Production Function

Definition of Production

Production is a process transform input of resources into output goods and

services. Where the input resources are land, capital, labor and entrepreneur and
output of goods and services are rental, _____, wages or salary and ____. Below a
figure for production:

Efficient production can be determined by how the product can be produce in the
most efficient process and least cost manner.

Types of Inputs

Input are most important and required in the process to produce output. There are
2 types of inputs in the production process which are fixed and variable input.
Fixed input is an input that quantity can not be changed in the short run (For e.g.
capital, machine, vehicles, land, building and etc). And variable input is an input
whose quantity can be changed as output changes in the short run (For e.g. raw
materials and labor). For examples, a confectionery factory and planning to
increase the production in short run. So the fixed and variable inputs are:

i. Fixed Size of your factory, number of machines, technology

ii. Variable Operational Hours, numbers of manpower, raw materials, frequency

of transportation

Options to Increase Production

Production can be increase with 3 types of solution, where it can increase by:

iii. Short term solution (e.g.: More running time & electricity) (At least one input
is fixed)

iv. Medium term solution (e.g.: Obtain and install more machines)

v. Long term solution (e.g.: Build 2nd or 3rd factory) (All inputs are variable)
Definition of Short Run

The short run is a time period during which at least one factor of production or
input is fixed (e.g.: land and machinery). Output can be increased only by using
more variable factors (e.g.: labor and raw material). Where the:

i. Fixed input is an input whose quantity can not be changed as output changes
in the short run.

ii. Variable input is an input whose quantity can be changed as output changes
in the short run

Production Function Short Run

The production function shows the mathematical relationship between the output
of a good and the inputs used to produce it. It shows how output will be affected
by changes in the quantity of one or more of the inputs. Where the inputs of
resources or factors of production been expressed as:

i. Land (N)

ii. Labor (L)

iii. Technology (T)

iv. Capital (K)

v. Entrepreneur (E)

With the above inputs, the Production Function can be expressed as:

QP f ( N , K , L, E , T )

Where Q is output and f is function

Formula for Production Function Short Run

Average Product (AP) is where the average number of output produced by each
labor.
Measures the productivity of a firms labor in terms of how much, on average,
each worker can produce:

Output q
AP
Labor Input L

Marginal Product of labor (MP) is where additional output produced when labor
increases by one person. From MP, we can see how many of labor should be
employed to achieving maximum production.

Output q
MP
Labor Input L

How to Measure Efficiency of Production

Every company want to have efficient production and least cost manner. By that it
can measure the efficiency of a production by:

i. Output (Q) - it is inaccurate because total output of course will increase when
more labor employed.

ii. Average Product (AP) - it is also less accurate because it creates bias and we
cant identify which labor is productive and which labor is unproductive.

iii. Marginal Product (MP) is the best indicator to evaluate the efficiency of
production.

With Marginal Product (MP), it is shown that certain amount of labor increment
could impact the productivity in production. But there a certain point that a law of
diminishing return implied (this will be elaborate in Law of Diminishing Return
section).

Example Production Short Run

There are factory that want evaluate their efficiency of production, a manager was
been instructed to proposed a efficient production with only number of labor can
be varied and capital is fixed. With this information, output will be changes as the
amount of labor changed. Production Functions can be expressed by:

Q = f (K, L)
where Q is quantity of total output, K is amount of capital but is fixed in short run,
the only can be varied is L, the amount of labour.

We will begin looking at the short run where there is only one input can be varied.
We assume that capital is fixed and labour is variable. Quantity output can only be
increased by increasing labour. In order to evaluate the labour productivity, we
take into account on Average product of labour, marginal product of labour and
total output. The question here we need to know how many output changes as the
amount of labour is changed?

With data that the manager collected, it is shown in Table 1.0:

Table 1.0

From Table 1.0, we can see where capital is fixed input, labor is variable input,
output given based on input, average product and marginal product.By using
formula AP and MP, the manager managed to calculate the values.

And from Table 1.0, we can extract and conclude that:

i. the number of labor increases and the total output increase as well but for
certain point the value of output will decrease even though the variable input
increase. The output is maximised at 112 units at the point where there are 8
labours.

ii. the average product of labour also increase when labour are used up to 4
person, the highest average product is 20 units produced by each labour. The
additional of labour to be used will lead the Average product decreased.

iii. Based on Marginal Product we can conclude that:

a) from 1 to 3 labors, the marginal product increases rapidly and greater.

b) however when more than 3 labors, the marginal product becomes

decreasing.

c) and 8 labors are the maximum point that can be employed.

d) After 8 labors the marginal product are negative values , where the law of
diminishing return implied (this will be elaborate in Law of Diminishing
Return section).
 e) This implied that the larger numbers of labor does not create any high
productivity and in fact they could create problem in production such as
laziness, delay, less efficient and interruption.

f) With the values that been given and calculated, the Total Product Curve
(Graph1.0) and Average Product and Marginal Product (Graph 1.1) can be
construct:

The diagrams below show the total product, average product and marginal
product curve.

Graph 1.0: Total Product Curve

Graph 1.1: Average Product and Marginal Product

The relationship between Total Product, Average Product and Marginal Product
i. When Marginal Product is greater than Average Product, Average Product is
increasing

ii. When Marginal Product is smaller than Average Product, Average Product is
decreasing

iii. Marginal Product is equal to Average Product at the point where Average
Product is maximum.

iv. When Marginal Product is zero, total output reached the maximum level at the
point where there are 8 labours being used.

If there have situation that the manager has realize the marginal products values
are decreasing, he or she needed to do an action to avoid the inefficient
production. Where the manager can increase the labors productivity with:

i. Employee Performance Evaluation System

ii. Supervision and Management Control

iii. Staff Disciplinary Control

iv. Reward and Punishment System

v. Training Program

vi. Total Quality Management (TQM)

Law of Diminishing Returns

Law of diminishing returns or principle of diminishing marginal productivity is a

concept that if one input in the production of a commodity is increased while all
other inputs remain unchanged (fixed), output will increase rapidly in beginning
but increasing slowly and smaller if the firm continues to increase input and
eventually output is diminishing.

For example, when the labour input is small and capital is fixed, output increases
considerably since workers can begin to specialise and marginal product of labour
increases. When the labour input is large, some workers become less productivity
and its marginal product decreases and even negative.

There are three stages of production

Stage 1:Production Stage 1 arises due to average product rising. The total product
curve has a positive slope. Average product is facing positive and marginal
product is greater than average product.

Stage 2:Production Stage 2 arises due to average product declining (but marginal
product positive). The total product curve has a diminishing positive slope. Its
slope becomes flatter with each additional unit of variable input. Average product
is still positive but its curve has a negative slope. Marginal product is positive but
its curve has also a negative slope. Every firm can only produce at this level,
beyond to this level, the production is negative.
Stage 3:Production Stage 3 arises due to marginal product is negative, or total
product is declining. The total product curve has a negative slope. It has passed
its peak and is heading down. Average product remains positive but the average
product curve slope negatively. Marginal product is negative.

The diagram below shows the stage of production based on the total
product, average product and marginal product function

Graph 1.2: Three Stages of Production

Technological Improvement

The Effect of Technological Improvement

Changes in technology will cause shifts in the total product curve

More output can be produced with same inputs

Labor productivity can increase if there are improvements in technology, even

though any given production process exhibits diminishing returns to labor.

Managers should adopt the advanced technology such as advanced machine,

knowledge and skills in production.

Graph 1.3: The Effect of Technological Improvement

Long Run Production Functions

All inputs become variable and no fixed input. For e.g. Firms will shift his building
or land to bigger plant size after few years (long term).

Q = f ( K, L )

In the long-run, capital and labour are both variable.

We can look at the output we can achieve with different combinations of capital
and labour.

ISOQUANTS curve -- usually used to show all possible combinations of inputs that
yield the same output level.
ISOQUANT CURVE AND ANALYSIS

Graph 1.4: Isoquant Curve 1

Isoquant means ISO=equal and QUANT=quantity. Isoquants shows all the possible
combinations of variable input that can be use to generate same quantity of
output (Total product).

This is an example of isoquant map, where a number of isoquants curves are

combined in the same graph.

Example:

The isoquant curve Q1 above refers to the production of bottled mineral water.
Capital may refer to machine in the production line. To produce 100 bottles, the
factory can use:

1. 3 unit of machine and 1 worker.

2. 1 unit of machine and 3 workers.

Both combinations will give 100 bottle of output. With the available technology
and all inputs, points on the isoquant curve Q1 shows all the combinations of
labour and machines that can produce maximum 100 bottles in that period.

Point A represents a capital-intensive firm, using more machines than labour,

while point D represents labour intensive firm, with higher quantity of workers
compared to machine.

Different slopes represent different total output. Example: Q2 curve represent

combinations of input that will produce a maximum of 200 bottles of mineral
water, while Q3 curve will produce 300 bottles.
 Graph 1.5: Isoquant Curve 2

PROPERTIES OF ISOQUANT CURVE

Graph 1.6: Properties of an Isoquant Curve 1

Isoquant curves will slopes downward from left to right. This due to the concept of
opportunity cost, where any increase in labour, we need to decrease the capital
input or machines in this example to get the same output.
 Graph 1.6: Properties of an Isoquant Curve 2

Isoquant curve that is further from origin represents a larger output. Example;
isoquant q3 produce more than isoquant q1. Isoquant q3 is furthest from origin.

Graph 1.6: Properties of an Isoquant Curve 3

An Isoquant curve with different output never intersects each other. 2 different
outputs cannot be produce using the same level of input.
Cobb-Douglas Production Functions

In the long run, all factors of production are variable while technology is constant. A
Cobb-Douglas production function can be used to describe the relationships of
production level, labour, capital and technology. It also measures the impact of
changes in the inputs, i.e. labour and capital, the relevant efficiencies, and the yields
of a production activity. The Cobb-Douglas Production Function is

Q=A L K

where:

Q = Quantity produced from inputs L and K

L = Amount of labour,

K = Amount of capital input,

A = Total factor productivity (change of technology)

= the capital elasticity of output,

= the labor elasticity of output

In economics, total factor productivity (TFP) reflects the effects in total production
growth relative to the growth in measured inputs of labour and capital. TFP also
reflects the level of technology growth, knowledge of worker and efficiency level.

Output elasticity measures the responsiveness of output to a change in levels of either

labour or capital used in production. The capital elasticity of output (), how
efficiency of capital used in production, the greater value of capital elasticity of output
(), the greater quantity can be produced by using capital, for e.g. machinery.

The labour elasticity of output (), how productivity of labour used in production, the
greater value of labour elasticity of output (), the greater amount can be produced by
labour.

Application of Cobb-Dauglas Production Function

The production function shows:

0.45 0.55
Q = 1.4 L K
If = 0.55, a 1% increase in capital usage would lead to 0.55% increase in output.
Similarly, if = 0.45, a 1% increase in labour would lead to 0.45% increase in output.

Long run Production Return to scale

Return to scale refers to the behaviour of the rate of increase in output relative to the
associated increase in the inputs or factors of production in the long run. In practice,
the firm need to decide the best way to increase out in long run. One of the ways in
changing the scale of production by increasing all inputs in proportion. If the inputs
increase double, how much will output most likely increase? There are 3 possibilities
of scale of production:

a. Increasing Returns to Scale

b. Constant Returns to Scale
c. Decreasing Returns to Scale

Given a Cobb-Douglas production function is Q = A L K . and are parameters
that are determined by the technology and technical efficiency of producing a specific
product.

When + is greater than 1, production is increasing return to scale where its output
increased by greater proportion than input increased. For example, A 50% increase in
both labour and capital results in a larger percentage (for e.g. 100%) increase in
output. With increasing in scale of production happened where specialisation was
made in managerial department. The labours become expert and professional in a
particular subject or skill, has increased the productivity and efficiency in production,
and thus minimized the cost. However, small firms are unable to afford to specialise.
Other than that, more sophisticated machineries used to increase the efficiency,
maximise the production capacity and then minimized the average cost. The diagram
below shows increasing return to scale.

When the input increases double, the

output increase more than double, it is
increasing return to scale.
When + is equal to 1, the production is constant return to scale, where its output
increased by the same proportion with input increased. For example, if labour and
capital both increase by 50%, the output also increase by 50%. It happened where
there is no improvement and decrement in efficiency of production. Firms chose not
to do anything to increase the efficiency and maintain the productivity of labour and
machine. The diagram below shows the constant return to scale.

When the input increases double, the

output also increase double, it is constant
return to scale.

When + is less than 1, the production exhibits decreasing return to scale, where its
output increased by lesser proportion than input increased. For example, if labour and
capital both increase by 50%, the output increase by smaller percentage (for e.g.
20%). Decreasing return to scale happened also because of specialisation in labour.
Labours are easy to get bored, lost interest or passion for work, laziness and
absenteeism. These leads to downturn of productivity and thus increase the average
cost. Other than that, as the firm grows bigger, the management encountered
difficulties and problem in supervision. Miscommunication, re-coordination, re-
structuring, hiring more managers and less controlling would lead to higher
management cost. The efficiency of production drops when optimum capacity of
machinery exceeded.
When the input increases triple, the output
increase less than triple, i.e. double only, it
is decreasing return to scale.