Lecture 13: Classical production function and three stages of production –

Elasticity of production

Production Function

“Production function is a technical and mathematical relationship describing the manner and
extent to which a particular product depends upon the quantities of inputs or services of inputs,
used at a given level of technology and in a given period of time”. It shows the quantity of output
that can be produced using different levels of inputs. A production function can be specified as

Y = f ( X1 / X2 , X 3…………….X n)

(Output of Rice in Kgs per hectare is the function of fertilizers, seeds, manures…..etc.). Here the
inputs which are variable in the process of production are placed on left hand side of the bar and
the inputs which are held constant are written on the right hand side.

Here we need to understand certain concepts, which help in analysis of the input-output
relationship.

Total Physical Product (TPP)

It represents the total output or yield that can be attained with the variable input X 1 and a
set of fixed inputs X 2 …… X n, measuring in physical units like quintals, kgs. etc.

TP (Y) = f (X1 / X2, X 3…………….X n)

Average Physical Product (APP)

It is the average amount of output produced by each corresponding unit of input. It is obtained by
dividing the total output at a given level by the number units of the variable input applied at the
corresponding level. APP reflects the efficiency of the variable input (technical efficiency).

Total Physical Product Y

APP= =
Input level X

Marginal Physical Product (MPP)

MPP is the additional quantity of output, added by an additional unit of input i.e., the
change in output as a result of change in the variable input. It is calculated as

Change∈Total Physical Product ΔY

MPP= =
Change∈ Input level ΔX
Law of Diminishing Marginal Returns (LDMR)

Alfred Marshall stated the law thus: “An increase in labour and capital applied in the
cultivation of a land causes, in general, a less than proportionate increase in the amount of
produce raised, unless it happens to coincide with an improvement in the arts of
agriculture”.

The advancement in agricultural technology may bring about changes where the operation of this
law is delayed, for example, by evolving, varieties of crops, which give higher yields at higher
levels of fertilizer application. But so far, science has not succeeded in stopping the operation of
this law in agriculture. The law of diminishing returns is also called the law of variable
proportions. E.O. Heady has stated that if the quantity of one productive service is increased by
equal increments, with the quantity of other resource services held constant, the increment to
total product may increase at first but will decrease, after a certain point. In other words, as the
amount of a variable resource used in the production of an output is increased, the level of output
will at first increase at an increasing rate, then increase at a decreasing rate and finally a point
will be reached, where further applications of the variable resource will result in a decline in the
total output of the production.

b) Relationship between Total, Average and Marginal products (or) Three Stages or Phases
or Zones of Production Function: Since both average and marginal products are derived from
total product, the average and marginal product curves are closely related to the total product
curve. The input-output relationship showing total, average and marginal productivity can be
divided into three regions in such a manner, that one can locate the portion of the production
function, in which the production decisions are rational. A non-linear total product curve and the
three zones of production are shown in the figure 1.

Stage I: As we increase the level of a variable input, say seed rate per hectare, the total
production (yield per hectare) increases at an increasing rate till point ‘L’ is reached on the TPP
curve. Thus, upto this point (L) the marginal physical product (MPP) is shown as increasing and
then it starts declining. Point L is the point of inflection on the TPP curve where the curvature
changes from convex to concave to the input axis as we move away from origin. The TPP curve
is continuously increasing but at a decreasing rate as we move from the point L to M on TPP by
increasing the seed rate from Xi to Xm. The stage I ends at the point N where marginal product is
equal to average product when the latter is at its maximum. In this stage, APP keeps on
increasing and MPP remains greater than APP. It is not reasonable to stop the use of an input
when it’s efficiency-in- use is increasing (This is indicated by continuous increase in APP). In
this stage, more use of variable input increases its physical production efficiency in combination
with fixed inputs. So it is irrational to stop increasing the use of variable input, as long as fixed
inputs are not fully utilized. For this reason, it is called irrational stage of production.
 Figure 1: Three Zones of Production Function

Stage II: The Stage II occurs when MPP is decreasing and is less than APP. In Stage II, MPP is
equal to or less than APP but equal to or greater than zero. It starts at a point where APP is at its
maximum and ends where the total product is at its maximum. Within the boundaries of this
region is the area of economic relevance. It is only in this region that marginal product of
variable and fixed factors are positive. Optimum point of input-use must be somewhere in this
region. Hence, it is called rational stage of production. The optimum point can, however, be
located only when input and output prices are known. It needs to be emphasized that this region
of rational production embodies diminishing returns phase. Both average and marginal products
are decreasing in this region.

Stage III: A part of TPP curve beyond the point M is called the third phase of production. As
variable input use is extended beyond X m, the marginal product beyond point M is negative. It is
irrational to increase the input level for obtaining lower total product. Thus, Stage III is also
called irrational stage of production. The difference between the irrationality in Stage I and Stage
III can be explained in terms of scarcity of the variable input in Stage I and its excess use in
Stage III in relation to the fixed factors of production. Thus, while the marginal product of the
variable factor is negative in the third stage of production, the same is precisely true for the fixed
factor in the first stage of production. E.g.) more fertilizer dosage, excessive irrigation, etc.
would result in reduction of yield.
Three Regions of Production-Economic decisions

Stage I: It is called irrational zone of production. Any level of resource use falling in this region
is uneconomical. The technical efficiency of variable resource is increasing throughout the zone
(APP is increasing). Therefore, it is not reasonable to stop using an input when its efficiency is
increasing. In this zone, more products can be obtained from the same resource by reorganizing
the combination of fixed and variable inputs. For this reason, it is called irrational zone of
production.

Stage II: It is rational zone of production. Within the boundaries of this region is the area of
economic relevance. Optimum point must be somewhere in this rational zone. It can, however,
be located only when input and output prices are known.

Stage III: It is also an area of irrational production. TPP is decreasing at increasing rate and
MPP is negative. Since the additional quantities of resource reduces the total output, it is not
profitable zone even if the additional quantities of resources are available at free of cost. In case
if a farmer operates in this zone, he will incur double loss. i.e.,

1. Reduced Production

2. Unnecessary additional Cost of inputs.

Relationship between APP, MPP and Elasticity of Production

The elasticity of production refers to the percentage change in output in response to the
percentage change in input. It can be denoted by Ep and can be computed as:

E p=
[ ∆Y
Y
×100
] [ ]
=
∆Y
Y
=
∆Y X
× .Therefore Ep=
∆Y
×
1
=
MPP

[ ∆X
X
×100 ] [ ]
∆X
X
∆X Y ∆ X Y / X APP

Thus, elasticity of production can also be worked out if MPP and APP are known. In the figure
1, at the end of stage I, the Ep is unity (a one per cent increase in input is always accompanied by
a one per cent increase in output). In stage I, MPP is greater than APP. Therefore, Ep is greater
than 1. In stage II, MPP is lesser than APP and Ep is lesser than one, but greater than zero, (0 ≤
Ep ≤ 1). In stage III, MPP is negative and Ep is also negative.

Example

Total physical product function (TPP): Y = 4X+2X2- 0.1X3

Average physical product function (APP): Y /X = 4+2X-0.1X2

Marginal physical product function (MPP): = dY / dX = 4 + 4X - 0.3X2