dr.

moeenuddin

DR MOEEN UD DIN
Reference Book

DR MOEEN UD DIN
 Theory of Production

“Production is a term which includes

The production of services as well as commodities
And even in the case of commodities
production is basically the performing of services”

Prof. J. L. Hanson
 Concepts of Production
▪ Total Product: Total product of a variable input is the amount of output produced
over any given period when that input is used along with other fixed input.

▪ Average Product: Average product of a factor is the total output produced per-
unit of the factor employed.

𝑇𝑜𝑡𝑎𝑙 𝑃𝑟𝑜𝑑𝑢𝑐𝑡
Average Product = 𝑁𝑢𝑚𝑏𝑒𝑟 𝑜𝑓 𝑢𝑛𝑖𝑡𝑠 𝑜𝑓 𝐹𝑎𝑐𝑡𝑜𝑟 𝐸𝑚𝑝𝑙𝑜𝑦𝑒𝑑

▪ Marginal Product: Marginal product of a factor is the addition to the total output
by the employment of an extra unit of a factor.

𝐶ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑇𝑜𝑡𝑎𝑙 𝑃𝑟𝑜𝑑𝑢𝑐𝑡

Marginal Product = 𝐶ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝐹𝑎𝑐𝑡𝑜𝑟 𝐸𝑚𝑝𝑙𝑜𝑦𝑒𝑑
 Scale of Production
“The size of business, total quantity of inputs used and the volume of production”

Factors Determining the Scale of Production

▪ Financial Resources
▪ Entrepreneurial Abilities
▪ Production Techniques
▪ Market Extent
▪ Transport and Communication

. . . .
 Economies of Scale
“The phenomenon whereby increasing the overall level of output
Leads to decreasing production cost per-unit”

Types of economies of Scale

i. Internal Economies
“Internal economies are those which are open to a single factory, or a single firm
independently of the action of other firms. These result from an increase in the scale
of output of a firm and cannot be achieved unless output increases.”

ii. External Economies

“External economies are those benefits which are shared in by a number of firms or
industries when the scale of production in any industry increases.”

. . . .
 Pure Competition/ Perfect Competition

i. Internal Economies ii. External Economies

▪ Technical Economies
▪ Managerial Economies
▪ Economies of Concentration
▪ Financial Economies
▪ Economies of Information
▪ Commercial Economies
▪ Economies of Disintegration
▪ Risk-bearing Economies
▪ Economies of Localization
▪ Research Economies
▪ Economies of By-Products
▪ Welfare Economies

. . . .
 Diseconomies of Scale
“The possible increase in long-run unit or average cost
Which may occur as the scale of the firm`s output
Is increased beyond some critical point”

Diseconomies of Scale arise into the production process in two ways:

▪ As the size of firm increases, monitoring cost generally increase

▪ As the size of firm increases, team spirit or morale generally decreases.

. . . .
 Law of Variable Proportions
“Law of variable proportions examines
the short-run production function with one factor variable
keeping the quantities of other factors fixed”

Prof. J. L. Ryan:

“The law of Variable Proportions tells that given the production techniques,
When unit of a variable factor are increased to work with the fixed factors of production,
the output first increases more proportionately than input
But later-on the proportion of increase in output relative to input decreases.”

. . . .
 Law of Variable Proportions
Three Stages of the Law of Variable Proportions

▪ Stage – I Increasing Returns

TP (increase at increasing rate), MP > AP
at the end of stage-1, MP = AP (or MP is maximum),
rate of increase in TP changes
▪ Stage – II Diminishing Returns
TP (increase at decreasing rate), MP > AP
at the end of stage-2, MP = 0 TP becomes maximum,
(Point of Operation)
▪ Stage – III Negative Returns
TP , MP (becomes –ve ), while AP (+ve)

. . . .
 Law of Variable
Proportions

Q TP AP MP
1 10 10 10
2 30 15 20
3 60 20 30
4 80 20 20
5 90 18 10
6 90 15 0
7 80 11.4 -10

. . . .
 Law of Variable Proportions

Assumptions
▪ Fixed quantity of some inputs
▪ Variable factors (Labor)
▪ Homogeneous units of labor
▪ Continuous employment of labor
▪ Short-run model
▪ Factors proportions are variable
▪ Physical measurement

. . . .
 The Laws of Returns to Scale
“The laws of Returns to Scale describes the relationship
between outputs and the scale of inputs in the long-run
when all the inputs are increased in same proportion”

When all the inputs are increased in unchanged proportions and the scale of
production is expanded, the effect on output shows three stages:

▪ Stage – I Increasing Returns to Scale or Decreasing Costs

• When all the factors of production are increased, output increases at a higher
rate.
• Increase in output is due to many reasons like division of labor, specialization,
external economies, etc.
• hence, Marginal Cost decreases

. . . .
 The Laws of Returns to Scale

▪ Stage – II Constant Returns to Scale or Constant Costs

• Output increases exactly in the same proportion in which factors of production
are increased
• Internal and external economies are exactly equal to the internal and external
diseconomies
• It is homogeneous production function
• Hence, Marginal Cost remain unchanged

▪ Stage – III Diminishing Returns to Scale or Increasing Costs

• When all the factors of production are increased, output increases at a smaller
rate.
• Internal and external economies are less than the internal and external
diseconomies
• Hence, Marginal Cost increases

. . . .
 The Laws of Returns to scale
Assumptions

▪ Variable Factors ---- Land, Labor, Capital

▪ Fixed Factors ---- Enterprise
▪ Long-Run Model
▪ Profit Maximization
▪ Same technology
▪ Perfect Competition
▪ Homogeneous Factors
▪ Continuous Employment
▪ Fixed factor Proportion
▪ Physical Measurement

. . . .
 The Laws of
Returns to Scale
Scale
Q MP MC
L+N+K
1 1+2+3 10 10.00
2 2+4+6 20 5.00
3 3+6+9 30 3.33
4 4+8+12 40 2.50
5 5+10+15 40 2.50
6 6+12+18 40 2.50
7 7+14+21 30 3.33
8 8+16+24 20 5.00
9 9+18+27 10 10.00

. . . .
 The Laws of Returns to Scale
Applicable to the
Law Reasons
Sector(s)

Division of Labor, Use of Machinery,

Law of Increasing Returns/ Law
Manufacturing Sector Economies of Scale. Innovations,
of Diminishing Costs
Elastic Supply

Law of Constant Returns/

Field of Handicrafts Equal role of the Nature and Human Being
Law of Constant Costs

Natural factor, Manual methods,

Agricultural Sector, Limited Division of labor. Lack of close supervision,
Law of diminishing Returns/ Mines, Less than full capacity use of variable factors (seasonal)
Law of Increasing Costs Forests, Limited Deposits of minerals, High Cost of Mining Operation
Buildings Forest requires cleaning of shrubs, Paving of ways, hauling of woods
Building of skyscraper requires high expenses

. . . .
 Difference between
Laws of Returns and Laws of Returns to Scale

Basis Laws of Returns Laws of

. Returns to Scale
Quantity of Quantity of some inputs are fixed
All the inputs are variable
Inputs while Quantity of other inputs vary

Laws of Returns are known as Short- Laws of Returns to Scale are known as
Run Run Production Function Long-Run Production Function
Nature of
Laws of Returns are non- Laws of Returns to Scale are
Production homogeneous production function homogeneous production function
Function

.
 .

dr.moeenuddin

dr.moeenuddin