how much it produces and how much of raw material,
fixed capital and labour should be used.

Theory of production defines the relationship between prices of the product and factors, and
quantities of the product and factors. Theory of production is basically concerned with two
major things:

 Production Function
 Law of production or laws of returns

Production Function:

The production function of a business is the connection between the inputs used and the
output produced by the business. For different amounts of inputs used, it gives the maximum
amount of output that can be produced.

“The production function is a purely a technical relation which connects factor inputs and
output.” -Koutsoyiannis

“Production function is the relation between a firm’s physical production (output) and the
material factors of production (inputs).” -Prof. Watson

“The production function is a technical or engineering relation between input and output. As
long as the natural laws of technology remain unchanged, the production function remains
unchanged.” –Pro. L. R. Klein

“The relationship between inputs and outputs is summarized in what is called the production
function. This is a technological relation showing for a given state of technological
knowledge how much can be produced with given amounts of inputs.” –
Prof. Lipsey

The production function is clarified for the provided technology. It is the technological
knowledge that regulates the highest degrees of output that can be produced using various
combinations of inputs. As the technology improves, the maximum output levels achievable
for various combinations of inputs will increase. We now have a new production feature.

The inputs that a business uses in the production process are called factors of production. A
firm may require any number of different inputs to produce an output. Consider a firm that
produces output using only 2 factors of production –
  Labour
 Capital

The production function, explains the maximum amount of output (Q) that can be produced
using different combinations of these 2 factors of production labour (L) and capital (K).

We can write the production function as:

Q = ƒ (a, b, c, -----------, z) -------------------(i)

Where Q is the level of output and a, b, c, -----------, z are inputs like land, labour and capital.

If there is only two inputs labour (L) and capital (K) then (i) can be rewritten as

Q = ƒ (L, K)

Contemplate the farmer is mentioned in the introduction to the concept of Production and
Costs. Suppose a farmer uses only 2 inputs to produce rice: labour and land. The production
function tells us the maximum amount of rice it can produce given the amount of land it uses
and the given number of hours of work it does. Suppose he uses 2 hours of labour per day and
1 hectare of land to produce a maximum of 2 tons of rice. Then the function that explains this
connection is called the 'production function'. One possible example of the form this could
take is: Q = K × L, where q is the amount of rice produced, K is the area of land in hectares,
L is the number of hours of work done per day.

Important Features of Production Function

The salient features of the production function are as follows: –

1. Substitutability: – Thus, the quantity of any output can change with changes in the
quantity of even one input while other factors remain constant.
2. Complementary: – So a producer can produce output by mixing factor inputs together.
If the quantity of any input is zero, no output can be produced.
3. Specificity: – For the production of a specific product, for example, raw materials,
specialized labor, machines and equipment can be used. However, all these factors of
production are not completely specialized, as they can also be used in the production
of other products.
4. Manufacturing Time: – Manufacturing any type of product takes time. Production can
only be possible in the long term. In the production function, a change in total output
is caused by a change in the input quantity. The amount of one input can be possible
in a short period of time.

Production Analysis

The analysis in which resources i. e., inputs are employed to produce vital product. The input
are classified into two groups i.e., variable and fixed inputs.
Variable inputs: The inputs which can be changed (variables) in the short or long period are
called variable inputs.

Fixed Inputs: The inputs that remain constant in the short period are called fixed inputs.

Laws of production

Laws of production or laws of returns are classified in two categories:

 Law of variable proportion or law of return to factor

 Law of return to scale

Law of
Production

law of law of return

variable to scale
proportion
Law of variable proportion

“The law of variable proportions states that if the inputs of one resource are increased by
equal increments per unit of time while the inputs of other resources are held constant, total
output will increases, but beyond some point the resulting output increases will become
smaller and smaller.” –Leftwitch

“The law states that an increase in some inputs relative to other fixed input will, in a given
state of technology, cause total output to increase; but after a point the extra output resulting
from the same addition of extra inputs is likely to become less and less.” -
Samuelson

The law of variable proportion is considered an important theory in economics. It is referred

to as the law that states that when the quantity of one factor of production increases while all
other factors remain constant, the marginal product of that factor will fall.
If a producer increases units of a variable factor while keeping other factors fixed, then total
product initially increases at an increasing rate, then increases at a decreasing rate, and finally
begins to decrease.

The Law of Variable Proportions states that as the amount of a factor increases while other
factors remain constant, the total product first increases at an increasing rate, then increases at
a decreasing rate, and then decreases. Schedule – There are three law degrees with a variable
proportion.

Assumptions

The law has following assumptions:

1. One of the factors is variable while all other factors are fixed.

2. All units of the variable factor are homogeneous.

3. There is no change in the production technique.

4. Factors of production can be used in different proportions, e.g. 2 hectares of land with 1
worker; or 2 hectares of land with 4 workers etc.

Explanation of Law of variable proportion

This law shows short-run production functions in which one factor changes while the others
are fixed. Also, when you get extra output when using another unit of input, then that output
is either equal to or less than the output you get from the previous unit.

The law of variable proportions deals with how the output changes when you increase the
number of units of the variable factor. So it means the effect of changing factor ratio on
output.

The law states that, holding other factors constant, when you increase a variable factor, then
total product initially increases at an increasing rate, then increases at a decreasing rate, and
finally begins to decrease.

Law of variable proportion can be explained with the help of table:

Units of Units of Total Marginal Average

Land Labour Product Product Product
1 1 2 2 2
1 2 5 3 2.5
1 3 9 4 3
1 4 12 3 3
Beginning of the stage II
1 5 14 2 2.8
1 6 15 1 2.5
1 7 15 0 2.1
End of the stage II
 Beginning of the stage III
1 8 14 1 1.75

Law of variable proportion graphically:

TP

TP

Stage I Stage II Stage III

Labour

Increasing Return Diminishing Return

Negative Return

AP

MP

Graph makes it clear that:

Up to four units of labour employed, total product which is 2, 5, 9, 12 can be said to be

increasing at increasing rate is the stage I of the law (Increasing Return). Therefore first stage
is presented by TP increasing significantly.

It is noted that beyond 4th unit of labour, TP has increased to 14, 15, which means it is
increasing at decreasing rate. It is obvious that contribution of labour i.e. MP has started
falling. This portion of TP signifies diminishing return.

After 6th unit of labour, the values of TP are factually falling. This is the stage of negative
return. After 6th unit of labour MP=0. As TP curve slopes down, the MP has entered in the
negative territory.

Relation between TP, MP and AP

Systematically memorised:

1. TP increases at increasing rate, MP and AP also increase, but in the stage MP>AP.
2. TP increases at decreasing rate MP and AP decreases, but fall in AP is low. Here
MP<AP.
3. TP fall, MP is negative, but AP is falling but remains positive (i.e. above x-axis)
4. MP and AP intersect at point when AP is maximum and here MP=AP

Kinds of Laws of production

There are three different phases in the law:

1. Returns to factor
2. Returns to scale
3. Isoquant

Phases of law of return to factor

Classical economists used to study Laws of Returns mainly in three parts:

1. Increasing Returns to a factor

2. Decreasing Returns to a factor
3. Constant Returns to a factor

Increasing return to a factor: In this part of the law, output increase at an increasing rate, as
more of variable inputs (factor) can be mixed with fixed factor. In this part marginal product
of the variable factor is increasing which means marginal price of production is diminishing.

“An increase of labour and capital leads generally to improved organisation which increases
the efficiency of the work of labour and capital. Therefore, an increase of labour and capital
generally gives a return which increases more than in proportion.” - Marshall

“As the proportion of one factor in a combination of factors is increased, up to a point, the
marginal productivity of the factor will increase.” - Benham

Diminishing return to factor: In this part output increase at diminishing rate as more of
variable factor is combined with a fixed factor. In this case MP of the factor is diminishing.
The marginal cost of production must be increasing.

“As we increase the quantity for any one input which is combined with fixed quantity of
other inputs, the marginal physical productivity of the variable inputs must eventually
decline.” –
Boulding

“As the proportion of one factor in a combination of factors is increased after a point, the
marginal and average product at that factor will diminish.” – Prof. Benham
Constant return to factor: In this part, output increase at a cost constant rate as more of
variable factor (input) does not result in increasing the marginal product of the factor, rather
MP of the factor has stabilised.

“Constant returns to a factor occurs, when additional application of the variable factor
increases output only at a constant rate.” - Hanson

Returns to scale

The relationship between outputs when all inputs have changed simultaneously is explained
with the help of return to scale. The scale here means that inputs are changed in the same
direction and proportion.

“Returns to scale relate to scale refers to the behaviour of total output as all inputs are varied
and is a long run concept.” - Leibhafasky

“The term returns to scale refers to the changes in output as all factors change by the same
proportion.” - Koutsoyiannis

There are three returns in the relationship between output and input:

 Increasing return to scale

 Decreasing return to scale
 Constant return to scale

Returns to scale can be explained with the help of table:

Percentage
increase in Percentage
Units of Units of Labour and Total increase in Return to
Labour Capital Capital Product Total Product Scale
1 2 10
2 4 100% 30 200%
3 6 50% 60 100% Increasing
4 8 33% 80 33%
5 10 25% 100 25% Constant
6 12 20% 110 10%
7 14 16% 120 9%
8 16 14% 125 4% Decreasing

Increasing returns to scale: If all inputs are doubled, then output increases by the same
amount. The main cause of its operation is that when scale of production is increased then
due to division of labour and specialization many types of economies are available. On
account of these economies, proportional increase in returns is more than increase in factors
of production.

Y Q

% increase in output

% increase in all factor inputs

Diminishing return to scale: If all inputs are doubled then output increases by the less than
two times. The main cause of its operation is that diseconomies outweigh economies of scale.

% increase in output

%increase in all factors input

Constant returns to scale: If all inputs are doubled, then output increases by the same
amount. This function states that if labour and capital are increased in equal proportion then
output will also increase in the same proportion.

% increase in output

% increase in all factor inputs

Isoquant
Isoquant is the geometric way of presenting production function. Various combinations of
inputs give the same output is the idea behind the isoquant – iso means same quant means
quantity (same output).

Characteristic of Isoquant

1. It slopes downward to the right

2. Convex to the origin
3. Smooth and continuous
4. Two isoquants do not intersect

Least cost combination of inputs

We have seen that the some level of output can be produced with much different combination
of two inputs. While choosing two inputs, the combination of two, the combination will be of
least cost of saving in the input replaced is greater than the cost of the input added.

The least cost combination will provide inverse price ratio = marginal rate of substitution.

Economies of Scale

The advantage in cost, when level of output is increased is referred to as economies of scale.
There is an inverse relationship between per unit fixed cost and quantity produced, which
creates cost advantage. The greater the quantity of output produced, the lower is the per unit
fixed cost.

Economies of scale are seen in falling average variable cost with an increase in output. It is
explained with the operational efficiencies and synergies as a result of increase in the scale of
production.

Economies of scale have following to happen:

 Efficient production
 Reduction in promotion cost
 Buy in bulk
 Reduction in logistic cost
 Cheaper capital
 Spread risk

Effect of economies of scale on production cost:

Production cost:

1. Per unit fixed cost is reduced because in increased production, the fixed cost gets
spread over more output than before.
2. Per unit variable cost is reduced became in expanded scale of production efficiency of
the production process is increased.

Average cost
 LRAC

Average cost

Q Q1
Output

The graph is long run average cost curve. When due to scale of production output expands
from Q to Q1, the average cost falls from C to G, the cost advantage or economies of scale is
available up to the output level Q1.

Diseconomies of scale

It can be seen that output beyond Q 1 leads to rise in average to rise in average cost called
diseconomies of scale defined as rise in average cost due to increase in the scale of
production.

Limitations of production analysis

1. It is restricted to two inputs and one output

2. The production curve is required to be smooth and continuous, but in real world, it is
not possible.
3. Production function assumes that technology is fixed but in the real world it is not
possible.
4. It is based on the assumption that market is perfectly competitive, but again it is not
possible.