PRODUCTION ANALYSIS

PRODUCTION
Transformation of I/Ps or resources into O/P of goods
and services
FACTORS AFFECTING PRODUCTION

•Inputs

•Time period of production

•Technology
 FACTORS OF PRODUCTION

INPUTS

FACTOR INPUTS NON-FACTOR INPUTS

Raw materials
Land Labor Capital Enterprise
and other goods
Inelastic Active Structures Innovative from other
Immobile Mobile Equipment Risk
Heteroge producing units
Variable Decision
neous Producti making
vity SECONDARY INPUTS

PRIMARY INPUTS
 INPUT CLASSIFICATION

• Fixed input: qty can not be readily changed

Example: Building, Plant, Machinery

• Variable input: quantity can be changed

Example: Labour, raw material
 PRODUCTION FUNCTION
When analyzing production, it is important to
distinguish between two time frames

– Short-run production function assumes that

at least one of the inputs is fixed

– Long-run production function assumes that

all inputs adjust
 LEVEL & SCALE OF PRODUCTION
• Level of production can be altered changing the
proportion of variable inputs

Output = Fixed inputs + Variable inputs

• Scale of production can be altered by changing the

supply of all the inputs only in the long run

Output = Total inputs (variable inputs)

 PRODUCTION FUNCTION

Technological relationship showing diff

combinations of I/Ps that can produce max O/P
within a given time period with a given
technology
 PRODUCTION FUNCTION
Mathematically, the production function can be
expressed as

Q=f(X1,X2,...,Xk)

– Q is the level of output

– X1,X2,...,Xk are the levels of the inputs in the
production process
– f( ) represents the production technology
 PRODUCTION FUNCTION
• For simplicity, consider a production function of two
inputs:

Q=f (L,K)
• Q is output
• L is Labor
• K is Capital
• Variable proportions production: O/P can be
changed by changing the I/Ps i.e. same O/P can
be produced using diff combinations of I/Ps

• Fixed proportions production: fixed

combination of I/Ps to produce a given O/P
• Technical efficiency: maximum amount
of O/P with a given combination of inputs

• Economic efficiency: Producing a given

O/P at the lowest possible cost.
PRODUCTION IN SHORT RUN
 PRODUCTION FUNCTION

Q = f (L,K)

Firm has chosen the level of capital so K is fixed in

amount
 CONCEPT OF PRODUCT

• Total Product - total volume of O/P resulting from

use of different quantities of I/Ps

• Average Product - the per unit product of a

variable factor

• Marginal Product - the rate at which total product

changes/ change in TP resulting from a unit
change in quantity of variable factor
 CONCEPT OF PRODUCT

Total Product TP = Q = f(L)

TP
Marginal Product MPL =
L
Average Product TP
APL =
L
 EXCERCISE
Variable
Input Total Product
(X) (Q or TP)
0 0
1 8
2 18
3 29
4 39
5 47
6 52
7 56
8 52

Calculate values of MP & AP

CALCULATION OF MARGINAL PRODUCT
Variable Marginal
Input Total Product Product
(X) (Q or TP) (MP)
0 0 8
1 8 10
2 18 11
3 29 10
4 39 8
5 47 Q 5
ΔX=1 ΔQ=5   5
6 52 X 1
4
7 56
-4
8 52
CALCULATION OF AVERAGE PRODUCT
Variable Total Average
Input Product Product
(X) (Q or TP) (AP)
0 0 ---
1 8 8
2 18 9
3 29 9.67
4 39 9.75
5 47 9.4
6 52 8.67
7 56 8
8 52 6.5
 DO YOURSELF- EXERCISE II

Find Marginal Product and Average Product

L Q MPL AP
0 0 - -
1 3 3 3
2 8 5 4
3 12 4 4
4 14 2 3.
5 14 0 2.
6 12 -2 2
 SOLUTION

L Q MPL APL

0 0 - -
1 3 3 3
2 8 5 4
3 12 4 4
4 14 2 3.5
5 14 0 2.8
6 12 -2 2
 WHY DO TOO MANY COOKS
SPOIL THE DISH?
 WHY DO MULTIPLEXES HAVE
3/4/5 SCREENS AND NOT MORE?
Video on law of variable proportions in production

• https://www.youtube.com/watch?v=Cfio
xJ4E_h4
LAW OF VARIABLE PROPORTIONS

As more & more units of some factors of

production are employed with some fixed
factor then initially TP increases at an
increasing rate, then at a decreasing rate &
finally decreases
 APPLICABILITY OF LAW
• This law is applicable virtually to all types of
production function
• Automobile production
• Retailing
• Textile operation
• Zinc mining
• Yield per acre
• Milk per cow
• And so on
 EXAMPLE
• Suppose, a farmer has 1 acre of land (fixed factor) on
which he wants to increase the production of wheat
with the help of labour (variable factor).

• When he employed more and more units of labour,

initially output increased at an increasing rate, then at
a decreasing rate and finally, at a negative rate.
 EXAMPLE
Fixed Factor Variable TP MP AP Stage
(land in Factor
acres) (labour)
1 0 0 - - I (Increasing
Returns)
1 1 10 10 10

1 2 30 20 15

1 3 45 15 15 II (Diminishing
Returns)
1 4 52 7 13

1 5 52 0 10.4

1 6 48 -4 8 III (Negative
Returns)
 THE LAW OF DIMINISHING RETURNS & STAGES OF
PRODUCTION
Total
Product

16
14
12 TP
10
8
6
4
2
0 1 2 3 4 5 6 Labor7
6
Marginal 5
Stage I Stage II Stage III
’
& 4
Average 3
Product 2
1
AP
0
0 1 2 3 4 5 6 7
-1
-2
MP Labor
-3
 THE LAW OF DIMINISHING RETURNS

• Why does MP eventually decline?

– Due to the law of diminishing return or as

additional units of a variable input are combined
with a fixed input, at some point the additional
output (i.e., marginal product) starts to diminish.
 RELATIONSHIP B/W TP & MP

• If MP is positive then
Max
TP is increasing.

• If MP is negative then
TP is decreasing.

• TP reaches a maximum
when MP=0
(Maximization
Condition!)
 RELATIONSHIP B/W AP & MP

– If MP > AP then
AP is rising.

– If MP < AP then
AP is falling.

– MP=AP when
AP is maximum
 STAGES OF PRODUCTION

Q Increasing Diminishing Negative

Marginal Marginal Marginal
Returns Returns Returns

Q=F(K,L)

AP
L
MP
 THREE STAGES OF PRODUCTION
– Stage I (increasing returns)
• From zero units of the variable input to where
AP is maximized

– Stage II (diminishing returns)

• From the maximum AP to where MP=0

– Stage III (negative returns)

• From where MP=0 on where MP < 0
 THREE STAGES OF PRODUCTION
• In the short run, rational firms should only be
operating in Stage II.
– Why Stage II?

• Why not Stage I?

• Under utilising fixed capacity

•Why not Stage III?

• Over utilising fixed capacity