PRODUCTION & BUSINESS

ORGANIZATION

AIMS & OBJECTIVES
After studying this lesson, you will be able to understand:
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The production function Short run vs Long run Total, Average and Marginal Product Law of Diminishing Returns to a factor Stages of Production Returns to Scale Concepts of isoquant & isocost line Idea of producer’s equilibrium

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PRODUCTION FUNCTIONS    Is a technical relation that connects factor inputs and output. I3………. I2. the production process employs only two inputs Labour (L) and Capital (K) and Q is the quantity of output ● ● A general form of production function can be expressed as Q = Q (I1. It specifies the maximum output that can be produced with a given quantity of inputs. It is defined for a given state of engineering and technical knowledge It may be represented as Q = Q (K.In Cobb.Douglas is a type of production function and is given as Q = AKLβ Where A denotes state of technology.. K & L are the inputs/factors and  & β are called the transformation parameters 3 .In) Where Q is the quantity of output and inputs are represented as I1.I2……. L) Where.

SHORT RUN VS LONG RUN ● ● Short run in production refers to a time period when some inputs used in production are fixed and some are variable Long run in production refers to a time period when all inputs used in production are variable 4 .

MP ● ● ● ● Three very important concepts related to production analysis are: Total product (TP) Average product (AP) Marginal product (MP) 5 . AP.TP.

TOTAL PRODUCT  Total product is total output. 6 .

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AVERAGE PRODUCT ● ● It is the total product divided by the number of variable input employed. That is. APx = Q/x Where Q denotes total product and x denotes quantity of input x 8 . it is the production per unit of input. It may be represented as.

total product is rising. total product is falling (rare).  If MPX=∂Q/∂X< 0.  It is represented as: MPX=∂Q/∂X  If MPX=∂Q/∂X> 0.  9 .MARGINAL PRODUCT Marginal product is the change in output caused by increasing input use.

reaches a maximum and falls thereafter. reaches a maximum and falls thereafter. MP also rises at first.AP curve rises at first. When AP is rising MP > AP When AP is maximum MP = AP When AP is falling MP < AP 10 .

Diminishing Returns to a Factor explains the shape of the TP curve and also explains the most efficient stage of production 11 . holding all other inputs constant. the Marginal Product of each unit of input will decline as the amount of that input increases. the additional output obtained is gradually lesser and lesser Alternatively stated.LAW OF DIMINISHING RETURNS TO VARIABLE FACTOR/LAW OF VARIABLE PROPORTION ● ● ● As more and more of a variable input is added in production while holding all other inputs fixed.

beyond X3 12 .STAGES OF PRODUCTION Stage I – origin to X2 Stage II – X2 to X3 Stage III.

beyond X3 13 .Stage I – origin to X2 Stage II – X2 to X3 – the most efficient stage of production Stage III.

RETURNS TO SCALE ● ● Returns to scale show the output effect of increasing all inputs. Three types of returns to scale    Increasing returns to scale ⇒ ∂Q/Q ÷ ∂Xi/Xi > 1 Constant returns to scale ⇒ ∂Q/Q ÷ ∂Xi/Xi = 1 Decreasing returns to scale ⇒ ∂Q/Q ÷ ∂Xi/Xi < 1 Where ∂Q/Q denotes proportional change in output ∂Xi/Xi denotes proportional change in input 14 .

– Short run phenomenon 15 .RETURNS TO SCALE AND RETURNS TO A FACTOR ● ● Returns to scale measure output effect of increasing all inputs..Long run phenomenon Returns to a factor measure output effect of increasing one input.

INPUT COMBINATION CHOICE ● ● ● Two tools are used Production Isoquants and Isocost lines 16 .

ISOQUANTS ● ●     Drawn in an input space it shows the different combination of inputs that can produce the same level of output.imply imperfect substitutability Higher isoquants represent higher levels of output 17 . Convex to the origin No two isoquants intersect each other . Characteristics of an isoquant Downward sloping – implies input substitutability.

Perfect substitutes Perfect complements Usual Shape 18 Different Shapes of an Isoquant .

MARGINAL RATE OF TECHNICAL SUBSTITUTION ● This shows the rate at which one factor may be substituted for another. MRTSXY gives the slope of an isoquant ● 19 . Its is given as MRTSXY = .ΔY/ΔX = -MPX/MPY.

y Where C denotes the total cost outlay x & y are the quantity of the two inputs used Px & Py are the given respective prices of the two inputs y C = Px. It is represented as C = Px.ISOCOST LINE ● ● This shows the various combinations of the inputs that can be had for the same cost outlay.x + Py.x + Py. y x 20 .

PRODUCER’S EQUILIBRIUM ●   Producer reaches his equilibrium when he maximizes his profit by Producing the maximum possible output for a given cost or ..….a Minimizing cost for a given level of output ……b Case: a Case: b E E 21 .

PRODUCER’S EQUILIBRIUM Equilibrium in both these cases occurs when an isocost line gets tangent to an isoquant  In case a. the given isocost line became tangent to the highest possible isoqant at E  In case b. the lowest possible isocost line became tangent to the given isoquant  The condition for producer’s equilibrium is thus. the isoquant must be convex to the origin  22 . the same in both case: Slope of isoquant = slope of isocost MRTSxy = Px/Py Or MPx/MPy = Px/Py ● Additionally.

BUSINESS ORGANIZATIONS ● Refer Pages 148 – 154 of text book 23 .