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Production: Any activity leading to value addition – Transformation of inputs into output Q= f (L,K)
Short term : Time when one input (say, capital) remains constant and an addition to output can be obtained only by using more labour. Long run: Both inputs become variable.
Production Function Production process is subject to various phasesLaws of production state the relationship between output and input. . 5 .
Laws of production Short run : Relationship between input and output are studied by varying one input . Law of Variable Proportions brings out relationship between varying proportions of factor inputs and output 6 . others being held constant.
Laws of production Long run: Production function is subject to different phases described under the Law of Returns to Scale – Studied assuming that all factor inputs are variable. 7 .
Law of Variable Proportions Law of Variable Proportions (Short run Law of Production) Assumptions: • One factor (say. K) is constant • Labour is homogeneous • Technology remains constant • Input prices are given 8 . L) is variable and the other factor (say.
Law of Variable Proportions No of Workers L 1 2 3 4 5 6 7 8 Total Product (TPl) 24 72 138 216 300 384 462 528 Marginal Product (MPl ) 24 48 66 78 84 84 78 66 Average Product (APl ) 24 36 46 54 60 64 66 66 II) Diminishing Returns Stages of Returns I) Increasing Returns 9 10 11 12 576 600 594 552 48 24 -6 -42 64 60 54 46 III) Negative Returns 9 .
TPl Beyond the 6th worker until 10th worker TP increases but rate of increase begins to fall TP turns negative from 11th worker onwards. This shows Law of Diminishing Marginal returns Total Product P r o d p r o d u c t .Law of Variable Proportions Panel A T o t a l T o t a l Labour 10 TP rises at an increasing rate till the employment of the 5th worker.
Law of Variable Proportions Panel B AP/MP Panel B represents Marginal and average productivity curves of labour APL labour M MPL P L 11 .
Stage I: TPl increases at an increasing rate. Hence K gets utilised better with every additional unit of labour 12 .Law of Variable Proportions Increasing Returns. Fixed factor (K) is abundant and variable factor is inadequate.
stage III.TPl begins to decline –Capital becomes scarce as compared to variable factor.Stage II.TPl continues to increase but at a diminishing rate. Hence over utilisation of capital and setting in of diminishing returns Causes of 3 stages: Indivisibility and inelasticity of fixed factor and imperfect substitutability between K and L 13 .
Empirical law. frequently observed in various production activities .Particularly in agriculture where natural factors (say land). .Law of Variable Proportions Significance of Law of Diminishing Marginal Returns: . are limited. which play an important role.Helps manager in identifying rational and irrational stages of operation 14 .
It provides answers to questions such as: a) How much to produce? b) What number of workers (and other variable factors) to employ in order to maximize output In our example. firm should employ a minimum of 7 workers and maximum of 10 workers (where TP is still rising) 15 .Law of Variable Proportions .
Law of Variable Proportions .So a firm operating in Stage I has to increase L and that in Stage III has to decrease labour. additional workers not only prove unproductive but also cause a decline in TPl.as a result.Stage III has very high L-K ratio. . . 16 .In Stage I capital is presumably underutilised.
all factors are variable. 17 . • Isoquant curves represent different combinations of K and L that lead to the same level of output. • Relationship between inputs and output is depicted in the form of isoquant curves.Law of Returns to Scale In the long run. • Production can be increased by adding both L and K.
ISOQUANT CURVES Y IQ300 Units of K IQ200 IQ100 o Units of L X 18 .
or some inbetween combination. Rs. • By joining the two extreme points we get an isocost line 19 . 7 per unit.Law of Returns to Scale Isocost line: • Assume that labour costs Rs. or 10 units of K (with no labour). 70.10 per unit and capital. • It can buy 7 units of labour (with no capital). • Suppose the company has a budget of Rs.
Law of Returns to Scale Y 10 o Units of L 7 X 20 .
Law of Returns to Scale Y Y Capital Producer has a constraintnamely. B Q2=200 1Q1=100 0 X 0 1 9 O Labour 21 . budget. Q3=300 Producer attains equilibrium when he reaches highest attainable level of output.
Law of Returns to Scale • Point of tangency between isoquant and isocost is the point of least cost combination of inputs. • At point B. labour and capital are combined in a proportion that maximises the output for a given budget. 22 .
then we have increasing returns to scale ε =1.Law of Returns to Scale ε = Δq/ q ÷ Δn /n where Δq/ q indicates proportionate change in output Δn /n indicates proportionate change in input If ε >1. then we have constant returns to scale ε <1. then we have decreasing returns to scale 23 .
Y Law of Returns to Scale Q140 Firm is subject to G increasing. Explanation for these E Q100 D phases is provided Q80 Through concepts C Q60 Called economies And diseconomies Q40 Of scale. Constant and Decreasing returns Q120 F to scale. Q 20 X L 24 K B B A o .
Causes of increasing returns to scale • Internal and external 25 .ECONOMIES OF SCALE • ECONOMIES OF SCALE are advantages enjoyed by a firm from large scale production.
g. then it would be technically and economically undesirable to use the indivisible factor for a smaller scale of production e.INTERNAL ECONOMIES INTERNAL: Those advantages and disadvantages that accrue to the firm as a result of its scale of operation Indivisibilities.. Can’t use a conveyor belt to unload a small truck.if some of the factors are indivisible. but need one for unloading a train or ship 26 .
.INTERNAL ECONOMIES Dimensional economies • A mere change in the size of capital can lead to a change in output which is proportionately more than the cost of enlarged input.g. e. Doubling the diameter of a pipeline more than doubles the water flow without doubling the cost. doubling the dimensions of a ship more than doubles its capacity without doubling costs 27 .
a process can be broken into sub processes .In large scale production. • Managerial economies • Commercial economies-bulk purchases 28 .specialised labour and specialised machines lead to increase in productivity and decrease in average cost of production.INTERNAL ECONOMIES • Specialisation.
• Risk bearing economies: • Diversification of output. markets and sources of supply 29 .INTERNAL ECONOMIES • Financial economies -Lower rate of interest. liberal terms and conditions because of reputation individual investors also like to invest money.
storage and standing costs in case of stoppage of work or lack of demand 30 .INTERNAL DISECONOMIES Internal Diseconomies • Effective supervision no longer possible • Unwieldy administration and ego clashes • Industrial unrest • Problems of re-conversion.
31 .External Economies of Scale External Economies of Scale Arise out of sharing and cooperation received from other firms in a given industry.
External Economies of Scale Economies of concentration • Supply of skilled labour in a region • Common services • Specialised institutions like training schools and research centres (Indian School of mines in Dhanbad). • Reputation of a region 32 .
External Economies of Scale Economies of Information • Trade associations. seminars • Economies of disintegration • An ancillary firm may specialise in the production of only one part • Waste and byproducts of all firms in the industry may be dealt with by a specialised firm. 33 . journals.
after a point economies turn into diseconomies • Excessive concentration leads to bottlenecks and diseconomies • Most firms experience these phases but some continue to defy these laws due to innovations and technological progress.External Diseconomies of Scale • As firms expand along with expansion of the industry. 34 .
thereby lowering the cost of each service • Using bye products to make something instead of throwing it away. • Management should be alert to such possibilities. 35 .Economies of Scope • Lowering of costs that a firm experiences when it produces more than one product together rather than each alone • A smaller airline can profitably extend into cargo services.
as managers and workers become more efficient as they gain production experience. but only 700 hours to assemble the 200th . 36 . • Learning Curve shows the decline in the average input cost of production with the rising cumulative total output over time.Learning Curve • As a firm gains experience in the production of a commodity or service. • Eg. AC often declines. 1000 hours to assemble 100th aircraft.
For practical decision making purposes. It is defined for a given state of engineering and technical knowledge. • .Production Function • The production function specifies the maximum output that can be produced with a given quantity of inputs. it is necessary to obtain production and Cost Function.
Production Function The Production Function Total Product Marginal Product Average Product .
and then reaching the maximum point at the maximum Capacity of Machine. • . in physical units such as total number of shoes produced by a machine.Production Function Total Production:• The total amount of output produced. It start from Zero for Zero Labor and then increases as additional units of labor are applied.
Production Function Marginal Product :• The Marginal product of an input is the extra output produced by each additional unit of that input while other inputs are held constant. .
.Production Function Average Product :• The average product is equal to the total number of output (product) divided by total number of input (labor).