ECONOMICS (HS 17101)

7th Semester
Dr. Rishiraj Sarkar
UNIT 3.2: PRODUCTION CONCEPTS &
ANALYSIS
 Production Analysis: Introduction

 Production is a process of using various material and immaterial inputs in order to

make output for consumption. Production process creates economic well-being. The
satisfaction of needs originates from the output. Production is the result of
cooperation of factors of production (land, labour, capital etc.)

 In Economics, production refers to the creation or addition of value. It simply

transforms the inputs into output. For example, if you make ice cream, you will say
that you have produced ice- cream (goods). But from the point of view of Economics,
you have not produced any new thing in the form of ice-cream; rather, you have
changed the form of milk, sugar, cream, etc, and thus, have created the utility.

 Production may be at varying levels. The scale of production influence the cost of
production. All manufacturers are aware that when production of a commodity takes
place on a larger scale, the average cost of its production is low. They stand to benefit
from the resulting economies of scale.
 Definitions:

 "Production may be defined as the creation of utilities. Anatol Murad

 "Production means an increase in the value of a commodity."- Nicholson
 "Production is any activity which adds to the value of a nation's supply of goods and
services.” -M.J.UImer
 "Production may be defined as the process by which inputs may be transformed into
output" - Robert Awh

 Difference between Consumption and Production:

 Generally, production and consumption are considered to be altogether contrary and

different activities.
 Consumption is the use of utility whereas production is creation of utility. In fact,
their difference is not so fundamental. Both these are two different aspects of the
same activity. For example, when a carpenter makes a chair, he performs an act of
production by increasing the utility of log of wood. But at the same time, he has also
consumed the log of wood by using its utility. Thus, two aspects of the same activity
are production and consumption.
 According to Prof. Mehta., "When the utility of a good is used for the direct
satisfaction of want, it is called consumption, and its use for the indirect satisfactions
of want is called production."
 Factors of Production:

 Factors of production means resources used in the process of production of

commodities. There are of four types viz., land, labour, capital and organization or
enterprise.
 Land represents natural resources (such as soil, mineral deposits, seas, rivers, natural
forests, fisheries etc). Labour represents human resources. Together, these two factors
are called the ‘primary factors of production’. These two factors produce some units
of goods for the purpose of consumption. And as consumption of these goods takes
place, there is the possibility of some of these goods getting left over. Thus, saving is
production minus consumption. This saved amount is called as capital, which serves
as investment in the production process. Also, organisation or enterprise is a special
form of labour. The third and the fourth factors are called ‘secondary factors of
production’. These four factors depend on each other. They have a coordinated impact
on production of goods and services.
 Production Function:

 Production function refers to the relationship among units of the factors of production
(inputs) and the resultant quantity of a good produced (output).

 According to George J. Stigler, “Production function is the relationship between

inputs of productive services per unit of time and outputs of product per unit of time.”

 Production function may be expressed as: Q = f (LB, L, K, M, T, t)

Where, Q = Quantity of output,
LB = Land & Building; L = Labour; K = Capital; M = Raw
Material; T = Technology and t = Time.
Depending on the efficiency of the producer, this production function varies.

 The function implies that the level of output (Q) depends on the quantities of different
inputs (LB, L, K, M, T, t) available to the firm.
The main theme of production function is to get the maximum production with the
present given set of variable.

E.g.# A firm can use the more labour and less machines OR it can use less labour and
more machines to get maximum production. Here which is suited best and how to find
the best alternative choice is the main aim of production function.
 Short-run Production and Long run Production:

 In Micro economics, the distinction between long run and short run is made on the
basis of fixed inputs that inhibit the production.

 The short-run is the period where some inputs are variable, while others are fixed.
Another feature is that firms do not enter into the industry and existing firms may not
leave the industry. Long run, on the other hand, is the period featured by the entry of
new firms to the industry and the exit of existing firms from the industry.

 In general, Production function may be classified into two:

1) Short-run Production Function as illustrated by the Law of Variable

Proportions.

2) Long-run Production Function as explained by the Laws of Returns to Scale.

 Production function with one variable input /Law of variable proportions./ Law
of diminishing marginal productivity:

 As equal increments of one input are added, the inputs of other productive services
being held constant, beyond a certain point, the resulting increments of product will
decrease, i.e., the marginal product will diminish.

 DEFINITION:
— According to Leftwitch, The law of variable proportions states that if the input of
one resource is increased by equal increments per unit of time while the inputs of
other resources are held constant, total output will increase, but beyond some point
the resulting output increases will become smaller and smaller."
— Eminent Economist Samuelson says, “The law states that an increase in some
inputs relative to other fixed input will, in a given state of technology, cause total
output to increase; but after a point the extra output resulting from the same addition
of extra inputs is likely to become less and less.”

 When there is increase in the production, we normally increase the labour rather than
the machinery. The more labour employed in the production process, there will be
raise in the production. But continues increase in the labour may lead to decrease in
the production after certain point. Here comes the question. How many employees
should be employed to get maximum production? Law of variable proportion answer
the question of the employment of labour for optimum production.
 ASSUMPTIONS:
 The law has following main assumptions:
(1) One of the factors is variable while all other factors are fixed.
(2) All units of the variable factor are homogeneous.
(3) There is no change in the technique of production.

 This law of variable proportion shows the input and output relationship with one
variable factor. e.g# labour.

 Illustration:

 Total Product (TP): It refers to the total amount of commodity produced by the
combination of all inputs in a given period of time.
Total Product = Summation of marginal products, i.e.
Mathematically, TP = ∑MP where, TP= Total Product, MP= Marginal Product
 Average Product (AP): It is the result of the total product divided by the total units
of the input employed. In other words, it refers to the output per unit of the input.
Mathematically, AP = TP/N Where, AP= Average Product, TP= Total Product and
N= Total units of inputs employed
 Marginal Product (MP): It is the addition or the increment made to the total product
when one more unit of the variable input is employed. In other words, it is the ratio of
the change in the total product to the change in the units of the input.
It is expressed as, MP= ∆TP/∆N Where, MP = Marginal Product, ΔTP = Change in
total product, ΔN = Change in units of input
It is also expressed as, MP = TP (n) – TP (n-1) Where, MP = Marginal Product,
TP(n) = Total product of employing nth unit of a factor, TP(n-1) = Total product of
employing the previous unit of a factor, i.e, (n-1)th unit of a factor.

 The Law of Variable Proportions is explained with the help of the following schedule
and diagram:
 In table 3.1, units of variable factor (labour) are employed along with other fixed
factors of production
 The table illustrates that there are three stages of production. Though total product increases
steadily at first instant, constant at the maximum point and then diminishes, it is always
positive for ever. While total product increases, marginal product increases up to a point
and then decreases. Total product increases up to the point where the marginal product is
zero. When total product tends to diminish marginal product becomes negative.

 In diagram 3.1, the number of workers is measured on X axis while TP L, APL and MPL are
denoted on Y axis. The diagram explains the three stages of production as given in the
table.

 Stage I
In the first stage MPL increases up to third labourer and it is higher than the average
product, so that total product is increasing at an increasing rate. The tendency of total
product to increase at an increasing rate stops at the point F and it begins to increase at a
decreasing rate. This point is known as ‘Point of Inflexion’.
 Stage II
In the second stage, MPL decreases up to sixth unit of labour where MPL curve intersects
the X-axis. At fourth unit of labor MPL = APL. After this, MPL curve is lower than the APL.
TPL increases at a decreasing rate.
 Stage III
Third stage of production shows that the sixth unit of labour is marked by negative MP L,
the APL continues to fall but remains positive. After the sixth unit, TP L declines with the
employment of more units of variable factor, labour.
 Law of Returns to Scale:

 In the long- run, there is no fixed factor; all factors are variable.
 The laws of returns to scale explain the relationship between output and the scale of
inputs in the long-run when all the inputs are increased in the same proportion.

 Assumptions:
Laws of Returns to Scale are based on the following assumptions:
(1) All the factors of production (such as land, labour and capital) are variable but
organization is fixed.
(2) There is no change in technology.
(3) There is perfect competition in the market.
(4) Outputs or returns are measured in physical quantities.

 Three Phases of Returns to Scale:

(1) Increasing Returns to Scale: In this case if all inputs are increased by one per
cent, output increase by more than one per cent.
(2) Constant Returns to Scale: In this case if all inputs are increased by one per cen,
output increases exactly by one per cent.
(3) Diminishing Returns to Scale: In this case if all inputs are increased by one per
cent, output increases by less than one per cent.
 Diagrammatic Illustration:
 The three laws of returns to scale can be explained with the help of the diagram
below.
 In the diagram 3.2, the movement from point a to point b represents increasing
returns to scale. Because, between these two points input has doubled, but output has
tripled.
 The law of constant returns to scale is implied by the movement from the point b to
point c. Because, between these two points inputs have doubled and output also has
doubled.
 Decreasing returns to scale are denoted by the movement from the point c to point d
since doubling the factors from 4 units to 8 units produce less than the increase in
inputs, that is, by only 33.33%
 Economies of Scale: (Brief Note)

 ‘Scale of Production’ refers to the ratio of factors of production. This ratio can change
because of availability of factors. The Scale of Production is an important fact or
affecting the cost of production.

 Every producer wishes to reduce the costs of production. Hence he(he includes she as
well) uses an advantage of economy of scale.

 This economy of scale is effected both by the internal and external factors of the firm.
Accordingly, Economies are broadly divided into two types: Internal and External
economies.

 Economies of scale reduces the cost of production: and, diseconomies of scale

increases the cost of production.
Thank You!