Production

&
Costs
Topic:
Production
Function – Long
Learning Objectives;
 Identify the difference between short run and long run production function
 Identify the difference between short run and long run production function
 Differentiate between fixed and variable factors
 Understand the terms associated with the short-run production function –
total product, average product, and marginal product
 Explain and illustrate how they are related to each other.
 Calculate Average and marginal products from given data
The production function of a firm is a

relationship between inputs used and output

produced by the firm. For various quantities

of inputs used, it gives the maximum quantity

of output that can be produced.

 Long-run Production-function or Returns to
Scale
• All factor-inputs can be varied.
• We expand or reduce the scale of production as well.
• We discuss the way in which the output varies with the changes in
the scale of production
• The law which states this relationship is also called returns to
scale.
• Since it is related to the long-period, it is called long-run
production-function.
• Here the scale of production is changing
Returns to Scale
• The expansion of output may be achieved by varying all factor-
inputs.
• Thus, the change in scale means that all factor inputs are
changed in the same proportion in the long run.
• The law expresses the relationship between varying scales of
production and quantities of output.
• The increase in output may be more than, equal to, or less than
proportional to the increase in factor-inputs.
• Accordingly, returns to scale are also of three types
- increasing returns to scale, constant returns to
scale and diminishing returns to scale.
 Returns to Scale

•Return means change in physical output

•Scale means quantity of input employed.

•Change in scale means all factors of production

increase or decrease in same proportion
Assumptions

1. All factors (inputs) are variable, but enterprise is fixed.

2. A worker works with given tools and implements.

3. Technological changes are absent.

4. There is perfect competition.

5. The product is measured in quantities.

• The law of returns to scale with its all the three stages (or
types) is shown in the following example and diagram below:
Returns to Scale
• From A to B in the diagram is the stage of increasing returns;
from B to C constant returns, and from C to D is the
diminishing returns to scale.
Returns to Scale
Returns to Scale
In figure 8, OX axis
represents increase in labour
and capital while OY axis
shows increase in output.
When labour and capital
increases from Q to Q1,
output also increases from P
to P1 which is higher than the
factors of production i.e.
labour and capital.
In this diagram 9, diminishing
returns to scale has been shown.
On OX axis, labour and capital are
given while on OY axis, output.
When factors of production
increase from Q to Q1 (more
quantity) but as a result increase
in output, i.e. P to P1 is less. We
see that increase in factors of
production is more and increase in
production is comparatively less,
thus diminishing returns to scale
apply.
A regular example of constant returns to scale is the commonly used Cobb-
Douglas Production Function (CDPF). The figure given below captures
how the production function looks like in case of increasing/decreasing and
constant returns to scale.
In the long run, the supply of both the inputs is assumed to be
elastic (changes frequently)
organizations can hire larger quantities of both the inputs.
Larger quantities of both the inputs ae employed, the level of
production increases.
In the long run, the functional relationship between changing scale
of inputs and output is explained under laws of returns to scale.
The laws of returns to scale can be explained with the help of
Increasing returns to scale (IRS) holds when a proportional
increase in all the factors of production leads to an increase in
the output by more than the proportion. For example, if both
the labour and the capital are increased by ‘n’ times, and the
resultant increase in the output is more than ‘n’ times, then we
say that the production function exhibits IRS.
Algebraically, IRS exists when
f(nL, nK) > n. f(L, K)
Constant returns to scale will hold when a proportional
increase in all the factors of production leads to an equal
proportional increase in the output. For example, if both labour
and capital are increased by 10% and if the output also
increases by 10%, then we say that the production function
exhibits constant returns to scale.
Algebraically, constant returns to scale exists when
f(nL, nK) = n. f(L, K)
This implies that if both labour and capital are increased by ‘n’
Decreasing returns to scale (DRS) holds when a proportional
increase in all the factors of production leads to an increase in
the output by less than the proportion. For example, if both
labour and capital are increased by ‘n’ times but the resultant
increase in output is less than ‘n’ times, then we say that the
production function exhibits DRS.
Algebraically, DRS exists when
f(nL, nK) < n. f(L, K)
Causes for the Operation of Returns to Scale
• Returns to scale occur mainly because of two reasons
Causes for the Operation of Returns to Scale
The increasing returns to scale are attributed to the
following factors:

1.There may be indivisibilities in machines, management,

labour, finance, etc. Some items of equipment or some
activities have a minimum size and cannot be divided into
smaller units. When a business unit expands, the returns to
scale increase because the indivisible factors are
employed to their full capacity.
2. Increasing returns to scale also result from
specialization and division of labour. When the scale
of the firm expands, there is wide scope for specialization
and division of labour. Work can be divided into small tasks
and workers can be concentrated to narrower range of
processes. For this, specialized equipment can be installed.
Thus with specialization, efficiency increases and
3. As the firm expands, it enjoys internal economies

of production. It may be able to install better

machines, sell its products more easily, borrow money

cheaply, procure the services of more efficient manager

and workers, etc. All these economies help in increasing

4. A firm also enjoys increasing returns to scale

due to external economies. When the

industry itself expands to meet the increased

long-run demand for its product, external

economies appear which are shared by all the

Distinction between Returns to a Variable Factor (or Law of Variable Proportions) and
Returns to Scale
• The main differences between returns to a variable factor and returns to scale are as
indicated below: