Theory of Production is the name of the ppt

Model Institute of
Engineering & Technology
Course Name-Managerial Economics
Course Code- OEC 701 ( C )
Topic –Theory of Production

Some basic Concepts
Meaning of Production
 Production means transforming inputs (labour, capital, raw materials, time etc.) into an output
with value added.
 Production refers to the process of combining various inputs (such as labor, raw materials, and
capital) to create goods or services that have value and can be sold in a market. It is the act
of transforming resources into finished products or services that satisfy human needs and wants.

Short Run and Long Run
 Production of good involves timer.
 The reference to time period involved in production process is an important concept used in
production analysis.
 The two reference periods are short run and long run.

Short run is a period during which at least one input is fixed and cannot be changed, while other
inputs can be varied.
 Typically, capital (e.g., machinery, land, factories) is considered fixed in the short run, while
labour and raw materials are variable.
 Firms can increase or decrease their production levels by adjusting variable inputs, but they
cannot make changes to fixed inputs.
 Fixed Inputs: In the short run, certain resources like factory size, machinery, or land remain
constant.
 Variable Inputs: Firms can adjust resources like labour and raw materials to respond to changes
in demand or production needs.
For Example: A car manufacturing company may add more workers (variable input) to increase
production in the short run, but the size of its factory (fixed input) remains unchanged.

 Long run is a period during which all inputs are variable, meaning that firms can change the
quantity of all inputs, including capital and labour.
 There are no fixed factors in the long run, and firms have the flexibility to adjust their
production capacity by expanding or contracting all resources.
 Firms can build new factories, buy more machinery, or change their production technology.
Example: The same car manufacturing company can build a new factory, invest in more machines, or
change its entire production process in the long run to increase its output capacity.
 All Inputs are Variable: In the long run, firms can fully adjust to changes in demand by altering
both variable and fixed inputs.

Production Function
A production function is a mathematical expression that defines the maximum amount of output a
firm can produce with a given set of inputs over a specific period. It shows the technological
relationship between physical inputs and outputs.
General Form:
Q=f(L,K,R,T) Where:
 Q = Output (Quantity of goods produced)
 L= Labour input
 K= Capital input
 R= Raw materials
 T = Technology
 Note: The inputs used in production can be broadly classified as labor, capital, land,
materials, and technology.

Types of Production Functions
(a) Short-run Production Function:
 In the short run, at least one input is fixed, meaning the firm cannot adjust it easily.
 The firm can only change variable inputs like labour or raw materials.
 The primary focus is on how output changes as the firm varies its variable inputs while holding
some inputs constant.
(b) Long-run Production Function:
 In the long run, all inputs are variable. Firms can adjust labour, capital, technology, and other
factors as needed.
 There are no fixed inputs in the long run.

Cobb-Douglas Production Function
 One of the most widely used production functions in economics is the Cobb-Douglas production
function, which represents output as a product of labour and capital inputs.
 Formula:
Where:
 Q= Output
 A= Total factor productivity (technological efficiency)
 L= Labour input
 K= Capital input

α alpha=Output elasticity of labour (percentage change in output due to a 1% change in
labour)

β beta =Output elasticity of capital (percentage change in output due to a 1% change in
capital)

Properties:
 If + =1, there are
α β constant returns to scale.
 If + >1, there are
α β increasing returns to scale.
 If + <1, there are
α β decreasing returns to scale.

 Total Product (TP)
 Definition: Total Product refers to the total quantity of output produced by a firm using a given
quantity of inputs (like labour or capital) over a specific period of time.
 Example: If a factory produces 100 units of goods per day with 5 workers, the TP is 100 units.
 Marginal Product (MP)
 Definition: Marginal Product refers to the additional output produced by using one more unit
of input, holding all other inputs constant.
Formula: MP= TP/L
Δ
Where TP is the change in total product and L is the change in the quantity of labour.
Δ Δ
 Example: If increasing the number of workers from 5 to 6 results in the production of 110 units
(i.e., an additional 10 units), then the MP of the 6th worker is 10 units.

 Average Product (AP)
 Definition: Average Product refers to the average output produced per unit of input.
Formula: AP=TP/L
 Where TP is the total product and L is the number of labour units.
 Example: If 5 workers produce 100 units of output, the AP is 100/5=20 units per worker.

Theory of Production is the name of the ppt

Reasons for Negative MP:
a) TP Decreases
b) Disguised Unemployment: Disguised unemployment refers to a situation where more workers
are employed than necessary for a given level of output, meaning that some workers'
contributions to production are essentially redundant.

Law of Variable Proportion
 The Law of Variable Proportion is also known as the Law of Diminishing Marginal Returns.
 The law highlights the relationship between input and output, focusing on how additional units
of a variable factor (e.g., labor) affect total production.
 It is particularly applicable in the short run, where at least one factor is fixed.
 The Law of Variable Proportions states that as more and more units of a variable factor (such
as labour) are combined with a fixed factor (such as capital or land), the marginal product of
the variable factor initially increases, then starts to decrease, and eventually becomes
negative.

If one input is increased while keeping other inputs constant, the resulting increase in output will
follow a three-stage process:
1. Increasing returns,
2. Diminishing returns, and
3. Negative returns.

First Stage (Stage of increasing returns)
 Total product increases at an increasing rate up to a certain point and then increases but at
the decreasing rate.
 In figure, TP is increasing at the increasing rate up to point A, increasing at diminishing rate
thereafter. TP is maximum at C and D (constant).
 MP is increasing up to point G and then it is decreasing.
 AP is increasing up to the point H, stable up to point E.
 The first stage ends at the point E where AP and MP are equal (i.e. AP = MP)

 Second Stage (Stage of decreasing returns)
 In this stage of production, total product continues to increase at the diminishing rate until it
reaches to maximum.
 In figure, this stage begins from the point B of TP curve. TP is maximum at point C and remains
stable up to point D.
 In this stage AP is continuously decreasing.
 MP is also continuously decreasing and becomes zero (Point F of figure) where second stage
ends.
 When TP is maximum and constant, MP is zero

Causes of decreasing returns
1. Scarcity of fixed factors
2. Indivisibility of fixed factor
3. Imperfect substitutability of the factor

Third Stage (Stage of negative returns)
 This stage begins from the point (point D in figure) in which TP is declining.
 AP is also declining but never becomes zero and negative.
 When TP declines, MP becomes negative.
Causes of negative returns
1. Inefficient utilization of variable factors
2. Over utilization of fixed factors
3. Complexity of management

Assumptions of the Law
 Technology is constant.
 Labour is only a variable factor.
 At least, one factor of production is fixed.
 There must be possibility of varying the proportion of factors of production.
 All units of labour are homogeneous

Theory of Production is the name of the ppt

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