PRODUCTION FUNCTION IN LONG RUN & SHORT RUN

Presented by: Prof. Zafrin Memon

CONTENTS
What

is Production? What is Production Function? Types of Production Function. Iso-Quant Properties of Iso-Quant. Iso Quant map Law of Variable Proportion. Law of Returns to Scale.

WHAT IS PRODUCTION
Very important activity that satisfies the human wants. Refers to the transformation of inputs into outputs. Inputs Conversion Process output

Inputs are the resources used in Production of Goods & Services. For Example, Suppose we want to Produce mangoes, we and so on. These are called inputs and the outputs are

Without Production, there cannot be consumption.

Production is the organized activity of transforming resources into finished product in the form of goods & Services, and the objective of production is to satisfy the demand of such transformed resources.
- James Bates & J.R. Parkinson

WHAT IS PRODUCTION FUNCTION

between physical inputs and Physical Outputs.

Production function describes the relationship

It shows how Output responds to the different levels of input.

Inputs

Output

The term production function is applied to the physical relationship between a firms input of resources and its output of goods or services per unit of time leaving price aside - Richard H. Leftwich It is determined by the state of Technology. As technology changes, production function also changes. With the developed technology, there will be new production - yield more output with the same inputs.

Mathematically, it can be expressed as:

Q = f (l, L, K, O)
Where,

Q Quantity of Output f Functional relationship l- Labour L Land K- Capital O- Organisation

TYPES OF PRODUCTION FUNCTION

On the basis of time periods production function is classified into:

Short run production Function Long run production Function

SHORT RUN VS. LONG RUN

The short run is defined as the period of time when the plant size is fixed. The long run is defined as the time period necessary to change the plant size.

Plant size is fixed, labor is variable Both Plant size and labor are variable

Duration of the long/short run depends on the production process

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SHORT RUN VS. LONG RUN

Plant size is Short Run fixed, labor is variable To increase Short Run production firms increase Labor but cant expand their plant 10 Firms produce in the short run

SHORT RUN VS. LONG RUN

Short Run

Q Quantity of output f - Functional relationship l- Labour (a variable Factor) K Capital (a fixed Factor)

Q = f (l,K)

Capital

Variable factor

Fixed Factor

SHORT RUN VS. LONG RUN

Long Run How can the plant size be Long Run variable?

Plant size is variable, labor is variable To increase production firms increase Labor and expand their plant. Plant size is variable in the planning stage
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Firms plan in the long run

SHORT RUN VS. LONG RUN

Long Run

Q = f (l,K)

Q Quantity of output f - Functional relationship l- Labour (a variable Factor) K Capital (a Variable Factor)

Capital

Variable factor

Variable Factor

ISO-QUANT
The term iso quant is derived from Greek Word . ISO EQUAL QUANT QUANTITY

Is the Locus of all the combination of two factors of production that yield same level of output.

For Example: Labour and Capital are taken in any proportion in which one will increase and the other will decrease to maintain same level of Output.

Also Known as Iso-Production Curve , Iso Indifference Curve, Equal Production Curve. It can be explained with the help of a Schedule and the graph.

Combination Labour

Capital

Output

A B C D E

1 2 3 4 5

200 150 100 50 25

100 100 100 100 100

ISO - QUANT TABLE SHOWING COMBINATIONS OF LABOUR AND CAPITAL PRODUCING 100 UNITS OF X

Processes 1 2 3

Units of Labour 1 2 3

Units of Capital 10 7 5

4 5 6

4 6 9

4 3 2

CONVEX ISO - QUANT

K 7

2 X O Y 2 4 L

ASSUMPTIONS:-

There are only two factors or inputs of production. Divisible into small units. Technical conditions.

CHARACTERISTICS OR PROPERTIES OF ISO QUANTS

Iso
A

- Quants are negatively sloped.

higher represents a larger output. two Iso - Quants intersect or touch each other. - Quants are convex to the origin. quant do not intersect either Axis

No Iso Iso

ISO - QUANTS ARE NEGATIVELY SLOPED

Iso

- Quants having positively sloped segments

Capital

IQ O Labour

A HIGHER REPRESENTS A LARGER OUTPUT

Two

Iso - Quants representing different output levels

NO TWO ISO - QUANTS INTERSECT OR TOUCH

EACH OTHER
No

two Iso - Quants intersect one another

ISO - QUANTS ARE CONVEX TO THE ORIGIN

Convexity

of an Iso - Quant

ISO QUANT DO NOT INTERSECT EITHER AXIS

If an Iso-quant touches one of the axis it implies that Output can be produced only with the help of one factor of production.
Y-axis

Capi tal

Labour

ISO - QUANT MAP

Output varies as the factor input change. Nearer the point of origin lower the production. Complete set of Iso - Quants for the producers

Iso - Quants nearer to the point of origin represent relatively lower level of production.

LAWS EXPLAINING PRODUCTION FUNCTION

Law of variable proportion (short run) Law of Returns to scale (Long run)

LAW OF VARIABLE PROPORTION

Also called Law of Diminishing Returns Marshall Marshall applied the law only to the agriculture. Joan Robinson, Stigler, and other modern economist called it the law of Variable proportion which could be applied in all sector of economics.

It states that as more and more units of the variable factor are used with the fixed factor, marginal product of the variable factor may initially increase and subsequently stabilize, but much finally decrease.

THERE ARE THREE IMPORTANT WAYS TO

UNDERSTAND LAW OF VARIABLE PROUCTION:
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Total

product (TP) Average product (AP) Marginal product (MP)

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TOTAL PRODUCT FUNCTION (TP)

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Represents

the relationship between the number of workers (L) and the TOTAL number of units of output produced (Q) holding all other factors of production (the plant size) constant.
For a coffee shop, output would be measured in number of coffee cups a day For a steel mill, output would be measured in tons of steel produced a day

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BUILDING A TOTAL PRODUCT GRAPH

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The Total Product Curve must show that: 1. With more workers more output can be produced.
INCREASING FUNCTION.
Total Product Total Product Total Product Labor

Labor

Labor

Number of units of output produced

Constant Slope

25

20
15

5 5 5

10 5

Output increases by the same amount for each worker hired

5
5 0 1
Number of Workers hired

75 25 50
20

Increasing Slope

30
15 15 5
5

ALL workers become more productive as increases they Output concentrate on by increasing doing only one task amounts for each worker hired

10

75 70 60 45

Decreasing Slope
5

10 15
ALL workers become LESS productive as the plant gets crowded and Output increases by equipment breaks down decreasing amounts often for each worker hired

20
25 25

ALL THREE FUNCTIONS ARE INCREASING. Q Same size steps Larger steps Constant Slope Increasing Slope

L As L increases, Q increase by the same amount Q

As L increases, Q increase by increasing amounts

Smaller steps

Decreasing Slope
As L increases, Q increase by decreasing amounts L

FOR MOST PRODUCTION PROCESSES

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In

the short run, the plant size is fixed. Adding more workers is favorable to production at first, as specialization increases productivity. Eventually, adding more and more workers to a FIXED PLANT size results in decreases in productivity due to crowded conditions:

Workers will have to SHARE EXISTING EQUIPMENT Equipment will break down more often.

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As more of a variable input (labor) is added to a fixed input (plant), additions to output eventually slow down.

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THE LAW OF DIMINISHING MARGINAL PRODUCT.

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If more of the variable input (labor) continues to be added to a fixed input (plant), additions to output continue to decline until eventually output decreases

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NEGATIVE MARGINAL PRODUCT

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CHOOSING THE SLOPE:

2. For most productions processes as we add more workers, additions to output increase at the beginning but eventually decrease (could become negative). For this, we use a function with both increasing and decreasing steps. The most common production function has increasing slope at the beginning. Eventually, slope decrease and slope may become negative
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MARGINAL PRODUCT (MP)

The additional output that can be produced by adding one more worker while holding plant size constant. MP = DQ/DL Is the slope of the Total Product Function

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MP: SLOPE OF THE PRODUCTION FUNCTION Slope = 30/3 = 10

Q

MP = 10
TP

160 units 130 units

30

Rise
Run

Each one of these three workers adds 10 units to production

3
9 12
L

MP INCREASES AND DECREASES WHILE TOTAL PRODUCT STILL RISING

If more workers are added, MP turns NEGATIVE

MP
25 27 23 2

-4

MP = 12 MP = 8

20

5
12
MP = 5

8
1 1st 2nd
2

MP = 2
5

3rd

4th

5th

MP = -4

TOTAL PRODUCT VS. MARGINAL PRODUCT

TP rises up to 4th worker 25 27 23 MP rises up to 2nd worker MP MP falls after to 2nd worker MP becomes negative after 4th worker

TP falls after 4th worker

MP = 12

20

MP = 8 MP = 5 MP = 2
1 2 3 4 5

MP = -4

L 0 1 2 3 4 5

MP 5 10 15 20 25

L 0 1 2 3 4 5

MP

Q 0 60 115 165 210 250

6 30 7 35 8 40 9 45 10 50 given In this table: youre the 11Marginal Product 55 and you must use it to calculate the Total Product. 12 60

6 285 7 315 8 340 9 360 10 375 In this table: youre given the Total Product and you 11 385 must use it to calculate the Marginal Product. 12 390

L 0 1 2 3 4 5 6 7 8 9 10 11 12

MP

L 0 1 2 3 4 5 6 7 8 9 10 11 12

MP

Q 0 60 115 165 210 250 285 315 340 360 375 385 390

5 10 15 20 25 30 35 40 45 50 55 60

5 15 30 50 75 105 140 180 225 275 330 390

60 55 50 45 40 35 30 25 20 15 10 5

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AVERAGE PRODUCT (AP)

Represents the amount of output produced by each worker on average. Or Output per worker.

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OUTPUT PER WORKER: AVERAGE PRODUCT (AP)

Slope of that ray= Q/L = AP Q

When 10 workers produce 150 units,

Output per worker = 15 units TP

150 units
If we draw a line (a ray) from the origin to a point on the production function

Q Rise

AP = Q/L AP = 150/10 = 15

Run L

10

AP = Q/L What happens to the AP as L FROM ORIGIN AP = SLOPE OF RAY What happens to
increases?

the slope as L increases?

Q L AP 82 80 70 TP 5 5 1.00 20 10 2.00 30 12 2.50 70 16 4.38 80 20 4.00 82 23 3.57 L

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30

20
5

10 12 16 20 23

AP: INCREASES, REACHES A MAXIMUM AND DECREASES.

AP AP Increases up to AP Decreases 16 workers after L=16

70/16 =4.38

Q L AP 5 5 1.00 20 10 2.00 30 12 2.50 70 16 4.38 80 20 4.00 82 23 3.57 L L

50

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THE RELATIONSHIP BETWEEN AP AND MP

IfIfthe your MP next of the grade next isworker say 70is > say your 70 test > If MP (70) > AP (60), then the Average per average worker so average far say so 60,far then say your 60, test then Product increases. the Average per worker increases. average (AP) increases. If MP (50) < AP (60), then the AP will decrease. If MP of the next say 50 < Ifthe your next grade is worker say 50 is < your test If MP = AP, then the AP issay not increasing per worker average so far 60, then average so far say 60, then your test or decreasing: it is at the maximum the per worker average (AP) decreases. Average decreases. point. your next grade isworker 60 = your test IfIfthe MP of the next is say 60 = per average so far 60, then your Average worker average so far say 60, test then the per 51 stays the same . worker average (AP) stays the same.

THE AP AND MP
TP Slope of ray is max
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Changes concavity L MP is max AP is max AP

MP,AP

MP