Theory of Production

THEORY OF PRODUCTION
PRODUCTION FUNCTION
• The production function expresses a
functional relationship between physical
inputs and physical outputs of a firm at
any particular time period.
• The output is thus a function of inputs.
• Mathematically production function can
be written as
Q= f (L, L, C, O)
PRODUCTION FUNCTION
• Where “Q” stands for the quantity of
output and L, L, C, O are various input
factors such as land, labour, capital and
organization.
• Here output is the function of inputs.
Hence output becomes the dependent
variable and inputs are the independent
variables.
PRODUCTION FUNCTION
• The above function does not state by
how much the output of “Q” changes as
a consequence of change of variable
inputs.
• In order to express the quantitative
relationship between inputs and output,
Production function has been expressed
in a precise mathematical equation i.e.
PRODUCTION FUNCTION
Y= a+b(x)
Which shows that there is a constant
relationship between applications of input
(the only factor input ‘X’ in this case) and
the amount of output (y) produced.
PRODUCTION FUNCTION
• Importance:
• When inputs are specified in physical units, production
function helps to estimate the level of production.
• It becomes is equates when different combinations of
inputs yield the same level of output.
• It indicates the manner in which the firm can
substitute on input for another without altering the
total output.
• When price is taken into consideration, the production
function helps to select the least combination of
inputs for the desired output.
PRODUCTION FUNCTION
• It considers two types’ input-output relationships
namely ‘law of variable proportions’ and ‘law of
returns to scale’.
• Law of variable propositions explains the pattern of
output in the short-run as the units of variable
inputs are increased to increase the output.
• On the other hand law of returns to scale explains
the pattern of output in the long run as all the units
of inputs are increased.
PRODUCTION FUNCTION
• The production function explains the
maximum quantity of output, which can be
produced, from any chosen quantities of
various inputs or the minimum quantities of
various inputs that are required to produce a
given quantity of output.
• Production function can be fitted the
particular firm or industry or for the economy
as whole. Production function will change
with an improvement in technology.
PRODUCTION FUNCTION
• Assumptions:
• Production function has the following assumptions.
• The production function is related to a particular
period of time.
• There is no change in technology.
• The producer is using the best techniques available.
• The factors of production are divisible.
• Production function can be fitted to a short run or
to long run.
ISOQUANTS
• The term Isoquants is derived from the words
‘iso’ and ‘quant’ – ‘Iso’ means equal and
‘quent’ implies quantity.
• Isoquant therefore, means equal quantity.
• A family of iso -product curves or isoquants or
production difference curves can represent a
production function with two variable inputs,
which are substitutable for one another
within limits.
ISOQUANTS
• Isoquants are the curves, which represent
the different combinations of inputs
producing a particular quantity of output.
• Any combination on the isoquant represents
the some level of output.
• For a given output level firm’s production
become.
Q= f (L, K )
• Where ‘Q’, the units of output is a function
ISOQUANTS
• Thus an isoquant shows all possible
combinations of two inputs, which are
capable of producing equal or a given level of
output.
• Since each combination yields same output,
the producer becomes indifferent towards
these combinations.
ISOQUANTS
Assumptions:
• There are only two factors of
production, viz. labour and capital.
• The two factors can substitute each
other up to certain limit
• The shape of the isoquant depends
upon the extent of substitutability of
the two inputs.
• The technology is given over a period.
ISOQUANTS
isoquant may be explained with the help of an
arithmetical example.
Combinations Labour (units) Capital (Units) Output (units)
A 1 20 20000
B 2 15 20000
C 3 11 20000
D 4 8 20000
E 5 6 20000
f 6 5 20000
ISOQUANTS
• Combination ‘A’ represent 1 unit of labour and 20
units of capital and produces ‘20000’ units of a
product all other combinations in the table are
assumed to yield the same given output of a
product say ‘20000’ units by employing any one of
the alternative combinations of the two factors
labour and capital.
ISOQUANTS
If we plot all these

combinations on a
paper and join
them, we will get
continues and
smooth curve called
Iso-product curve as
shown side.
ISOQUANTS
• Labour is on the X-axis and capital is

on the Y-axis.
• IQ is the ISO-Product curve which
shows all the alternative
combinations A, B, C, D, E which can
produce 20000 quintals of a product.
ISOCOSTS
• Isocosts refers to that cost curve that
represents the combination of inputs that
will cost the producer the same amount
of money. In other words, each Isocost
denotes a particular level of total cost for
a given level of production.
• If the level of production changes, the
total cost changes and thus the Isocost
curve moves upwards and vice-versa.
ISOCOSTS
• Below graph presents three down ward sloping
straight line cost curves (Assuming that the input
prices are fixed, no quantity discounts are
available).
• Each costing Rs.1lakh Rs.1.5lakhs & Rs.2lakhs for
the output levels of 20000, 30000, 40000 units.
• Isocosts farer from the origin, for given input costs
are associated with higher costs.
• Any change in input prices, it changes the slopes of
Isocost lines.
ISOCOSTS
ISOCOSTS
• Marginal rate of technical substitution
(MRTS)
• The marginal rate of technical substitution
(MRTS) refers to each rate at which one
input factor is substituted with the other to
attain a given level of output.
• In other words, the lesser units of one input
must be compensated by increasing
amounts of another input to produce the
same level of output.
ISOCOSTS
• The below table presents the rate of Marginal rate of
technical substitution (MRTS) between the two inputs
factors, say capital and labour.
Combination Capital (Rs. In lakhs) Labour Marginal rate of technical
substitution (MRTS)
A 1 20 -
B 2 15 5:1
C 3 11 4:1
D 4 8 3:1
E 5 6 2:1
F 6 5 1:1
ISOCOSTS
MRTS= Change in one input / change

another input
OR
MRTS = ∆K /∆L
ISOCOSTS
Producer’s Equilibrium:
The tem producer’s equilibrium is the
counter part of consumer’s equilibrium.
Just as the consumer is in equilibrium
when be secures maximum satisfaction, in
the same manner, the producer is in
equilibrium when he secures maximum
output, with the least cost combination
of factors of production.
ISOCOSTS
• The optimum position of the producer
can be found with the help of iso-product
curve.
• The Iso-product curve or equal product
curve or production indifference curve
shows different combinations of two
factors of production, which yield the
same output.
This is illustrated as follows.
ISOCOSTS
• Let us suppose. The producer can produces the given output of
paddy say 100 quintals by employing any one of the following
alternative combinations of the two factors labour and capital
computation of least cost combination of two inputs.
L K Q L*LP (3Rs.) K*KP(4Rs.) Total cost
Units Units Output Cost of labour cost of capital
10 45 100 30 180 210

20 28 100 60 112 172
30 16 100 90 64 154
40 12 100 120 48 168
50 8 100 150 32 182
ISOCOSTS
• It is clear from the above that 10 units of ‘L’
combined with 45 units of ‘K’ would cost the
producer Rs. 20/-. But if 17 units reduce ‘K’ and
10 units increase ‘L’, the resulting cost would be
Rs. 172/-.
• Substituting 10 more units of ‘L’ for 12 units of
‘K’ further reduces cost pf Rs. 154/-/ However,
it will not be profitable to continue this
substitution process further at the existing
prices since the rate of substitution is
diminishing rapidly.
ISOCOSTS
COBB-DOUGLAS PRODUCTION FUNCTION
• Production function of the linear homogenous
type is invented by Junt wicksell and first
tested by C. W. Cobb and P. H. Dougles in 1928.
• This famous statistical production function is
known as Cobb-Douglas production function.
• Originally the function is applied on the
empirical study of the American manufacturing
industry.
• Cabb – Douglas production function takes the
following mathematical form.
Y= (AK L )
X 1-x
Where
Y=output
K=Capital
L=Labour
A, ∞=positive constant
• Assumptions:
It has the following assumptions
• The function assumes that output is
the function of two factors viz. capital
and labour.
• It is a linear homogenous production
function of the first degree
• The function assumes that the logarithm of
the total output of the economy is a linear
function of the logarithms of the labour
force and capital stock.
• There are constant returns to scale
• All inputs are homogenous
• There is perfect competition
• There is no change in technology

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THEORY OF PRODUCTION

If we plot all these

• Labour is on the X-axis and capital is

MRTS= Change in one input / change

10 45 100 30 180 210

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