301 Unit 2.ppt

UNIT 2
CLASSICAL PRODUCTION FUNCTION
Factor-Product Relationship
Determination of Optimum Input and Output
The law of diminishing returns describes the relationship
between output and the variable input when other inputs
are held constant.

Factor-Product Relationship
Determination of Optimum Input and Output

Relationship between TPP & MPP

Relationship between MPP & APP

Elasticity of production
• The elasticity of production is a concept that measures
the degree of responsiveness between output and input.

Factor – Factor Relationship
• Factor-factor relationship is concerned with the
possibilities of substituting one input/factor (X1)
for another input/factor (X2) for producing a given
level of output.
• The two fold object of factor-factor relationship is
(i) Minimization of cost at a given level of output.
(ii) Optimization of output to the fixed factors
through alternatives resources combinations.

Isoquant (Iso-product curve)
• Various combinations of two inputs yielding the same level
of output.
• Each point on an isoquant represents the maximum
output that can be attained with these input combinations.

Types of Factor-Factor Relationship

Fixed proportion combination
• These represent such products that can be produced if
inputs are added in fixed proportion at all levels of
production. In this case there is no substitution between
inputs and thus there is strict complementarily between
the two inputs.
• Also called Leontief isoquants.
• e.g. One tractor and one driver.

• Substitutes: Two resources are said to be substitutes when
change in price of one leads to a change in demand for
another (MRTS is –ve). Example labour and machinery
• Complements: Resources used together in production. When
Price of X1 increases the demand for X2 decrease.
(MRTS is zero). Example Tractor and diesel

Constant rate of substitution
• Such type of a factor-factor relationship gives linear
isoquants.
• The substitution occurs at constant rate i.e. the amount of
one input replaced by the other input does not change as
the added input increases.

Varying Rate of substitution
• In this there can either be increasing rate or decreasing
rate of substitution.

Iso-cost line
• Locus of all possible combination of two inputs which can
be purchased with a given outlay or budget.

Computing Least cost combination:

Iso-cline
• line or curve connecting the isoquants of inputs for all
output levels is known as isocline.

Ridge lines
• Represent the points of maximum output from each input,
given a fixed amount of the other input.
• On the ridge lines MPP is zero.

Expansion Path
• the line or curve connecting the points of least cost
combination for different levels of output.
• Expansion path is an isocline on which slope of isoquant
• (MRTS) equals the slopes of isocost line (price ratio).
• The expansion path indicates the best way of producing
the different levels of output given the input prices & the
technology

• If expansion path is a straight line through origin, it means
inputs will be used in the same proportion at all output
levels and hence it is called scale line.
• It is curved; it implies the inputs will be used in various
proportions.

Product-Product Relationship
• What combination of enterprises should be produced.
• Algebraically, y1 = f (y2)

• Basic Relationship: The basic product-product
relationships are
• Joint Products- Joint products result from the same
production process and the production of one without the
other is not possible

• Complementary Products- Complementarity between
two enterprises exists when with a change in the level of
one, the other also changes in the same direction.

• Supplementary products: Exists when increase or
decrease in one product does not affect the production
level of the other product
• .

• Competitiveness: This relationship holds when increase
or decrease in the production of one product affects the
production of other commodity inversely
• When two products are competitive, they may substitute
at constant rate, increasing rate or decreasing rate.

Constant Rate of Substitution
• It means that a unit change in one product is throughout
accompanied by the same unit opposite change in the
other product e.g. wheat & gram for land.

Increasing Rate of Substitution
• In this each unit increase in the level of one product is
accompanied by larger and larger decrease in the level of
other product.

Decreasing Rate of Substitution
• In this case a unit increase in the level of one product is
accompanied by lesser & lesser decrease in the level of
other product

Marginal Rate of Product Substitution
or Rate of Product Transformation
RPT is nothing but the slope of production possibility
or opportunity curve.

PRODUCTION POSSIBILITY CURVE
(ISO-RESOURCE CURVE)
• The production possibility curve or product transformation
curve is the locus of maximum amounts of two products/
enterprises, say Y1 and Y 2 that can be produced from a
given quantity of resources.

Iso Revenue Line
• It is the line which defines all possible combinations of two
commodities which would yield an equal revenue or
income.

Revenue Maximizing Combination of
Outputs

LAW OF EQUI-MARGINAL RETURNS
• A limited input should be allocated among alternative uses
in such a way that the marginal value products of the last
unit are equal in all its uses.

OPPORTUNITY COST
• Opportunity cost is defined as the returns that are
sacrificed from the next best alternative.
• Opportunity cost is also known as real cost or alternate
cost.

PRINCIPLE OF COMPARATIVE
ADVANTAGE
• Individuals or regions will tend to specialize in the
production of those commodities for which their resources
give them a relative or comparative advantage.

Fixed cost
Variable cost
Total cost
Average fixed cost
Average variable cost
Average total cost
Marginal cost
Marginal revenue
COST CONCEPT

301 Unit 2.ppt

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301 Unit 2.ppt