Production

The processes and methods used to transform tangible inputs (raw materials, semi-finished
goods, subassemblies) and intangible inputs (ideas, information, knowledge) into goods or
services. Resources are used in this process to create an output that is suitable for use or has
exchange value.

Production is the result of co-operation of four factors of production viz., land, labour, capital
and organization.

This is evident from the fact that no single commodity can be produced without the help of
any one. Therefore, the producer combines all the four factors of production in a technical
proportion. The aim of the producer is to maximize his profit. For this sake, he decides to
maximize the production at minimum cost by means of the best combination of factors of
production.e of these four factors of production.

Production Function: In simple words, production function refers to the functional

relationship between the quantity of a good produced (output) and factors of production
(inputs).

“The production function is purely a technical relation which connects factor inputs and
output.” athematically, such a basic relationship between inputs and outputs may be
expressed as:

Q = f( L, C, N )

Where Q = Quantity of output

L = Labour

C = Capital

N = Land.

Hence, the level of output (Q), depends on the quantities of different inputs (L, C, N)
available to the firm. In the simplest case, where there are only two inputs, labour (L) and
capital (C) and one output (Q), the production function becomes.

Q =f (L, C)

Or

Q=f(k,l)

Where,

K=capital

L=labour

Types of production
Total product or total output is the total number of units of production obtained from the
productive resources employed. Average product is total product divided by the number of units of
the variable factor employed. Marginal product is the change in total product associated with a
change in units of a variable factor of production.

The following diagram provides a graphical presentation of total, average, and marginal products for
a hypothetical firm.

Total product

TP

Diminishing negative marginal returns

Marginal returns

o Unit of labour

product

AP

o Unit of labour

MP

The top graph shows total product. After total product reaches its maximum marginal product
where marginal product changes from positive to negative (first derivative is zero, second derivative
is negative). When the total product curve reaches its maximum, increased output results in
negative marginal product. The maximum on the marginal product curve is also associated with the
first inflection point (the acceleration or where the curve becomes steeper) on the total product
curve.

Four factors of production

In the theory of Economics, there are four factors of production. The factors are land, labor,
capital, and entrepreneurship.

These four factors of production are used in various combinations for the production of goods
and services. Since these factors are limited by nature, and human wants are unlimited, we, as
a country, face a decision over the efficient allocation of these scarce resources or factors of
production.

1. Land/Natural Resources

Land refers to all the natural resources. These resources are gifts that are given by nature. Some
common examples of natural resources are water, oil, copper, natural gas, coal, and forests. These
resources can be renewable, such as forests, or non renewable such as oil or natural gas. The income
earned from land or other such natural resources is called rent.

2. Labor

Labor, as a factor of production, involves any human input. The quality of labor depends on the
workforce’s skills, education, and motivation. Generally speaking, the higher the quality of labor, the
more productive is the workforce. Labor can be physical or mental. The income earned by labor
resources is called wages. It is the largest source of income for most people.

3. Capital

Here capital refers to manufactured resources such as factories and machines. These are man-
made goods used in the production of other goods. Their use in commercial production is
what separates them from consumer goods..

Some common examples of capital include buildings, hammers, forklifts, conveyor belts,
computers, and delivery vans. An increase in capital goods means an increase in the
productive capacity of the economy. The income earned by owners of capital resources is
interest.

4. Entrepreneurship

An entrepreneur is someone who takes on risk and brings the other three factors of
production together. Entrepreneurs are a vital engine of economic growth helping to build
some of the largest firms in the world as well as some of the small businesses in your
neighborhood.

The payment an entrepreneur receives is called profit as a reward for the risk they take.

Q. On what factors efficiency of labor depends?

Efficiency of Labor is the ability of Labor to increase output without increasing the quantity
of Labor. Increase in efficiency is usually expressed in terms of increase in output of Labor
within a shorter period of time without any fall in the quality of goods and services produced.
If labor is efficient, the quality of goods and services produced will be high.

Factor # 1. Personal Qualities of Labourers:

The efficiency of a worker is influenced by qualities which he acquires or possesses.

The important of them are as follows:

(i) Racial Qualities:

It has been seen that every person inherits certain qualities from the race to which he belongs.

For example:

The people of Northern India, especially the Jats, the Rajputs and the Punjabi’s and the
Dogras are considered mere hardly and strong in comparison to those of Bengal. Hence, the
efficiency of the former is higher than that of the later.

(ii) Hereditary Qualities:

A child inherits the skill of his father by birth. He will be more efficient if he enters the trade
of his father.

For example:

Swiss people are considered to be more efficient watchmakers than others because they have
been making watches from generations.

(iii) Moral Qualities:

Man is a moral animal. In man not only self-alertness is present but all moral alertness and
self-morality is present. Moral qualities increase the efficiency of the worker. An honest,
sincere and good character worker is liked by the management and this quality helps in
increasing the efficiency.

(iv) Individual Qualities:

If a worker is mentally alert, possesses good physique, is intelligent, sober, honest and
resourceful and is responsible, he will be more efficient than others.

v) General Education and Intelligence:

There are certain qualities which a worker acquires by education, general and technical.
Among these attributes may be mentioned honestly intelligence, perseverance, judgment,
health and strength of the body, resourcefulness, sense of responsibility, etc. Efficiency of
labour depends also on these qualities. An honest intelligent and hard-working person will be
more efficient in his work than one who lacks these qualities.

(vi) Standard of Living:

A worker having high standard of living is more efficient than a worker having low standard
of living. Good nourishing food, suitable clothing, ventilated and comfortable home with
healthy surroundings tend to increase the efficiency of the workers.

(vii) Organisation among the labourers:

Good and proper organisation of labour inside the factory will improve labour efficiency. A
good and well organised trade union can also improve labour efficiency through its fraternal
functions.

Factor # 2. Working Conditions:

The conditions under which the worker works also influence his efficiency.

The factors which affect his working conditions are as under:

(i) Factory Environment and Place of Work:

If the factory is neat and well ventilated and the surroundings are sanitary and attractive and
there is sufficient space for movement between machines and provision for fresh water,
refreshment and rest between work, their efficiency will be higher.

(ii) Working Hours:

It must be remembered that small working hours with tea and lunch break, rest and recreation
always help increase the efficiency of labour. It has been proved that long hours mean low
efficiency.

(iii) Rate of Wages:

Efficiency of worker depends to a great extent on wages which he receives. A worker who
receives sufficiently high wages will ensure an adequate standard of living will have high
efficiency. A low-paid worker will always grumbles and is unable to put his heart into the
job. Consequently, his efficiency will be low.

(iv) Regularity of Wages:

Regular payment of wages on a due date fixed increases efficiency of labour because workers
adjust their budgets accordingly, otherwise they are put to much more inconvenience when
wage payment is irregular and they are not able to devote themselves whole heartedly to their
work which reduces their efficiency.

(v) Methods and System of Wage Payment:

If a worker is paid wages according to the work which he is doing, this increases efficiency of
the worker. These days economists have recommended for ‘incentive methods of wage
payment’.

(vi) Nature of Machines:

The more advanced the machines are in a factory, the more efficient are the workers therein.
A labourer, however, skilled and intelligent he may be, will produce relatively little if the
machines on which he works are outmoded.

(vii) Prospects of Promotion:

If the worker knows that he will be suitably rewarded and promoted to a higher grade when
he will produce more, then he will work diligently and his efficiency will increase. On the
other-hand, the trade in which such incentives do not exist, the efficiency of labour will be
low.

Factor # 3. Conditions of the Country:

Efficiency of labour is also dependent on the social, political and economic conditions of the
country.

Important factors are:

(i) Climatic Conditions:

The climate of a place also determines the efficiency of labour in a country. Workers who
live and work under hot climate becomes tired soon both physically and mentally. As a result
their efficiency declines. On the other-hand workers living and working in cold and temperate
regions are more alert and hence their efficiency is high.

(ii) Social Conditions:

If the society to which the workers belong is backward and is based on caste and creed
relationships, workers will not work in co-operation with workers belonging to other castes.
This labour efficiency will be definitely low. Similarly workers who are fatalists are seldom
hard-working by nature and hence their efficiency is also low.

(iii) Political Conditions:

Political conditions also affect the efficiency of labour. If the government of the country in
which the worker lives is strong enough to preserve peace at home and provide security from
foreign aggression, his efficiency will be high as against that worker who leads a life of
insecurity in a country full of internal disturbances and constant threat of war from abroad.

(iv) Cultural and Religious Traditions:

The cultural and religious traditions of a country also affects the efficiency of a labourer, less
educated people or illiterate people always fear with religion and they don’t want to take such
steps which may affect their normal efficiency.
(v) Social Security:

If a worker is to give his best, he must have reasonable assurance that in the event of injury,
sickness, unemployment, disablement or death in service, he or his dependents must be
compensated suitably. If such provision is available this will definitely increase the
efficiency.

(vi) Form of Economic System:

Form of economic system in a country also affects the efficiency of labour. A labourer of an
under-developed country will get less wages or salary in comparison to a developed country.

Factor # 4. Organisational and Managerial Ability:

Organisational and Managerial ability of the manager working in an organisation also affects
the efficiency of the worker:

(i) Efficient Management:

Efficient management of the organisation affects the efficiency of labour. The worker will
start working efficiently. In inefficient management efficiency of worker will decrease and
working capacity will reduce.

(ii) Proper Relationship between Employer and Employee:

Efficiency of labour also depends upon the employer-employee relations. If the relations
between the two are friendly and cardinal, efficiency of labour will be high. But the
relationship between the employer and employees itself dependents upon the behaviour of the
employer towards the employees and that of trade unions towards the employer.

(iii) Sympathetic Attitude of the Management:

If the management possesses a sympathetic attitude towards the workers, the workers will
give their best. On the other hand, a trade union which adopts militant attitude towards the
employer, will lower labour efficiency.

Factor # 5. Other Factors:

There are other factors also which affects the efficiency of labour and their considerations has
been considered important.

They are:

(i) Labour Policy of the Government:

Labour policy of the government also affects the efficiency of a labourer. If the policy of the
government is favourable towards labourer, it will create confidence in labourer and their
efficiency will improve. If policy is unfavorable the labourer may feel disappointed.

(ii) Trade Unions:

If trade union is well organised the workers will have upper hand and they will get more
wages and their standard of living will improve.

(iii) Sense of Patriotism:

Country in which workers are loyal to the country and have sense of patriotism the efficiency
of workers will automatically go up. Love for the country encouraged them to do more
efficiently.

Q. Why economies arise in large scale production?

economies of large scale production are classified by Marshall into:

(1) Internal Economies and (2) External Economies.

(1) Internal Economies of Scale:

Internal economies of scale are those economies which are internal to the firm. These arise within
the firm as a result of increasing the scale of output of the firm. A firm secures these economies from
the growth of the firm independently. The main internal economies are grouped under the following
heads:

(i) Technical Economies: When production is carried on a large scale, a firm can afford to install up
to date and costly machinery and can have its own repairing arrangements. As the cost of machinery
will be spread over a very large volume of output, the cost of production per unit will therefore, be low.

A large establishment can utilize its by products. This will further enable the firm to lower the price per
unit of the main product. A large firm can also secure the services of experienced entrepreneurs and
workers which a small firm cannot afford. In a large establishment there is much scope for
specialization of work, so the division of labor can be easily secured.

(ii) Managerial Economies: When production is carried on a large scale, the task of manager can be
split up into different departments and each department can be placed under the supervision of a
specialist of that branch. The difficult task can be taken up by the entrepreneur himself. Due to these
functional specialization, the total return can be increased at a lower cost.

(iii) Marketing Economies: Marketing economies refer to those economies which a firm can secure
from the purchase or sale of the commodities. A large establishment is in a better position to buy the
raw material at a cheaper rate because it can buy that commodities on a large scale. At the time of
selling the produced goods, the firm can secure better rates by effectively advertising in the
newspapers, journals and radio, etc.

(iv) Financial Economies: Financial economies arise from the fact that a big establishment can raise
loans at a lower rate of interest than a small establishment which enjoys little reputation in the capital
market.

(v) Risk Bearing Economies: A big firm can undertake risk bearing economies by spreading the risk.
In certain cases the risk is eliminated altogether. A big establishment produces a variety of goods in
order to cater the needs of different tastes of people. If the demand for a certain type of commodities
slackens, it is counter balanced by the increase in demand of the other type of commodities produced
by the firm.

(vi) Economies of Scale: As a firm grows in size, it is-possible for it to reduce its cost. The reduction
in costs, as a result of increasing production is called economies of scale. The economies of scale are
obtained by the firm up to the lowest point on the firms long run average cost curve. The main sources
of economies of scale are in brief as under.:

(2) External Economies of Scale:

External economies of scale are those economies which are not specially availed of by .any firm.
Rather these accrue to all the firms in an industry as the industry expands. The main external
economies are as under:

(i) Economies of localization. When an industry is concentrated in a particular area, all the firms
situated in that locality avail of some common economies such as (a) skilled labor, (b) transportation
facilities, (c) post and telegraph facilities, (d) banking and insurance facilities etc.

(ii) Economies of vertical disintegration. The vertical disintegration implies the splitting up the
production process in such a manner that some Job are assigned to specialized firms. For example,
when an industry expands, the repair work of the various parts of the machinery is taken up by the
various firms specialists in repairs.

(iii) Economies of information. As the industry expands it can set up research institutes. The
research institutes provide market information, technical information etc for the benefit of alt the firms
in the industry.

(iv) Economies of by products. All the firms can lower the costs of production by making use of
waste materials.

Q. Internal Diseconomies of Scale:

Definition:

The extensive use of machinery, division of labor, increased specialization and larger plant size etc.,
no doubt entail lower cost per unit of output but the fall in cost per unit is up to a certain limit. As the
firm goes beyond the optimum size, the efficiency of the firm begins to decline. The average cost of
production begins to rise.

Factors of Diseconomies:

The main factors causing diseconomies of scale and eventually leading to higher per units cost are
as follows:

(i) Lack of co-ordination. As a firm becomes large scale producer, it faces difficulty in coordinating
the various departments of production. The lack of co-ordination in the production, planning,
marketing personnel, account, etc., lowers efficiency of the factors of production. The average cost of
production begins to rise.
(ii) Loose control. As the size of plant increases, the management loses control over the productive
activities. The misuse of delegation of authority, the redtapisim bring diseconomies and lead to higher
average cost of production.

(iii) Lack of proper communication. The lack of proper communication between top management
and the supervisory staff and little feed back from subordinate staff causes diseconomies of scale and
results in the average cost to go up.

(iv) Lack of identification. In a large organizational structure, there is no close liaison between the
top management and the thousands of workers employed in the firm. The lack of identification of
interest with the firm results in the per unit cost to go up
External Diseconomies:

Definition:

A firm or an industry cannot avail of economies for an indefinite period of time. With the expansion
and growth of an industry, certain disadvantage also begin to arise. The diseconomies of large
scale production are:

(i) Diseconomies of pollution, (ii) Excessive pressure on transport facilities, (iii) Rise in the prices of
the factors of production, (iv) Scarcity of funds, (v) Marketing problems of the products, (iv) Increase in
risks.

Law of Returns to Scale : Definition, Explanation and Its Types!

In the long run all factors of production are variable. No factor is fixed. Accordingly, the
scale of production can be changed by changing the quantity of all factors of production.

Definition:

“The term returns to scale refers to the changes in output as all factors change by the same
proportion.” Koutsoyiannis

“Returns to scale relates to the behaviour of total output as all inputs are varied and is a long
run concept”. Leibhafsky

Returns to scale are of the following three types:

1. Increasing Returns to scale.

2. Constant Returns to Scale

3. Diminishing Returns to Scale

Explanation:
In the long run, output can be increased by increasing all factors in the same proportion.
Generally, laws of returns to scale refer to an increase in output due to increase in all factors
in the same proportion. Such an increase is called returns to scale.

Suppose, initially production function is as follows:

P = f (L, K)

Now, if both the factors of production i.e., labour and capital are increased in same
proportion i.e., x, product function will be rewritten as.

The above stated table explains the following three stages of returns to scale:
1. Increasing Returns to Scale:

Increasing returns to scale or diminishing cost refers to a situation when all factors of
production are increased, output increases at a higher rate. It means if all inputs are doubled,
output will also increase at the faster rate than double. Hence, it is said to be increasing
returns to scale. This increase is due to many reasons like division external economies of
scale. Increasing returns to with the help of a diagram 8. scale can be illustrated

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 P1
which is higher than the factors of production i.e. labour and capital.

2. Diminishing Returns to Scale:

Diminishing returns or increasing costs refer to that production situation, where if all the
factors of production are increased in a given proportion, output increases in a smaller
proportion. It means, if inputs are doubled, output will be less than doubled. If 20 percent
increase in labour and capital is followed by 10 percent increase in output, then it is an
instance of diminishing returns to scale.

The main cause of the operation of diminishing returns to scale is that internal and external
economies are less than internal and external diseconomies. It is clear from diagram 9.
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.

3. Constant Returns to Scale:

Constant returns to scale or constant cost refers to the production situation in which output
increases exactly in the same proportion in which factors of production are increased. In
simple terms, if factors of production are doubled output will also be doubled.

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.
Consumer price index (CPI)

A measure of changes in the purchasing-power of a currency and the rate of inflation. The
consumer price index expresses the current prices of a basket of goods and services in terms
of the prices during the same period in a previous year, to show effect of inflation on
purchasing power. It is one of the best known lagging indicators. See also producer price
index.

the consumer price index (CPI) reflects the average change over time in
the prices of a specified set of final commodities and services
representing the market basket of a given group of consumers.

Consumer Price Index (CPI) is a measure that examines the weighted average of prices of a basket of
consumer goods and services, such as transportation, food and medical care. It is calculated by
taking price changes for each item in the predetermined basket of goods and averaging them.
Changes in the CPI are used to assess price changes associated with the cost of living; the CPI is one
of the most frequently used statistics for identifying periods of inflation or deflation.
The CPI represents the cost of a basket of goods and services across the country on a monthly
basis. Those goods and services are broken into eight major groups:

• Food and beverages

• Housing
• Apparel
• Transportation
• Medical care
• Recreation
• Education and communication
• Other goods and services