PRODUCTION

ANALYSIS

Managerial Economics
Concept of Production

A process of converting inputs Factors of Production include:

into outputs is termed as
production Land
Labor
I’m economic terms, production Capital
is an act of creating value or Enterprise
utility that can satisfy the wants
of individuals

The production process is

dependent on a number of
inputs, such us raw material,
labor, capital, technology, and
time. These inputs are also
known as factors of production
Production Function

Production function is the mathematical representation of relationship

between physical inputs and physical outputs of an organization.

Production function represents the maximum output that an

organization can attain with the given combinations of factors of
production (land, labor, capital, and enterprise) in a particular time
period with the given technology.

Long Run- the organization can increase labor and capital both for
increasing the level of production.
Q= f ( L,K )

Short Run- the supply of capital is inelastic.This implies that

capital is constant.
Q= f ( L,K )
Production Function

Properties of Production Functions

Determined by technology,
equipment, input prices
Discrete functions are lumpy
Continuous functions employ
inputs in small increments

Return to Scale and Returns to a factor

Returns to scale measure output

effect of increasing all inputs
Returns to a factor measure output
effect of increasing one input
 Total, Marginal, and
Average Product

Total Product (TP)

Total Product is whole output

Marginal product is the change in output caused

by increasing any input X. (MP)

If MPx= , total product is rising

If MPx= , total product is falling (rare)

Average product (AP)

APx= Q/X
Law of Diminishing Returns to a
Factor
Returns to a Factor
Shows what happens to MPx as X usage
grows
-MPx> 0 is common
-MPx< 0 implies irrational input
use (rare)

Diminishing Returns to a Factor Concept

MPx shrinks as X usage grows
If MPx grew with use of X, there would
be no limit to input usage
 Law of Diminishing Returns

Law of Diminishing returns explains that when more and

more units of a variable input are employed on a given
quantity of fixed outputs, the total output may initially
increase at increasing rate and then at a constant rate, but it
will eventually increase at diminishing rates.

Assumptions:

Assumes labor as an only variable inpu, while Capital is

constant
Assumes labor to be homogeneous
Assumed that state of technology is given
Assumes that input prices are given
Stages of production in Law of Diminishing

STAGE I STAGE III

Refers to the stage of Refers to the stage in which
production in which the the total product starts
total output increases STAGE II declining with an increase in
initially with the increase number of workers
Refers to the stage in which
in number of labor
total output increases but
marginal product starts
declining with the increase in
number of workers
Laws of Return to Scale

In long run production function, the relationship between changing input

and output is studied in the laws of returns to scale, which is based on
production function and isoquant curve

Isoquant Maps
Isoquant- is a curve that shows the various combinations of inputs that will
produce the same (a particular) amount of outpu.

Isoquant Maps- is a contour map of a firm’s production function

All of the isoquants from a production function are
part of this isoquant map
 Input Combination Choice

Production Isoquants
Show efficient input combinations
Technical efficiency is least-cost production

Isoquant shape shows input substitutability

Straight line isoquant depict perfect substitutes

C-shaped isoquants depict imperfect substitutes
L-shaped isoquants imply no substitutability
Marginal Rate of
Technical
Substitution

Marginal Rate of Technical

Substitution (MRTS) is the
quantity of one input
(Capital) that is reduced to
increase the quantity of
the on there input (Labor),
so that the output
remains constant.
Marginal Rate of Marginal Rate of Technical Substitution

Technical Shows amount of one input that must

Substitution be substituted for another to maintain

constant output
For inputs X and Y, MRTSxy = MPx/MOy

Rational Limits of Input Substitution

Ridge lines show rational limits of input

substitution
MPx<0 or MPy<0 are never observed
Elasticity of Factors
Substitutions

Elasticity of factor substitution (ó) refers to the ratio of percentage change in

capital-labor ratio to the percentage change in MRTS. It is mathematically
represented as follows

ó= percentage change in capital labor ratio/ percentage change in MRTS

OR
 Iso-cost Lines

Iso-cost line represents the price of factors

along with the amount of money an
organization is willing to spend on factors

An isocost line is also called outlay line or

price line or factor cost line. An isocost line
shows all the combinations of labor and
capital that are available for a given total cost
to-the producer. Just as there are infinite
number of isoquants, there are infinite
number of isocost lines, one for every possible
level of a given total cost. The greater the total
cost, the further from origin is the isocost line.
 Producers Equilibrium

A producer can attain equilibrium by The producer equilibrium would be

applying the least cost combination of attained when the output produced
factors of production to attain by spending an additional unit of
maximum profit money (marginal rupee) on A is
The producers try to use ratios of equal to the output produced by
factors in such a ways so that maximum spending an additional unit of
output can be obtained, while keeping money on B
the cost as low as possible The producer equilibrium can be
represented as follows:
MPa/Pa = MPb/Pa………..= Mpn/Pn
Determination of Produce’s
Equilibrium
For attaining equilibriu, a producer needs
to obtain a combination that helps in
Producers equilibrium can be obtained producing maximum output with the
with the help of isoquant and iso-cost least price
line
Return
to
Scale
Return to Scale

The law of returns to Scale explains the proportional change

in output with respect to proportional change in inputs

The degree of change in output varies with change in the

amount of input.For example, an output may change by a
large proportio, same proportio, or small proportion with
respect to change in input.
Return to Scale

01 02 03

Increasing Returns to Constant Returns to Diminishing Returns to

Scale Scale Scale
If the proportional The production is said to Diminishing returns to
change in the output of generate constant scale refers to a situation
an organization is greater returns to scale when the when the proportionate
than the proportional proportionate change in change in outputs is less
change in input, the inputs is equal to the than the proportionate
production is said to proportionate change in change in input.
reflect in increasing output
returns to scale.
Increasing Returns
Scale
In figure 8, OX axis represents
increase in labour and capital
while OY axis shows increase in
output. When labour and capital
increases from Q to Q1, output
also increases from P to P1which
is higher than the factors of
production i.e. labour and
capital.
 Constant Returns
Scale
In this case internal and external
economies are exactly equal to internal and
external diseconomies. This situation arises
when after reaching a certain level of
production, economies of scale are
balanced by diseconomies of scale. This is
known as homogeneous production
function. Cobb-Douglas linear homogenous
production function is a good example of
this kind. This is shown in diagram 10. In
figure 10, we see that increase in factors of
production i.e. labour and capital are equal
to the proportion of output increase.
Therefore, the result is constant returns to
scale.
 Diminishing
Returns Scale
In this diagram 9, diminishing
returns to scale has been shown.
On OX axis, labour and capital
are given while on OY axis,
output. When factors of
production increase from Q to Q1
(more quantity) but as a result
increase in output, i.e. P to P1 is
less. We see that increase in
factors of production is more and
increase in production is
comparatively less, thus
diminishing returns to scale
apply.
Isoquant Maps showing Constant,
Decreasing and Increasing Returns
to Scale
Returns to Scale

Returns to scale show the

output effect of increasing all
inputs
Output elasticity is
where Xi is all inputs (labor,
Capital, etc.)

Output Elasticity and Returns to

Scale
1 implies increasing returns

1 implies constant returns

1 implies decreasing returns

Production Function
In economics, a “production function“ describes an empirical relationship
between specified output and inputs. A production function can be used to
represent output production for a single firm, for an industr, of for a nation. Just
to illustrate a production function of a wheat farm might have the form

W=F(L,A,M,F,T,R)

That is, production of wheat in tons (W) depends on the use of labor measured in
days (L), land in acres, (A) machinery dollars (M), fertilizer in tons (F), mean
summer temperature in degrees (T), and rainfall in inches (R)
Production Function

Letting q represen the output of a particular good during a period, K represent

Capital use, L represent Labor input, and M represent raw materials, the following
equation represents production function

q= f (K,L,M……)
 It is generally assumed that a production functio, F(L,C)

Properties of
satisfies the following properties
F(L,0)=0, F(0,C)=0 (both factor inputs are required for

Production output )
dF/dL> 0, dF/dC> 0 (an increase in either input
increases output)
Functions At a given set of inputs (L,C) the production function
may show decreasing, constant, or increasing “returns to
scale”

If F(kL, kC) < kF(L,C)- there are decreasing returns to

scale
If F(kL, kC) = kF(LC)- there are constant returns to
scale
If F(kL, kC) > kF(LC)- there are increasing returns to
scale
Properties of Production
Functions

Constant returns to scale imply that the total income

from output production equals the total costs from
inputs:

pF(L,C) = wL + rC

(p the price per unit outpu. w and r costs of labor and

Capital)
The Cobb-Douglas Production Function

The simplest production function is the Cobb-Douglas model.

It has the following form:

where Q stands for outpu, L for labor, and C for capital. The
parameters a,b and c (the latter two being the exponents are
estimated from empirical data.

If b + c = 1, the Cobb-Douglas model shows constant returns to

scale. If b+ c > 1, it shows increasing returns to scale, and if b +
c < 1, diminishing returns to scale
Productivity Measurement
Economic Productivity
Productivity growth is the rate of change in output per unit of output
Labor productivity is the change in input per worker hour

Caused of Productivity Growth

Efficiency gains reflect better input use

Capital deepening is growth in the amount of capital
workers have available for use
Example
QUESTION?
 Group Members

Esquillo, Jewel Mae

Duela, Jericho
Formanes, Kim