THEORY OF PRODUCTION

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 Concept of total, Average and Marginal production

• Generally, production refers to the process of transforming

inputs to outputs. In another words, it is the process of making
or creating new goods and services that can satisfy human
wants.
• Total production (TP):
Total production refers to total quantity of output produced by
using both fixed and variable factors of production but in short
run production is only the function of variable factor.
TP = f(QL)
Where,
TP = total production
F = functional relationship
Ql = quantity of labor
• Average production (AP):
Average production of a factor which is obtained by
dividing the total production, by number of input
used in production or it is the per unit output
produced by factors used.
AP= TP/L or AP= TP/Q
Where,
APL= average product
TP = total product
L = no. of labors
Q= Quantity of product.
• Marginal production (MP):
Marginal production of an input is the change in
TP due to change in an additional unit of input in
production. Mathematically it is expressed as
MP= ∆TP / ∆L or ∆TP / ∆ Q
• Or MP= TP1-TP
Where,
MPL = marginal production of labor
∆TP = change in total product
∆L = change in no. of labor
∆Q= change in Quantity
 Concept of production function
Generally production function refers to the functional
relationship between physical output and physical input.
It is also called mathematical relationship between
output and input. In production process output is
depend on the input. Input refers to all factor of
production. It can be express by following equation
Q=f(L,K,Ld,o,T,…..) or Q=f(K,L)
Where
• Q=output L=Labor
• O=Organization Ld=Land
• K=Capital T=Technology
• There are two types of production function.
• Short run production function:-short run is the time
period in which a firm cannot change all factor of
production so same factor of production are remain
constant. In short run labor is only changeable
factor of production. Land , capital and organization
cannot be changed by producer. So

• Q=f(L,K )
• Where capital is constant.
• Long run production function:-
Long run refers to the long time period. Long run
time period in which a firm can change all factor
of production or inputs. It is also called returns
to scale because there are two or more than two
factors are variable it can be expressed by
Q=f(L,K)
where,
Q= quantity
L= labor
K= capital.
Cobb-Douglas Production Function
• The Cobb-Douglas production function was propounded by Charles
Cobb and Paul Douglas .
• In economics, a production function represents the relationship
between the output and the combination of factors, or inputs, used
to obtain it. The Cobb-Douglas production function is a particular
form of the production function. The basic form of the Cobb-
Douglas production function is:
• Q(L,K) = A L^aK^b
where,
Q = the quantity of products.
L = the quantity of labor.
K = the quantity of capital.
A = a positive constant.
a and b are constants between 0 and 1.
 Law of variable proportion

The law of variable proportion explains about the short run production
function. In the short run if we want to change output we can change only
variable factor but not the fixed factor of production.
This law states that, if we use more and more units of variable i.e. labor with
given fixed factor i.e. capital then in initial phase total production increases
at increasing rate to some extent and increases at decreasing rate then
reaches to maximum and remains constant after that it start to decline at
increasing rate.
This law is based on following assumptions:
• Production technology remains constant
• Labor is single variable factor which is homogeneous
• There must be the possibility of changing the proportion of factors of
production
• At least one factor of production is fixed.
On the basis of assumption it can be explain by following
table.

Land Unit of labor T8otal Average Marginal Stages

production production production
10 0 0 0 0
10 1 10 10 10
10 2 30 15 20
10 3 60 20 30 1st stage
10 4 80 20 20
10 5 90 18 10
10 6 90 15 0 2nd stage
10 7 80 11.4 -10 3rd stage
• The above table shows when the more and
more labor are used then TP increases at
increasing rate to some extent then increases
at decreasing rate. AP gradually increases and
reaches to maximum. MP sharply increases
and reaches to the maximum and starts to
decline. In second stage TP increases at
decreasing rate, reaches to the maximum. AP
gradually decline, MP tends to zero. In the
third stage, TP starts to decline, AP gradually
declines and MP negatively decline. The same
concept can be explained by the given figure.
On the above figure we can observe three stage of production which is
given below:
• 1st Stage: ( increasing returns)
First stage covers 0 to A but it covers up to B point. In this stage TP
increases at increasing rate to point A and start to increases at
decreasing rate. AP gradually increases and MP gradually increases,
reaches to maximum and starts to fall. At the ending point of 1 st
stage AP =MP.
In the 1st stage increasing return to scale crop up due to the increase
in efficiency of fixed factor and variable factor.
• 2nd Stage: )decreasing returns)
Second stage covers B to C Point. In this stage TP increases at
decreasing rate and reaches to the maximum. AP gradually declines;
MP also declines and reaches to zero. In the second stage
diminishing return to scale crop up due to the imperfect substitution
of factors of production and scarcity of resources.
• 3rd Stage: (Negative returns)
Third stage starts from C. In this stage TP starts to decreases at
increasing rate, AP gradually decreases, MP negatively declines. In
the third stage negative return to scale crop up.
 Which stage of production does a rational producer
choose?
• A rational producer does not choose first and third stage.
In first stage TP is increasing at increasing rate there is
not full utilization of available resources. so the producer
wants to more produce of product. And in third stage, TP
is decreasing at increasing rate. AP also decline and MP
become negative. So rational producer will choose
second stage. In second stage both AP and MP of
variable factors are diminishing and there is full
utilization resources . In this stage TP has been
maximum.
The relationship between AP and MP

• When MP>AP, AP rises

• When MP=AP, Ap is maximum

• When MP<AP, AP falls

 Iso quant
• Isoquant is a graphical curve in Production
Economics, which shows the various combinations of
two inputs or factors of production(usually labor and
capital) to achieve a certain fixed amount of output.
• This term Iso quant has been derived from the Greek
word Iso and Latin word quant. In Greek word Iso
refers to the equal and Latin word quant refers to the
quantity. So, iso quant curve shows different
combination of inputs which yield same product.
 It can be cleared by following table and
diagram.
combination labour capital product
A 1 9 50
B 2 7 50
C 3 4 50
 Iso quant map
A set of Iso quant map is called Iso quant map. Every higher
Iso quant map represent higher level of output/ production,
and lower Iso quant map represent lower level of output.
 Properties of Iso quant
• It has negative slope
• It is convex to the origin
• Higher curve, higher product
• Never intersect to each other iso quant
curves.
 Marginal rate of technical substitution(MRTS)

• Marginal rate of technical substitution

(MRTS) is, "The rate at which one factor can be
substituted for another while holding the level of
output constant". Or the rate at any one factor
replace another factor for producing any product.
• The slope of an iso-quant shows the ability of a firm
to replace one factor with another while holding the
output constant. For example, if 2 units of factor
capital (K) can be replaced by 1 unit of labor (L),
marginal rate of technical substitution will be thus:
 MRTSL,K = - dk/dL= MPL/MPK
 It can be cleared by following table.
combination Unit of labor Unit of capital Total output MRTS
A 1 15 100 -
B 2 11 100 4:1
C 3 8 100 3:1
D 4 6 100 2:1
E 5 5 100 1:1

It is clear from the above table that all the five different combinations
of labor and capital that is A, B, C, D and E yield the same level of
output of 150 units of commodity X, As we move down from factor
A to factor B, then 4 units of capital are required for obtaining 1
unit of labor without affecting the total level of output (150 units
of commodity X). The MRTS is 4:1. As we step down from factor
combination B to factor combination C, then 3 units of capital are
needed to get 1 unit of labor. The MRTS of labor for capital 3:1. If
we further switch down from factor combination C to D, the MRTS
of labor for capital is 2:1. From factor D to E combination, the
MRTS of labor for capital falls down to 1:1.
Diagram look at the Board.
 Iso-cost line
• An iso cost line shows all possible combination of two factors that the producer can get
by spending in a given amount of money on two factors Labor and capital given their
price. It is the total cost using the total amount of money for spending L and K. the total
cost of producer is the sum of cost of labor and capital.
C= PL.L+ PK.K
= w.L+ r.K
Where,
C=total cost
W=wage
L= labor
R= rate of interest
K = capital
Suppose a producer wants to spend Rs 200 on factor L and K. Price of L is 20 and price of
K is 40.
• C= w.L+r.K
200= 20.L+ 40.K
If the producer spends whole money on labor,
200= 20L+40(0)
200=20L
L=200/20
L=10 where k=0
If producer spends whole money on capital
200=20(0)+40.K
200=40k
k=200/40
K=5 where L=0
Other combinations are cleared by following diagram.
combinations wage Unit of labor interest Unit of Total outlay
capital

A 20 10 40 0 200
B 20 8 40 1 200
C 20 6 40 2 200
D 20 4 40 3 200
E 20 2 04 4 200

F 20 0 40 5 200
 Change in iso-cost line

Iso-cost line shifts when there are change in total outlay or price of
factor of production. Such changes are explained separately below.

1. Effects of change in total outlay:-

If producer changes his total outlay of production the iso cost line
shifts one place to another place but price of labor and capital
should be remaining constant. If total amount of expenditure
increases the isocost line shifts right side, amount decreases isocost
line shift left side. It can be cleared by following diagram.
 In the given diagram, unit of capital and labor measure along OY and
Ox axis. AB line is initial iso cost line at initial total outlay at the given
price of factor of production. If totl outlay increases, isocost line shift
AB line to A’B’ line. At this line producer can use more number of
factors than AB line. But, if total outlay decreases. Isocost line shift AB
line to A’’B’’ line. At this line producer can purchases less number of
factor of production.
 2, effects of change in price of inputs:-

• If other thing remaining the same ( total outlay).

Factor price changes, the isocost line will swing .
If price of labor decreases the price line swing
rightward, and increases price line swing
leftward.
(Diagram look at board)
• If price of capital increases or decreases the price
of capital line swing upward and downward.
(Diagram look at board)
 Optimum employment of input/ least cost
combination of two inputs.

• The optimum factors combination or the least

cost combination refers to the combination of factors with which
a firm can produce a specific quantity of output at the lowest
possible cost. As we know, there are a number of combinations of
factors which can yield a given level of output. It assumes that
rational producer always seeks to minimize cost and maximize
profit. The choice of particular combination of two factors are
depends open the technical possibilities and price of factor.
There are some assumption of optimum
employment of inputs.

• Producer is rational
• Producer use only two inputs (L,K)
• Price of factor is fixed
• Units of factors are equal
• MRTS must diminishing
• Total cost is given etc
• Following two conditions must be fulfilled in
order to achieve optimum employment of
inputs.
1)Necessary condition:- isoquant must be
tangent to the isocost line. Or the slope of
isoquant should be equal to isocost line.
Slope of isoquant=slope of isocost
MRTSL,K=-w/r
-MPL/MPK= -w/r
MPL/MPK= w/r
2) Sufficient condition:- isoquant must be convex
to the origin at the point of tangency.
 Law of returns to scale
• The term returns to scale refers to the changes in output as all
factors change by the same proportion. In the long run all factors of
production are variable. No factor is fixed. Accordingly, the scale of
production can be changed by changing the quantity of all factors
of production. The law of returns to scale is different from law of
variable proportion. There are some kinds of returns to scale.
• Increasing returns to scale:- Increasing returns to scale or
diminishing cost refers to a situation when all factors of production
are increased, output increases at a higher rate. It means if all
inputs are doubled, output will also increase at the faster rate than
double. Hence, it is said to be increasing returns to scale. This
increase is due to many reasons like division external economies of
scale, higher degree of specialization. Increasing returns to scale
can be illustrated with the help of a diagram
• Constant returns to scale:- constant returns to scale
refers to the equal proportion or percentage change
in output and inputs the main cause of constant
returns to scale are limitations of economies of scale,
divisibility of inputs. It can explained by following
diagram.
Decreasing returns to scale:-if all the factors of
production are increased in a given proportion,
output increases in a smaller proportion. It means, if
inputs are doubled, output will be less than doubled.
The main cause of the operation of diminishing
returns to scale is that internal and external
economies are less than internal and external
diseconomies. It is clear from diagram