GOOD AFTERNOON

PRODUCTION ANALYSIS
(SR)
• ‘PRODUCTION’ means ‘CREATING SOME THING’.

• ‘PRODUCTION’ is the ‘CREATION’ (or) ADDITION of those

ECONOMIC UTILITIES which possess ‘EXCHANGE VALUE’.

• To satisfy human wants, goods and services are needed.

• They are not freely available.

• They have to be produced. The type of goods, quality, quantity

every thing is decided by the nature of demand.

• Demand induces the production.

 Factors affecting Production
• Several factors affect volume of production:
• Natural Factors.
• Political Factors.
• Technical progress.
• Development of credit and banking.
• Means of transportation and communication.
• Peoples’ nature.
• Factors of production are:
• Any thing that contributes to output is called factor of
production.
• Land, Labor, Capital, Organization.
 Important Concepts of
Production Analysis
• Total Product (TP):
• TP is the total quantity produced by all factor inputs
per unit of time.
• Short run-variable input only,
• long run-variable + fixed input.
• Average Product (AP):
• AP is the total output divided by the number of units of
the variable factor or the factor inputs.
• Marginal Product (MP):
• MP is the change in total output resulting from change
in variable factor Inputs (OR) an addition made to total
output because of an change in factor input.
 What is a Production Function ?
• Production Function:
(PF)
• PF states the technical relationship between the physical inputs and
the physical output in the existing state of technology, per unit of time.
• The output will change when the quantity of any input is changed.-
technical relationship – catalogue of output possibilities.

• Factors affecting Production Function:

• Quantity of resources used;

• State of technical knowledge;
• Possible processes-type of combinations;
• Size of the firms;
• Nature of market structure;
• Relative prices of the factors of production;
• The manner in which the factors of production are combined.
• If above factors change, production function will change too.
 Nature of PF:
• The PF is expressed in the form of a a mathematical equation in
which output is the dependent variable and inputs are the
independent variable.

• This relationship is stated as:

• Q = f (L, N, K, …………..n).

• PF tells us how large an output can be produced with the help of a

given quantity of inputs.
• PF differs from firm to firm. It depends on the technical knowledge
and the managerial ability available to firm.
• PF of a firm changes when firm has access to higher level technical
knowledge and managerial ability.
• The actual PF existing in a firm/industry – statistical methods –
statistical PF – Example: Cobb-Douglas PF.
 Assumptions of PF:
• PF is based on certain assumptions (conditions):
• Related to specified time period.
• The state of technological change (knowledge) does not change during
the time period.
• Assumed that the firm will use the best and efficient technique available
in production.
• Factors should be easily divisible into necessary requirement units.

• There are three types of Production Function in economic theories:

• PF with one variable input. This is called short run production function.
• PF with all variable inputs. This is called long run production function.
• Production Theory with two variable inputs (substitutes). Cobb- Douglas
production function is such example of two variable inputs.
 Short Run Production Function:
• This is also called as:
• LAW OF VARIABLE PROPORTIONS
• (or)
• LAW OF DIMINISHING MARGINAL RETURNS.

• It is a PF with one variable input.

• It shows the technical relationship of outputs with only one variable

input.

• The Law of VARIABLE PROPORTION states that:

• “As more and more of the factor input (labor) is employed, all other
input quantities remaining constant, a point will be reached in the end
where additional quantities of varying input will yield (produce)
diminishing marginal contributions to total product”.

• Symbolically, {Q = f (L), ‾K‾ }

NO. of Labor Units TP AP MP
(L) (Kgs) (TP/L) ( TPn -TPn-1) Stage
1 20 20 20 I

2 50 25 30 I

3 90 30 40 I

4 120 30 30 II

5 135 27 15 II

6 144 24 9 II

7 147 21 3 II

8 148 15.5 1 II

9 148 16.4 0 II

10 145 14.5 -3 III

 Three stages of production:
• The three concepts of production when observed pass through
three different stages of production. (Diagram-P8 –> labor on x axis and
output on y axis)
• First Stage:
• TP increases at an increasing rate. AP increases. MP increases
first and then starts diminishing.
• Second Stage:
• TP is increasing at a diminishing rate. AP starts diminishing. MP
diminishes. The stage from where the MP of labor starts declining
shows the Law of diminishing returns or Law of Variable
proportions.
• Third Stage:
• TP starts diminishing. AP also diminishes. MP becomes zero.
Thereafter it is negative.
• Reasons for different stages to occur:
• In first stage – there are fixed inputs-under
utilized capacity- specialization and team work –
cause AP to increase when additional input
(labor) is used.
• In Second stage – specialization-teamwork and
proper utilization of the fixed inputs continues.
• In Third stage - fixed inputs capacity gets
exhausted and the additional labor (variable
input) causes the output to fall.
 Optimum use of the variable Input:

• A rational firm has to decide about how much of variable input

should be used to maximize profits – choose stage – extra
revenue equals extra cost.
• Stage one and Stage three should be avoided.

• Stage one – underutilizing fixed capacity- the MP of labor rises-

profitable for employing additional labor.
• Stage three – over utilizing its fixed capacity- the MP is
negative- not profitable.

• Stage two is OPTIMUM and should be selected – proper

utilization of fixed inputs and variable input – TP and AP are
positive – Production only till MR=MC.
• Stage Two is ideal for Short Run (maximizing the goal)
•
 End
Law of variable proportions

PPTs by
Dr. Thirumagal Pillai