Theory of Production

Input- output Relationship

Theory of Production
Production is the process in which the
inputs are converted into outputs.
Production involves a process, so process
means a time period which is required for
producing something.
There are two types of time period
involves in the Production theory.
1. Short Term or Short Run time period
2. Long Term or Long Run time period
Short Run time period.
A time period where some inputs are variable and some
inputs are fixed, furthermore plant capacity is also
fixed.(As we know there are four factors of production ;
Land , Labor, Capital, and Entrepreneurs). In these
factors the more variable factor which change rapidly is
the Labor so in short run time period only variable
input is labor while remaining inputs are fixed.
Long Run time period.
A time period is long enough to adjust all the changes
in all inputs, which means all factors of productions
(L,L,K,E) are variable. No input is fixed. And plant size
is also changeable.
Production Function
Production function means the functional relationship
between inputs and outputs in the process of
production.
 It is a technical relation which connects factors inputs
used in the production function and the level of
outputs
Q = f (Land, Labor, Capital, Organization, Technology,
etc )
Factors of Production
Inputs : Fixed inputs and Variable inputs
The factors of production that is carry out the
production is called inputs.
Land, Labor, Capital, Organizer, Technology, are
the example of inputs
 Inputs : Fixed inputs and Variable inputs
Fixed inputs
Remain the same in the
short period .
At any level of out put, the
amount is remain the same.
The cost of these inputs are
called Fixed Cost
Examples:- Building, Land
etc ( In the long run fixed
inputs are become varies)
Variable inputs
In the long run all factors
of production are varies
according to the volume of
outputs.
The cost of variable inputs
is called Variable Cost
Example:- Raw materials,
labor, etc
Short Run Production Function
It shows the relationship between the
maximum level of output and some fixed
inputs and some variable input with fixed
level of technology during a given time
period.
Q = f(L) ; (L , K, E ----
constant)
It describes Q(output) is dependent on
variable input(Labor) while keeping (Land,
Capital and Entrepreneurs )constant.
Short Run Production Function (Cont.)
Assumptions
Rational Producer
Some inputs fixed (Both in Quantity and Quality)
Some inputs variable
Fixed Technology
Given Time Period
Basic Question in Short run production function.
What is the maximum level of out put for a producer.
Or
How does a producer take input decision in short run.
Various concept of production

Total Product: the total output that is produced by

using all fixed and variable inputs during a time
period.
Average Product- Ratio of Total Product and one
variable input. Ap = TP/L
Marginal Product – The rate of change of out put as a
result changes in one variable input. MP = ∆TP/∆L
Or
MP is the additional output which can be produced by
employing an extra unit of labor.
 Short run Production table
Labor(L) Total Product AP MP
(TP)/Q
0 0 - -
1 10 10 10
2 30 15 20
3 60 20 30

4 80 20 20
5 95 19 15
6 108 18 13
7 112 16 4
8 112 14 0

9 108 12 -4

10 100 10 -8
 D
112
Output per
month Total Product
C

60 B

Labor per month

3 4 8
30

E
20

Average product
10

3 4 Labor per month

8
Marginal product
Trends of TP , AP, And MP curves
TP curve first increases at an increasing rate, after which it
continues to increase but at a decreasing rate and then start
declining.
MP curve also initially increases, reaches its maximum and
then declines.
The AP curve also shows a similar trend as the MP. It rises,
reaches its maximum and then falls. At the point where AP
reaches its maximum, AP = MP.
Now in case of decision making in short run production
MP concept is very important
So question arises why MP is falling and becomes
negative ?
It is just because of Law of Diminishing Returns or Law of
Variable Proportion.
Law of Diminishing Returns /Law of variable
proportion: Short run Production Function
“If one of the variable factor of production
used more and more units, keeping other
inputs fixed, the Marginal product (MP)
increases at some specific point, after that it
starts declining and becomes zero and
negative.”
Input Decision in short run
For this we have the concept of 3 Stages of production

First Stage
MP also increase at it become equal to AP at the end
of the stage.
MP>AP

Second Stage
 MP become zero when TP is at Maximum, at the end
of the stage
 MP<AP
Third Stage
 As TP is decrease MP is negative
 Short run Production Function with Labour as Variable factor

Capital Total Average Marginal Product

Labour Land
(K) Output
(L) (TP) Product (MP)
(AP)
0 10 10 0 -
1 10 10 10 10 10
First Stage
2 10 10 30 15 20

3 10 10 60 20 30

4 10 10 80 20
20
10 19 tage
5
6 10 95
108 15 nd
10 Seco S
7 0 112 4
10 16
18
13
1
8 0 10 14 0
112
ge
1
10 10 10 100 10 -8
9 0 108 -4
10 12
 D
112
Output per
month Total Product
C

60 B

Labor per month

3 4 8
30 Second Stage
Third Stage
E
20

First Stage Average product

10

3 4 8 Labor per month

Marginal product
Where should rational firm produce?
 Where should rational firm produce?

 Stage I: MP is above AP implies an increase in input increases

output in greater proportion.

 The firm is not making the best possible use of the fixed factor.

 So, the firm has an incentive to increase input until it crosses over
to stage II.

 Stage III: MP is negative implies contribution of additional labor

is negative so the total output decreases .

 In this case it will be unwise to employ an additional labor.

 Stage II: MP is below AP implies increase in input
increases output in lesser proportion.

 A rational producer/firm should produce in stage II.

 But where exactly the firm will operate within stage II

cannot be determined only on the basis of the product
curves.

 We need information about input costs and price of

output.
 2. Law of return to scales: Long run
Production Function
 Explain long run production function when
the inputs are changed in the same proportion.
 Production function with all factors of productions
are variable..
 Q = f( L,L,K,E,T….)
 Show the input-out put relation in the long run with
all inputs are variable.
“Return to scale refers to the relationship between
changes of outputsand proportionate changes in the
in all factors of production ”
Returns to scale is the variation or change in productivity that is the
outcome from a proportionate increase of all the input.
1. An increasing returns to scale occurs when the output increases
by a larger proportion than the increase in inputs during the
production process. For example, if input is increased by 3 times,
but output increases by 3.75 times, then the firm or economy has
experienced an increasing returns to scale.
2. A decreasing returns to scale occurs when the proportion of
output is less than the desired increased input during the
production process. For example, if input is increased by 3 times,
but output is reduced 2 times, the firm or economy has
experienced decreasing returns to scale.
3. A constant returns to scale means that the proportionate
increase in input is exactly equal to the increase in output. In
Barry's case the 25% increase in input would result in a 25%
increase output.
 Law of return to scales: Long run
Production
Labour Capital TP MP
Function

2 1 8 8
4 2 18 10 Increasing returns to scale

6 3 30 12
8 4 40 10
10 5 50 10 Constant returns to scale
12 6 60 10
14 7 68 8
16 8 74 6 Decreasing returns to scale
18 9 78 4
 • Law of return to scales: Long run
Production Function
Inputs 10% increase – Outputs 15% increase Increasing returns to scale

Inputs 10% increase – Outputs 10% increase Constant returns to scale

Inputs 10% increase – Outputs 5% increase Decreasing returns to scale

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