Managerial Economics

Faculty : SOUJANYA L
Semester : II SEMESTER (BBA)
Programme BBA
Department Commerce & Management
Module : Introduction to Economics
 MEANING OF PRODUCTION
• Production may be defined as a process through which a firm transforms
inputs into output. It is the process of creating goods and services with the
help of factors of production or inputs for satisfaction of human wants.
• In other words, ‘transformation of inputs into output’ whereby value is
added, is broadly called production. Whatever is used in the production of a
commodity is called input.
• For example, in the production of wheat, the use of land, seed, fertilizer
water, pesticides, tractors, labour etc. are inputs and wheat is output. The
relationship between inputs and output of a commodity depends upon the
state of technology because with the help of advanced technology more can
be produced with the help of same inputs or same output can be produced
with the help of less inputs
 Before defining production function, we should understand
the following concepts related to production function

Short run and long run: Short run refers to a time period in which a
firm does not have sufficient time to increase the scale of output. It can
increase only the level of output by increasing the quantity of a variable
factor and making intensive use of the existing fixed factors.
On the other hand long run refers to the time period in which the firms
can increase the scale of output by increasing the quantity of all the
factor inputs simultaneously and in the same proportion.
 Fixed factors and variable factors

Fixed factors and variable factors Fixed factors are those factors of
production whose quantity can not be hanged with change in the level of
output. For example, the quantity of land, machinery etc. can not be
hanged during short run.
On the other hand, variable factors are those factors of production
whose quantity can easily be hanged with change in the level of output.
For example, we can easily change the quantity of labour to increase or
decrease the production.
 Level of production and scale of production

Level of production and scale of production When any firm

increases production by increasing the quantity of one factor
input where as the quantity of other factor inputs keeping
constant; it increases the level of production.
But on the other hand, when the firms increases production by
increasing the quantity of all the factors of production
simultaneously and in the same proportion, it increases the
scale of production.
 DEFINITION OF PRODUCTION FUNCTION

production function refers to the physical relationship between

inputs and output under given technology.
In otherwards production function is a mathematical functional/
technical/engineering relationship between inputs and output
such that with a given combination of factor inputs and
technology at a given period of time, the maximum possible
output can be produced. Such as land, labour capital and
entrepreneurship.
If there are two factor inputs: labour (L) and capital (K), then
production function can be written as: Qx = f (L, K) where Qx is the
quantity of output of commodity x, f is the function and L and k are the
units of labour and capital respectively. It says that quantity of output
depends on units of labour on capital used in production.
production function must be considered with reference to particular
period of time i.e. short period and long period.
 Production process

It is process by
which the inputs or
factors of production
are transformed into
output.
Factors of Production
 a)Land: Land is heterogeneous in nature. The supply of land is fixed
and it is a permanent factor of production but it is productive only with
the application of capital and labour.
b)Labour: The supply of labour is inelastic in nature but it differs in
productivity and efficiency and it can be improved.
c)Capital: is a manmade factor and is mobile but the supply is elastic.
d)Organization: the organization plans, , supervises, organizes and
controls the business activity and also takes risks
 Productivity
Productivity refers to the physical relationship between the quantity
produced (output) and the quantity of resources used in the course of
production (input).
“It is the ratio between the output of goods and services and the input of
resources consumed in the process of production.”
 Factors Affecting Productivity
1. Human Resourse
(a) Ability to work – Productivity of an organization depends upon the
competence and calibre of its people—both workers and managers. Ability to
work is governed by education, training, experience, aptitude, etc. of the
employees.
(b) Willingness to work – Motivation and morale of people is the second
important group of human factors that determine productivity. Wage incentive
schemes, labour participation in management, communication system,
informal group relations, promotion policy, union management relations,
quality of leadership, etc., are the main factors governing employees’
willingness to work. Working conditions like working hours, sanitation,
ventilation, schools, clubs, libraries, subsidized canteen, company transport,
etc., also influence the motivation and morale of employees.
 2. Technological

(a) Size and capacity of plant

(b) Product design and standardization
(c) Timely supply of materials and fuel
(d) Rationalization and automation measures
(e) Repairs and maintenance
(f) Production planning and control
(g) Plant layout and location
(h) Materials handling system
(i) Inspection and quality control
(j) Machinery and equipment used
(k) Research and development
3. Managerial: The competence and attitudes of managers have an
important bearing on productivity. In many organizations, productivity
is low despite latest technology and trained manpower. This is due to
inefficient and indifferent management. Competent and dedicated
managers can obtain extraordinary results from ordinary people.
4. Natural: Natural factors such as physical, geological, geographical
and climatic conditions exert considerable influence on productivity,
particularly in extractive industries. For example, productivity of labour
in extreme climates (too cold or too hot) tends to be comparatively low.
Natural resources like water, fuel and minerals influence productivity
5. Sociological: Social customs, traditions and institutions influence attitudes
towards work and job. For instance, bias on the basis of caste, religion, etc.,
inhibited the growth of modern industry in some countries. The joint family
system affected incentive to work hard in India. Close ties with land and
native place hampered stability and discipline among industrial labour.
6. Political:Law and order, stability of Government, harmony between States,
etc. are essential for high productivity in industries. Taxation policies of the
Government influence willingness to work, capital formation, modernization
and expansion of plants, etc. Industrial policy affects the size, and capacity of
plants. Tariff policies influence competition. Elimination of sick and
inefficient units helps to improve productivity.
• Economic: Size of the market, banking and credit facilities, transport
and communication systems, etc. are important factors influencing
productivity.
• Productivity is an economics term which refers to the ratio of product
to what is required to produce the product. Productivity is outcome of
several interrelated factors. All the factors which are related to input
and output components of a production process are likely to affect
productivity.
 Productivity – Importance

• It helps to reduce the cost of production per unit through more economical or
efficient use of resources.

• Reduction in costs helps to improve the profits of a business. The enterprise

can more successfully compete in the market.

• The gains of higher productivity can be passed on to consumers in the form of

lower prices and/or better quality of products.

• Similarly, gains of higher productivity can be shared with workers in the form
of higher wages or salaries and better working conditions.
• Availability of quality goods at reasonably low prices helps to improve
the standard of living in the country
• Due to higher productivity, a firm can survive and grow better. This
helps to generate more employment opportunities.
• A more productive enterprise can better export goods and earn
valuable foreign exchange for the country.
• Higher productivity means better utilization of the country’s resources,
which helps to control inflation in the country.
 Role of technology in economics

1.Economic Growth & Productivity

Technology drives increased productivity, allowing businesses to
produce more goods and services with fewer resources.
Advances in automation, artificial intelligence (AI), and robotics
improve efficiency across industries.
2. Innovation & Entrepreneurship
New technologies create opportunities for startups and entrepreneurs,
leading to job creation and economic expansion.
Digital platforms like e-commerce and fintech have transformed
traditional business models.
1. Job Market & Employment Trends
While technology creates new job opportunities, automation and AI may
replace some traditional jobs, leading to shifts in employment
structures.
The rise of the gig economy (freelancing, remote work) is largely due to
technological advancements.
4. Financial Sector & Digital Transactions
Fintech innovations (mobile banking, blockchain, cryptocurrencies, and
Central Bank Digital Currencies - CBDCs) are reshaping financial
transactions.
Technology improves financial inclusion by making banking and
investment services more accessible.
5.Globalization & Trade
Technology facilitates faster communication, logistics, and international
trade, boosting global economic integration.
E-commerce enables businesses to reach international markets without
physical presence.
6. Data Analytics & Economic Policy
Governments and businesses use big data and AI to analyze economic
trends, consumer behavior, and policy impacts.
Predictive analytics helps in better decision-making for monetary and
fiscal policies
7. Education & Skill Development
Online learning and EdTech platforms enable skill development,
improving workforce quality and adaptability.
Digital literacy has become a key economic driver in knowledge-based
economies.
8. Environmental Economics & Sustainability
Green technology, renewable energy, and smart grids help in sustainable
economic growth.
Circular economy models leverage technology for waste reduction and
resource optimization
Short Run production function
 Law of Variable Proportion

The Law of Variable Proportions is a crucial concept in

production theory, providing insights into how varying one
input affects overall production. It underscores the importance
of optimal resource utilization and helps in making informed
decisions about input levels to achieve desired production
outcomes.
 What is the Law of Variable Proportions?

The Law of Variable Proportions, also known as the Law

of Diminishing Returns, is a fundamental principle in
economics that describes how the output of a production
process changes as the quantity of one input varies while
other inputs are kept constant. This law is applicable in
the short run, where at least one factor of production
(such as capital) is fixed
 Assumptions of the Law of Variable Proportion

• It operates in the short run because the factors are categorised as variable and
fixed.

• The law is applicable to all fixed factors, including land.

• The law of variable proportions allows for the combination of several variable
units with fixed factors.

• This law primarily applies to the production sector.

• It is simple to calculate the impact of a change in output caused by a change in

variable factors.
• It is considered that after a certain point, factors of production become
imperfect substitutes for one another.

• In order for this law to function, it is assumed that the state of

technology would remain constant.

• All variable factors are thought to be equally effective

 Example of Law of Variable Proportion

Let’s say a farmer has 1 acre of land (i.e., fixed factor) and wants to use
labour (i.e., variable factor) to improve the production of rice there. The
output increased initially at an increasing rate, then at a decreasing rate,
and finally at a negative rate as he employed more and more units of
labour. The below table displays the output behaviour in this case.
Table discussed as below:
Example of Law of Variable Proportion
 Phases of Law of Variable Proportion

Phase I: Increasing Returns to a Factor (TP increases at an increasing rate)

In the initial stage, each additional variable component raises the total production by an
increasing amount. This indicates that each variable’s MP rises and that TP rises at an
increasing rate.
• It occurs as a result of the initial variable input quantity being too small in comparison
to the fixed input. Due to the division of labour, efficient use of the fixed input during
manufacturing increases the productivity of the variable input.

• One labour generates 5 units, as shown in the schedule and diagram, whereas two
labours produce 20 units. It means that MP rises until it reaches its maximum point at
point P, which signifies the end of the first phase, while TP rises at an increasing rate
(up to point Q)
 Phase II: Decreasing Returns to a Factor (TP increases at
a decreasing rate)

Every extra variable in the second phase increases the output by a less and smaller amount.
This indicates that when the variable factor increases, MP decreases, and TP rises at a
decreasing rate. This stage is known as the diminishing returns to a factor.
• This occurs as a result of pressure on fixed inputs that results in a decline in variable input
productivity after a certain level of output.

• When MP is zero (point S), and TP is at its maximum (point M) at 40 units, the second
phase comes to an end.

• The second phase is highly important because a rational producer will always try to produce
during this time because MP and TP are both positive for each variable factor.
 Phase III: Negative Returns to a Factor (TP falls)

The third phase shows a decline in TP due to the use of more variable
factors. MP has now become negative. As a result, this stage is
referred to as negative returns to a factor.
• It occurs when the amount of variable input exceeds the fixed input by
a great difference, which causes TP to decrease.

• The third phase in the above graph begins after points S on the MP
curve and M on the TP curve.

• In the third phase, MP for each variable factor is negative. Therefore,

no company would deliberately decide to operate at this phase.
 Long run production function

In the long run all factors of production are variable. No

factor is fixed. Accordingly, the scale of production can be
changed by changing the quantity of all factors of
production.
Definition:
“The term returns to scale refers to the changes in output
as all factors change by the same proportion.”
Koutsoyiannis
• “Returns to scale relates to the behaviour of total output
as all inputs are varied and is a long run concept”.
Leibhafsky
 Returns to Scale
• Returns to scale are a measure of technical property of a production
function that examines how output changes subsequent to a proportional
change in all the factors of production. If proportional change in output is
equal to the proportional change in factors, then there are constant returns
to scale (CRS). If proportional change in output is less than the proportional
change in factors, there are decreasing returns to scale (DRS), whereas if
proportional change in output exceeds the proportional change in factors,
there are increasing returns to scale (IRS).
A homogenous function of degree k, exhibits
i) Constant Returns to Scale if k = 1
ii)Increasing Returns to Scale if k > 1
iii)Decreasing Returns to Scale if k < 1
 Isoquants

• Isoquants is the locus of all possible input combinations which are capable of
producing the same level of output (Q). In Fig. 5.2, all the possible combinations
of Labour (L) and Capital (K), for instance (L1,K1), (L2,K2) and (L3,K3), produce a
constant level of Output (Q).
 Properties of Isoquants
1) Isoquants are negatively sloped.
2) A higher isoquant represents a higher output.
3) No two isoquants intersect each other.
4) Isoquants are convex to the origin. The convexity of
isoquant curves implies diminishing returns to a
variable factor.
Marginal Rate of Technical Substitution
 Producer’s Equilibrium
• A rational producer attempts to
maximise his profits either by
maximising the production of output
for a given level of cost of production
or by minimizing the cost of
production of a given level of output.
Either way the producer chooses, it
will result in employment of an
optimum combination of resources in
the production process so that
MRTSLK equals the price ratio of the
factors. That is, producer’s
equilibrium is given by the condition: