Microeconomics

Session 8

Sagnik Bagchi, Ph.D.

School of Business Management, NMIMS-Mumbai

Production Function

Production function: defines the relationship between inputs and the maximum amount that
can be produced within a given period of time with a given level of technology

Q: Quantity of Output
xi: Input choice

We consider a simple production function with two inputs:

Q: Quantity of Output
L: Labour
K: Capital

18/07/2023 Microeconomics-MBA Core [2023-24], SB 2

Some Alternative Terms

 Alternative terms in reference to inputs

 ‘inputs’
 ‘factors’
 ‘factors of production’
 ‘resources’

 Alternative terms in reference to outputs

 ‘output’
 ‘quantity’ (Q)
 ‘total product’ (TP)
 ‘product’

18/07/2023 Microeconomics-MBA Core [2023-24], SB 3

Short-Run and Long-Run Production Function

Short Run Period of time in which quantities of one or more production factors cannot be changed.
Fixed Input Production factor that cannot be varied.
Long Run Amount of time needed to make all production inputs variable

Short-Run Production Function with capital as constant and labour as variable

Long-Run Production Function with capital and labour as variable:

18/07/2023 Microeconomics-MBA Core [2023-24], SB 4

Short-Run Production Function
Average Product: Output per unit of a particular input. 𝑄 ∆ 𝑄 𝜕𝑄
𝐴 𝑃 𝐿= ; 𝑀 𝑃 𝐿= =
𝐿 ∆𝐿 𝜕𝐿
Marginal Product: Additional output produced as an input is increased by one unit.

Labour (L) Capital (K) Output (Q) APL MPL

0 10 0 - -
1 10 10 10 10
2 10 30 15 20
3 10 60 20 30
4 10 80 20 20
5 10 95 19 15
6 10 108 18 13
7 10 112 16 4
8 10 112 14 0
9 10 108 12 -4
10 10 100 10 -8

18/07/2023 Microeconomics-MBA Core [2023-24], SB 5

Short-Run Production Function

Stage I: From zero units of the variable input to where AP is maximized (where MP=AP)

 Total product starts to increase at an increasing rate

 MP is greater than AP, AP is rising
 MP starts to fall and equals AP when AP is maximum

Stage II: From the maximum AP to where MP=0

 Total product starts to increase at an decreasing rate
 MP is less than AP, AP is falling
 MP starts to fall and reaches zero

Stage III: From where MP=0 on

 Total product starts to decrease
 MP is less than AP, AP is falling
 MP becomes negative

Law of diminishing returns: As additional units of a variable input are combined with a fixed input,
after some point the additional output (i.e., marginal product) starts to diminish

18/07/2023 Microeconomics-MBA Core [2023-24], SB 6

Short-Run Production Function

18/07/2023 Microeconomics-MBA Core [2023-24], SB 7

About Stage-II

In the short run, rational firms should be operating only in Stage II

 Why not Stage III?  firm uses more variable inputs to produce less output

 Why not Stage I?  underutilizing fixed capacity, so can increase output per unit by
increasing the amount of the variable input

18/07/2023 Microeconomics-MBA Core [2023-24], SB 8