DEPARTMENT OF MANAGEMENT STUDIES

M.B.A. 1ST SEMESTER

Session- 2022-23

Course Name: Managerial Economics

A Presentation
On
Topic: “Production Function”
Presented By:
Submitted To:
Deepanshu Gandhi
Dr.(Smt.) Bobby B. Pandey
Shubhankar Batwe
Associate Professor
Rummi Ambastha
Priya Kumari
Renu Chandra

GURU GHASIDAS VISHWAVIDYALAYA,

BILASPUR(C.G.)
(A central University)
INTRODUCTION:

 Production in economic terms is generally understood as the transformation of

inputs into outputs.

 The inputs are what the firm buys, namely productive resources, and outputs are
what it sells.

 Production is not the creation of matter but it is the creation of value.

 Production is a sequence of technical processes requiring either directly or

indirectly the mental and physical skill of craftsman and consists of changing
requiring either directly or indirectly the mental and physical skill of craftsman and
consists of changing the shape, size and properties of materials and ultimately
converting them into more useful articles.
FIXED AND VARIABLE FACTORS:

FIXED FACTORS-
 Fixed factors are those the application of which does not change with the change
in output.
 In fact, fixed factors (like machines) are installed before output actually
commences. Thus, a machine is there even when output is zero.

VARIABLE FACTORS-
 Variable factors are those the application of which varies (or changes) with the
change in output.
Labour is an example of variable factor. You need more labour to produce more
units of a commodity, other things remaining constant.
SHORT RUN AND LONG RUN PRODUCTION
FUNCTION:
SHORT RUN PRODUCTION FUNCTION-
 Short run production function is the relationship between the specific variable input
and quantity of output.
 In Short run production function, only one factor is variable, while others remain
fixed.

LONG RUN PRODUCTION FUNCTION-

 Long run production function explains the relationship between all inputs and the
quantity of output.
 In the long run production function, all factor of production, or inputs are variable.
THE PRODUCTION FUNCTION:

 Production Function studies the functional relationship between physical inputs and
physical output of the commodity
 It is purely a technical relationship between material output on the one hand and
material inputs on other.
 Usually, it is expressed in terms of the following equation:
Q = f (L,M,N,K,T)
Where, Q is the output, L for labour, M for management, N for land, K for capital and T
for given technology.
DEFINITIONS OF PRODUCTION FUNCTION:

 According to Watson “Production Function is the relation between a firm’s

production (output) and the material factors of production (input).”
 According to Michael R. Bayes “Production Function is that function which
defines the maximum amount of output that can be produced with a given set of
inputs.”
Objective of Production Function:

 The primary purpose of the production function is to address allocative efficiency

in the use of factor inputs in production and the resulting distribution of income to
those factors.
 Production function is a function that specifies the output of a firm for all
combinations of inputs.
 The relationship of output to inputs is non-monetary; that is, a production function
relates physical inputs to physical outputs, and prices and costs are reflected in the
function.
 Influences economic decision-making.
Nature of Production Function:

The production function depends upon the following factors:

 The quantities of inputs to be used.

 The state of technical knowledge.

 The possible processes of production.

 The size of the firm.

 The prices of inputs.

Attributes of Production Function:

 The production function is a flow concept.

 It is a technical relationship between inputs and outputs expressed in physical
terms.
 It depends on the state of technology and inputs.
 A rational firm is interested not in all the numerous possible levels of output but
only in that combination which yields maximum outputs.
 The short run production function pertains to the given scale of production while
the long run production function pertains to the changing scale of production.
Production Function as Graph:

 Any of these equations can be plotted on a graph. A typical (quadratic)

production function is shown in the following diagram under the assumption
of a single variable input (or fixed ratios of inputs so the can be treated as a
single variable).

 All points above the production function are unobtainable with current
technology, all points below are technically feasible, and all points on the
function show the maximum quantity of output obtainable at the specified
level of usage of the input.
Production Function as Graph:
TOTAL PRODUCT, MARGINAL PRODUCT AND
VARIABLE PRODUCT

TOTAL PRODUCT-
 TP is the sum total of output of each unit of the variable factor used in the process
of production. This is also called total return of variable factor.
 Algebraically denoted as, TP= AP*L
Where AP= Average product and L= Units of Variable factor
TOTAL PRODUCT, MARGINAL PRODUCT AND
VARIABLE PRODUCT:

MARGINAL PRODUCT-
 MP refers to change in TP when one more unit of the variable factor is used, fixed
factor remaining constant.
 Sum total of MP corresponding to each unit of the variable factor makes up TP.
 Algebraically, MP= TPn-TPn-1
AVERAGE PRODUCT-
 AP is output per unit of inputs of variable factors.
 It is estimated as, AP= TP/L
Where, TP= Total product and L= Units of variable factor
SHORT RUN PRODUCTION FUNCTION
 The technical conditions of production are rigid so that the various inputs used to
produce a given outputs are in fixed proportions.
 However, in the short run, it is possible to increase the quantities of one input
while keeping the quantities of other inputs constant in order to have more
output.
SHORT RUN PRODUCTION FUNCTION
 The short run production function in the case of two inputs, labour and capital with
capital as fixed and labour as the variable input can be expressed as
Q = f (L,R)
Where K refers to the fixed input.
LONG RUN PRODUCTION FUNCTION
 In the long run, it is possible for a firm to change all to change all inputs up or down in
accordance with its scale.
 This is known as returns to scale.
 The returns to scale are constant when output increases in the same proportion as the
increase in the quantities of inputs.
 The returns to scale are increasing when the increased in output is more than proportional
to the increase in inputs.
 They are decreasing if the increase in output is less than proportional to the increase in
inputs.
Q = (L, M, N, K T2)
LONG RUN PRODUCTION FUNCTION
The long run production function is depicted in Figure where the combination of
OK of capital and OL of labour produced 100Q. With the increase in inputs of
capital and labour to and , the output increases to 200Q. The long run production
function is shown in terms of an isoquant such as 100 Q.
LAW OF VARIABLE
PROPORTIONS:
 Law of Variable Proportions states that as more and more of variable
factor is combined with the fixed factor, a stage must ultimately come
when marginal product of the variable factor starts declining.

 When variable factor is increased while keeping all others factors

constant, the total product will increase initially at an increasing rate,
next it will be increasing at a diminishing rate and eventually there
will be decline in the rate of production.
 ASSUMPTIONS:
 CONSTANT STATE OF TECHNOLOGY- It is assumed that the state of technology
will be constant and with improvements in the technology, the production will improve.

 VARIABLE FACTOR PROPORTIONS- This assumes that factors of production are

variable. The law is not valid, if factors of production are fixed.

 HOMOGENEOUS FACTOR UNITS- This assumes that all the units produced are
identical in quality, quantity and price. In other words, the units are Homogeneous in
nature.
ASSUMPTIONS:

 SHORT RUN- This assumes that this law is applicable for those systems that
are operating for a short term, where it is not possible to alter all factor
inputs.
EXPLANATION OF THE
LAW
The law of Variable proportion is explained with the help of table and graph

UNITS OF TOTAL AVERAGE MARGINAL

LABOUR PRODUCT PRODUCT PRODUCT
Increasing MP
1 8 8 8 implying increasing
returns to factor
2 20 10 12
3 36 12 16
Diminishing MP
4 48 12 12 implying
5 55 11 7 diminishing returns
to factor
6 60 10 5
Negative MP
7 60 8.6 0 implying negative
8 56 7 -4 returns to factor
EXPLANATION OF THE LAW
THREE STAGES OF PRODUCTION
STAGE 1- INCREASING RETURNS

 When MP is increasing, called the stage of increasing returns.

 As the production of one factor in the combination of factor is increased up to a
point, the MP of the factor will increase.

REASONS:

 Fuller Utilization of the fixed factor- In the initial stages, fixed factor (such as
machine) remains underutilized. Its fuller utilization calls for greater application of
the variable factor (labour).Hence, initially (so long as fixed factor remains
underutilized) additional units of the variable factor add more and more to total
output, or marginal product of the variable factor tends to increase.
STAGE 1- INCREASING
RETURNS
 Increased Efficiency of the Variable Factor- Additional application of the
variable factor (labour) enables process based division of labour that raises
efficiency of the factor. Accordingly, marginal productivity of the factor
tends to rise.

 Better Coordination between the Factors- So long as fixed factor remains

underutilized, additional application of the variable factor tends to
improve the degree of coordination between the fixed and variable factors.
As a result, Total output increases at increasing rate.
STAGE 2- DIMINISHING RETURNS
• When MP is diminishing, called the stage of Diminishing Returns.

• As the production of one factor in the combination of factor is increased

after a point MP of the factor will decrease.

REASONS:

• Fixity of the Factor- Fixity of the factor(s) is the principle cause behind
the law of diminishing returns. As more and more units of the variable
factor are combined with the fixed factor, the latter gets excessively
utilized. It suffers grater wear and tear and loses its efficiency.
STAGE 2- DIMINISHING RETURNS

 Imperfect Factor is Substitutability- Factors of Production are imperfect

substitutes of each other. More and more of labour cannot be continuously
used in place of capital. Accordingly, diminishing returns are bound to set
in if only the variable factor is increased to increased output.

 Poor Coordination between the Factors- Increasing application of the

variable factor (along with the fixed factor) stretches the limit of ideal
factor ratio. This results in poor coordination between the fixed and
variable factors, causing diminishing returns.
STAGE 3- NEGATIVE RETURNS

When MP is negative, called the stage of negative returns.

REASONS:

 Limits of Fixed Factor- Some factors of production are always fixed in

nature. These factors cannot be increased with an increase in variable
factors which results in negative return to a factor.

 Decrease in the Efficiency of Variable Factor- The advantages related to

the specialization of a variable and its division of labour start to go down
with a continuous increment of variable factors. This causes negative
returns to take place.
LAW OF RETURNS TO
SCALE:
Returns to scale describes the relationship between outputs and scale of
inputs in the long run when all the inputs are increased in the same
proportion.

 In the words of Prof. Roger Miller, "Returns to scale refer to the

relationship between changes in output and proportionate changes in all
factors of productions."

To meet a long run change in demand, the firm increases its scale of
production by using more space, more machines and laborers in the factory.
Assumptions:

This law assumes that

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

 A worker works with given tools and implements.

 Technological changes are absent.

 There is perfect competition.

 The product is measured in quantities.

EXPLANATION OF THE LAW
The Law of returns is explained with the help of Table and Graph.

Returns to Scale in Physical Units

UNITS SCALE OF PRODUCTION TOTAL MARGINAL
RETURNS RETURNS
1 1 Workers + 2 Acres Land 8 8
2 2 Workers + 4Acres Land 17 9 INCREASIN
3 3 Workers + 6 Acres Land 27 10 G RETURNS

4 4 Workers + 8 Acres Land 38 11

5 5 Workers + 10 Acres Land 49 11 CONSTANT
RETURNS

6 6 Workers + 12 Acres Land 59 10

DIMINISHING
7 7 Workers + 14 Acres Land 68 9
RETURNS

8 8 Workers + 16 Acres Land 76 8

EXPLANATION OF THE LAW
Increasing Returns to Scale:

Returns to scale increase because the increase in total output is more than proportional
to the increase in all inputs.

Causes of Increasing Returns to Scale

Returns to scale increase due to the following reasons:

 Indivisibility of Factors.
 Specialization and Division Labour.
 Internal Economics.
 External Economies.
Constant Returns to Scale:

Returns to scale become constant as the increase in total output is in exact proportion
to the increase in inputs. If the scale of production in increased further, total returns
will increase in such a way that the marginal returns become constant.

Causes of Constant Returns to Scale

Returns to scale are constant due to:

 Internal Economies and Diseconomies .
 External Economies and Diseconomies.
 Divisible Factors.
Diminishing Returns to Scale:

Returns to scale diminish the increase in output is less than proportional to the
increase in
inputs.

Causes of Diminishing Returns to Scale

 Constant returns to scale is only a passing phase, for ultimately returns to scale
start diminishing indivisible factors may become inefficient and less productive.
 Large management creates difficulties of control and rigidities.
 To theses internal diseconomies are added external diseconomies of scale.
 These arise from higher factor prices or from diminishing productivities of the
factors.
Economies of Scale:

 Economies of scale, in microeconomics, refers to the cost advantages that a business

obtains due to expansion.

 There are factors that cause a producer's average cost per unit to fall as the scale of output
is increased.

 "Economies of scale" is a long run concept and refers to reductions in unit cost as the size
of a facility and the usage levels of other inputs increase.

 The common sources of economies of scale are purchasing (bulk buying of materials
through long-term contracts), managerial (increasing the specialization of managers), and
technological (taking advantage of returns to scale in the production function).
Economies of Scale:

These factors reduces the long run average costs (LRAC) of production by
shifting the short-run average total cost (SRATC) curve down and to the right.
Economies of scale are also derived partially from learning by doing.
Economies of Scale:
An economy of scale exists when larger output is associated with lower per unit cost.
Economies of scale have been classified by Marshall into Internal Economies and External
Economies.

INTERNAL ECONOMIES- Internal Economies are internal to firm when it expands its size
or increases its output.

EXTERNAL ECONOMIES- External Economies are external to a firm which is available to it

when the output of the whole industry expands.

Modern economists distinguish economies of scale in terms of real and pecuniary internal and
external economies.

Real Internal economies are "associated with a reduction in the physical quantity of inputs, raw
materials, various types of labour and various types of capital (fixed or circulating) used by a
large firm.
Economies of Scale:
Real internal economies which arise from the expansion of a firm are the
following:

1. Labour Economies.
2. Technical Economies.
i. economies of indivisibility.
ii. economies of superior technique.
iii. economies of increased dimensions.
iv. economies of linked processes.
v. economies of the use of by-products.
3. Economies in Power Consumption.
4. Marketing Economies.
5. Managerial Economies.
CONCLUSION:
 Production function is an equation that asserts the relationship between the quantities of
productive factors used and the maximum amount of product obtained at certain
technological level.
 The production function can thus measure the marginal productivity of a particular
factor of production and determine the cheapest combination of productive factors.
 Some inputs can be varied flexibly in a relatively short period of time. We
conventionally think of labor and raw materials as "variable inputs" in this sense.
 Other inputs require a commitment over a longer period of time. We have seen that the
concept of marginal productivity and the law of diminishing marginal productivity play
central parts in both the efficient allocation of resources in general and in profit
maximization.