PRODUCTION

➢Production:
✓It is the process by which resources (inputs) are combined to create goods
and services to satisfy human wants.
✓It is the creation of utility to satisfy human wants.
✓The resources (inputs) are otherwise known as factors of production.
➢Production function:
✓It shows the technical relation between the quantity of inputs and output.
✓If only labour and capital are considered as inputs, then a simple production
function can be expressed as:
✓Q = f(L, K)
✓That is, output (Q) is a function of inputs (labour and capital)
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 Fixed vs Variable factors of production
➢Fixed factors of production
✓They are those factors that do not or cannot be change as output is increased or
decreased, e.g. office/factory building, land, capital equipment such as machinery,
etc.
✓Fixed factors exist only in the short run
✓Fixed factors exist/are required even at zero level of output
➢Variable factors
✓ They are those factors that can or are easily changed so as to change the level of
output. E.g. labour and other raw materials directly used in production
✓Variable factors does not exist/are not required at zero level of output
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 Short run vs Long run time period

➢Short run:
✓It refers to that time period during which at least one of the factors
of production (in most cases capital) is fixed
➢Long run
✓It refers to the time period during which all factors of production
are variable.
✓That is, it is possible to change all factors of production, hence no
fixed factor exist.
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Short run production function vs long run production function

➢Production function that shows change in output by changing only

variable factors is known as short run production function

➢Production function that shows change in output by changing both

fixed and variable factor and maintaining the factor ratio is known as
a long run production function

➢For example,

✓From 50=f(5L,3K) to 60 = f(6L,3k) Situation of SR production function

✓From 40 = f(3L, 2K) to 80 = f(6L, 4K) Situation of LR production function

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 Level of production vs scale of production
➢Level of production

✓It refers to change in output (production) by changing only the variable

factors.

✓Thus level of production occurs only in the short run when only variable
factors can be changed

➢Scale of production

✓ It refers to change in output by changing both fixed and variable factors.

✓ Thus scale of production occurs in the LR when all the factors become
variable
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 Concept of product
➢Total Product (TP):
✓Total physical product or total product refers to the total quantity of
goods produced by a firm with given inputs during a specified period
of time
➢Average Product (AP):
✓Average Product or average physical product refers to the
amount/quantity of output produced per unit of variable factor
𝐓𝐏
✓AP = , L is the quantity of variable factor,(labour in this case)
𝐋
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 ..

➢Marginal Product (MP):

✓Marginal product refers to the change in TP resulting from the

employment of an additional unit of a variable factor(labour)

∆𝑇𝑃
✓MP =
∆𝐿

✓NOTE: Given MP and/or AP, TP can be calculated as:

✓TP =σ 𝑴𝑷 or TPP =APL× L

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 Exercise
A firm is faced with the following production schedule, Calculate the average
product at various level of output

Labour (L) TPL

0 0
1 15
2 35
3 50
4 40
5 35

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 Solution
Calculate the average product based on the following schedule

Labour (L) TPL 𝑻𝑷𝑳

APL =
𝑳
0 0 -
1 15 15
2 35 17.5
3 50 16.7
4 40 10
5 35 7

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 Exercise 2
Calculate the marginal physical product from the table below

Labour TPL
0 0
1 15
2 35
3 50
4 45
5 35

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 Solution
Calculate the marginal physical product from the table below

Labour TPL ∆𝑇𝑃

MPP =
∆𝐿
0 0 -
1 15 15
2 35 20
3 50 15
4 45 -5
5 35 -10

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 Exercise 3
Calculate the Total physical product from the table below

Labour APL
1 2
2 3
3 4
4 4.25
5 4
6 3.5

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 Solution
Calculate the Total physical product from the table below

Labour APL TPP =APL× L

1 2 2
2 3 6
3 4 12
4 4.25 17
5 4 20
6 3.5 21

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 Exercise 4
Calculate the total output at each level of employment of variable factors

Labour (units) MPL

1 3
2 5
3 7
4 5
5 3
6 -1

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 Solution
Calculate the total output at each level of employment of variable factors

Labour (units) MPL TP =σ 𝑴𝑷

1 3 3
2 5 8
3 7 15
4 5 20
5 3 23
6 -1 22

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 Exercise 5
Complete the flowing table below

Unit of labour TPP APP MPP

(units) (units) (units)

1 8
2 10
3 10
4 9
5 4
6 7

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 Solution 5
Complete the flowing table below

Unit of labour TPP APP MPP

(units) (units) (units)

1 8 8 8
2 20 10 12
3 30 10 10
4 36 9 6
5 40 8 4
6 42 7 2

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 TP, AP and MP curves

✓.

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 ..
As seen on the graphs above, the following relationship is established
➢Relationship between TP and MP
✓When TP is at maximum, MP is zero
✓When TP is falling, MP is negative
✓When TP is increasing at an increasing rate, MP is rising
✓When TP is increasing at a decreasing rate, MP is falling.
✓MP shows the rate of change in TP
➢Relationship between AP and MP
✓When MP is equal to AP, AP is at maximum. Or MP cuts AP at
maximum point of AP
✓When AP is increasing, MP is above AP or MP>AP
✓When AP is falling, MP curve is below AP curve or MP<AP
✓MP falls faster than AP
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 Return to factor - The law of variable proportion

✓Returns to a factor refers to the behavior of output when

only one variable factor of production is increased in the
SR and fixed factor remain constant.

✓The law of variable proportion states that “as we

increase quantity of one variable input keeping other
inputs fixed, total product (TP) initially increases at an
increasing rate, then at a decreasing rate, and finally
falls”
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 …
➢Assumptions of the law
✓one factor of production is variable with other factors fixed
✓All units of variable factors are homogenous
✓Techniques of production does not change
✓It operate in the SR
✓Factors of production becomes imperfect substitutes of each
other beyond a certain limit

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 ..
✓ The law of variable proportion (LVP)
✓ Based on the table below, Plot the TP curve on one graph. Draw a second graph directly below the
graph of the TP curve. On this second graph, plot the MP curve
Unit of Units of
fixed input variable
TP (unit) MP (unit)
(land in inputs
hectare) (Labour)
1 0 0 /
1 1 6 6
1 2 18 12 Stage 1
1 3 36 18
1 4 56 20
1 5 68 12
1 6 76 8
Stage 2
1 7 80 4
1 8 80 0
1 9 76 -4
Stage 3
1 10 68 -8 23
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 Various stages/phases of the LVP
➢Stage/Phase 1: stage of increasing returns to factor
✓TP increases at an increasing rate and MP of each variable factor
rises
➢Stage/Phase 2: stage of diminishing returns to factor
✓TP increases at a decreasing rate and MP falls with increase in
variable factors, but it’s still positive
➢Stage/Phase 3: stage of negative returns to factor
✓TP falls and MP becomes negative

➢It should be noted that the LVP is an extension of the law of

diminishing return or diminishing marginal returns.
✓The law of diminishing return states that, “in production
process, as successive units of variable factor is added to a fixed
factor, there will be a point at which the marginal product will start
to decrease, other things being equal”. 25
 Stage/phase of operation for a rational producer
✓In stage 1, employment of every additional unit of
variable factor gives more and more output (MP
increases). It means there is scope for more profits if
production is increased with more units of variable factor.
✓In stage 3, TP falls and MP of each additional worker is
negative, thus a rational producer will never operate in
this stage.
✓This brings us to the conclusion that a rational producer
will operate in stage 2 because TP is rising and gets to
maximum in this stage and the MP of each variable
factor is positive.
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 Exercise
➢1. The LVP operates in the,
✓a. Short-run b. Long-run c. Both a & b d. None of these
➢2. When there are diminishing returns to factor, TP always decreases. True or False?
➢3. Law of Variable Proportions holds when:
✓(a) State of technology is same (b) All units of variable factor are
homogeneous
✓(c) There is at least one fixed factor (d) All of the above
➢4. Stage II of Law of Variable Proportions is called:
✓(a) Diminishing returns to scale (b) diminishing returns to factor
✓(c) increasing returns to factor (d) Negative returns
➢5. What type of changes take place in total product and marginal product when there are
✓(i) increasing returns to factor TP increases at an increasing rate, and MP rises
✓(ii) negative returns to factor? TP falls, and MP becomes negative
✓(iii) diminishing returns to factor TP increases at a decreasing rate, and MP falls
but is positive 27
 Exercise
➢1. Complete the following table assuming that there are increasing returns to a factor
throughout
Units of variable factor 1 2 3
TPP 100 ? ?

➢2. Complete the following table assuming that there are diminishing returns to a factor
throughout
Units of variable factor 5 6 7
TP 60 ? ?

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