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Theory of Production (1) - 3

This document discusses the theory of production in the short run and long run. It defines fixed and variable inputs in the short run. It explains the law of variable proportions and the three stages of increasing, diminishing, and negative returns. It then discusses how a rational firm should determine production in stage II where marginal product is below average product. The document also discusses long run production functions when all inputs are variable. It defines increasing, constant, and decreasing returns to scale based on proportional changes in inputs and outputs. Finally, it explains homogeneous and linearly homogeneous production functions and introduces the concept of isoquants and the marginal rate of technical substitution.

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sana mushtaq
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0% found this document useful (0 votes)
131 views37 pages

Theory of Production (1) - 3

This document discusses the theory of production in the short run and long run. It defines fixed and variable inputs in the short run. It explains the law of variable proportions and the three stages of increasing, diminishing, and negative returns. It then discusses how a rational firm should determine production in stage II where marginal product is below average product. The document also discusses long run production functions when all inputs are variable. It defines increasing, constant, and decreasing returns to scale based on proportional changes in inputs and outputs. Finally, it explains homogeneous and linearly homogeneous production functions and introduces the concept of isoquants and the marginal rate of technical substitution.

Uploaded by

sana mushtaq
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© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Inputs : Fixed inputs and Variable

inputs
Fixed inputs ❑ Examples:- Building, Land
etc
❑ ( In the long run fixed inputs are
❑ Remain the same in the
become varies)
short period .
❑ At any level of out put, the
amount is remain the
same.
❑ The cost of these inputs
are called Fixed Cost
Variable inputs
❑ In the long run all factors
of production are varies ❑ The cost of variable inputs
according to the volume of is called Variable Cost
outputs. ❑ Example:- Raw materials,
labour, etc
• Law of variable proportion: Short run
Production Function

 Explain short run production function


 Production function with at least one variable factor
keeping the quantities of others inputs as a Fixed.
 Show the input-out put relation when one inputs is
variable
“If one of the variable factor of production used more
and more unit,keeping other inputs fixed, the total
product(TP) will increase at an increase rate in the
first stage, and in the second stage TP continuously
increase but at diminishing rate and eventually TP
decrease.”
Stages in Law of variable proportion
First Stage: Increasing return
▪ TP increase at increasing rate till the end of the stage.
▪ AP also increase and reaches at highest point at the end of the stage.
▪ MP also increase at it become equal to AP at the end of the stage.
▪ MP>AP
Second Stage: Diminishing return
▪ TP increase but at diminishing rate and it reach at highest at the end of
the stage.
▪ AP and MP are decreasing but both are positive.
▪ MP become zero when TP is at Maximum, at the end of the stage
▪ MP<AP.
Third Stage: Negative return
▪ TP decrease and TP Curve slopes downward
▪ As TP is decrease MP is negative. AP is decreasing but positive.
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..
 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 outputs and proportionate changes in the
in all factors of production ”
Law of return to scales: Long run
Production Function
Labour Capital TP MP

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


Homogeneous production function

In the long run all inputs are variable. The production


function is homogeneous if all inputs factors are
increased in the same proportions in order to change
the outputs.

A Production function Q = f (L, K )


An increase in Q> Q^ = f (L+L.10%, K+K.10% )-
Inputs increased same proportion

Increasing returns to scale Inputs increased 10% => output increased 15%

Constant returns to scale Inputs increased 10% => output increased 10%
Decreasing returns to scale Inputs increased 10% => output increased 8%

Homogeneous production function

In the long run all inputs are variable. The production


function is homogeneous if all inputs factors are
increased in the same proportions in order to change
the outputs.

A Production function Q = f (L, K )


An increase in Q> Q^ = f (L+L.10%, K+K.10% )-
Inputs increased same proportion

Increasing returns to scale Inputs increased 10% => output increased 15%
Constant returns to scale Inputs increased 10% => output increased 10%

Decreasing returns to scale Inputs increased 10% => output increased 8%

Linearly Homogeneous production


function
In the long run all inputs are variable. The production
function is Linearly homogeneous if all inputs factors
are increased in the same proportions and the output is
increased in the same proportion.

Constant returns to scale Homogeneous production function


Inputs increased 10% => output increased 10%

A Linearly homogeneous Production function Q = f (L, K )


if labour and capital increased 10% then output increased the same 10%
Linearly Homogeneous production
function

A Linearly homogeneous Production function Q = f (L, K )


if labour and capital increased 10% then output increased the same 10%

400 unit output


%changes in factor
Capital 300 unit output

200 unit output


100 unit output

%changes in factor Labour


Iosquants

Combination Labour Capital Output level

A 20 1 100 unit
B 18 2 100 unit
C 12 3 100 unit
D 9 4 100 unit
E 6 5 100 unit
F 4 6 100 unit

An isoquants represent all those possible combination


of two inputs (labour and capital), which is capable to
produce an equal level of output .
Iosquants

Isoquants or equal product curve

Capital

100 unit output

Labour

An isoquants represent all those possible combination


of two inputs (Labour and Capital), which is capable to
produce an equal level of output.
Marginal Rate Technical Substitute(MRTS)

Isoquants or equal product curve

Capital

100 unit output

Labour

The slop of isoquant is known as Marginal Rate of Technical Substitution (MRTS). It is the rate at
which one factors of production is substitute with other factor so that the level of the out put
remain the same.
MRTS = Changes in Labour / changes in capital
Welcome

Theory of Production

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