M.TULASINADH MBA.,(Ph.

D)
Research Anayst
PRODUCTION ANALYSIS
PRODUCTION
Production is concerned with the way in which resources or inputs such as land, labor, and
machinery are employed to produce a firms product or output. Production may be either services or
goods. To produce the goods we use inputs. Basically inputs are divided into two types. those are fixed
inputs and variable inputs. Fixed inputs are the inputs that remain constant in short-term. Variable
inputs are inputs, which are variable in both short-term and long-term.
Production Function
Production function expresses the relationship between inputs and outputs. Production
function explains that the maximum output of goods or services that can be produced by a firm in a
specific time with a given amount of inputs or factors of production.
Production Function: Q = f (K, L)
We are producing Q quantities of goods by employing K capital and L labor.
Here
Q
Represents quantity of goods
K
Represents Capital employed
L
Represents Labor employed
Economies of Scale:
As a result of increasing production the production cost is low, and it is known as
economies of scale.
As long as the output is increased in the long run, the cost of production will be at minimum
level, this is known as economies of scale, Economies of scale is divided into two parts.
1. Internal Economies
2. External Economies
Internal Economies:
Internal economies are those benefits or advantages enjoyed by an individual firm if it
increases its size and the output.
Types or Forms of Internal Economies:
1. Labors Economies : A large firm can attract specialist or efficient labors and due to increasing
specializations the efficiency and productivity will be increased, leading to decrease in the labors cost
per unit of output.
2. Technical Economies: A large firm can adopt and implement the new and latest technologies,
which helps in reducing the cost of manufacturing process, whereas the small firm may not have the
capacity to implement latest technologies. A large firm can make optimum utilization of machinery,
and it can manage the production activities in continuous series without any loss of time thereby saving
the time and transportation cost.
3. Managerial Economies: The managerial cost per unit will decrease due to mass scale
production. Like, the salary of general manager, which remains the same whether, the output is high or
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low. Moreover, a large firm can recruit the skilled professionals by paying them a good salary, but a
small firm does not have the much of capacity to pay high salaries. Thus, mass scale of production will
decrease the managerial cost per unit.
4. Marketing Economies: A large firm can purchase their requirements on a bulk scale therefore,
they get a discount. Similarly the advertisement cost will be reduced because a large firm produces a
variety of different types of products. Moreover, a large firm can employ sales professional for
marketing their products effectively.
5. Financial Economies: A large firm can raise their financial requirements easily from different
sources than a small one. A large firm can raise their capital easily from the capital market because the
investor has more confidence on the large firm than in small firm.
6. Risk Bearing Economies: The large firm can minimize the business risk because it produces a
variety of products. The loss in one product line can be balanced by the profit in other product line.
External Economies
External Economies are those benefits, which are enjoyed by all the firms in an industry
irrespective of their increased size and output. All the firms in the industry share external economies.
1. Economies of Localization: When all the firms are situated at one place, all the firms will be
enjoying the benefits of skilled labors, infrastructure facilities and cheap transport thereby reducing the
manufacturing cost.
2. Economies of Information: All the firms in an industry can have a common research and
development center through which the research work can be undertaken jointly. They can also have the
information related to market and technology.
3. Growth of subsidiary Industry: The production process can be divided into different
components. Specialized subsidiary firms at a low cost can manufacture each component.
4. Economies of By-Products: The waste materials released by a particular firm can be used as an
input by the other firm to manufacture a by-product.
TYPES OF PRODUCTION FUCNTION:
How to Produce?

SHORT RUN
LAW OF VARIABLE PRAPORTIONS
(ONE VARIABLE INPUT)

LONG RUN
ISOQUANT ANALYSIS
TWO VARIABLE INPUTS

RETURNS TO SCALE
(ALL VARIABLE INPUTS)

PRODUCTION FUNCTION WITH ONE VARIABLE INPUT

Consider the simplest two input production process - where one input with a fixed quantity and the
other input with is variable quantity.
Suppose that the fixed input is the service of machine tools, the variable input is labour, and the
output is a metal part. The production function in this case can be represented as:
Q = f (K, L) Where Q is output of metal parts, K is service of five machine tools (fixed input), and L is
labour (variable input). The variable input can be combined with the fixed input to produce different
levels of output. Total, Average, and Marginal Products The production function given above shows us
the maximum total product (TP) that can be obtained using different combinations of quantities of
inputs. Suppose the metal parts company decides to know the output level for different input levels of
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M.TULASINADH MBA.,(Ph.D)
Research Anayst
labour using fixed five machine tools. Table explains the total output for different levels of variable
input. In this example, the TP rises with increase in labour up to a point (six workers), becomes constant
betweensixth and seventh workers, and then declines.

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Law of variable proportions:

The law of variable proportions which is a new name given to old classical concept of Law of diminishing
returns has played a vital role in the modern economics theory. Assume that a firms production function
consists of fixed quantities of all inputs (land, equipment, etc.) except labour which is a variable input when
the firm expands output by employing more and more labour it alters the proportion between fixed and the
variable inputs. The law can be stated as follows:
The law of variable proportions refers to the behaviour of output as the quantity of one Factor is increased
Keeping the quantity of other factors fixed and further it states that the marginal product and average product
will eventually do cline. This law states three types of productivity an input factor Total, average and
marginal physical productivity.
Assumptions of the Law: The law is based upon the following assumptions:
The state of technology remains constant. If there is any improvement in technology, the average and marginal
output will not decrease but increase.
Only one factor of input is made variable and other factors are kept constant. This law does not apply to those
cases where the factors must be used in rigidly fixed proportions.
All units of the variable factors are homogenous.
Three stages of law:
The behaviors of the Output when the varying quantity of one factor is combines with a fixed quantity of the
other can be divided in to three district stages. The three stages can be better understood by following the table.
Fixed factor
Variable factor
Total product
Average Product
Marginal Product
(Labour)
1
1
100
100
Stage I
1
2
220
120
120
1
3
270
90
50
1
4
300
75
30
Stage II
1
5
320
64
20
1
6
330
55
10
1
7
330
47
0
Stage
1
8
320
40
-10
III
Above table reveals that both average product and marginal product increase in the beginning and then decline
of the two marginal products drops of faster than average product. Total product is maximum when the farmer
employs 6th worker, nothing is produced by the 7th worker and its marginal productivity is zero, whereas
marginal product of 8th worker is -10, by just creating credits 8th worker not only fails to make a positive
contribution but leads to a fall in the total output.
Production function with one variable input and the remaining fixed inputs is illustrated as below

From the above graph the law of variable proportions operates in three stages. In the first stage, total product
increases at an increasing rate. The marginal product in this stage increases at an increasing rate resulting in a
greater increase in total product. The average product also increases. This stage continues up to the point where
average product is equal to marginal product. The law of increasing returns is in operation at this stage. The
law of diminishing returns starts operating from the second stage awards. At the second stage total product
increases only at a diminishing rate. The average product also declines. The second stage comes to an end
where total product becomes maximum and marginal product becomes zero. The marginal product becomes
negative in the third stage. So the total product also declines. The average product continues to decline.
Thus, the total product, marginal product and average product pass through three phases, viz., increasing
diminishing and negative returns stage. The law of variable proportion is nothing but the combination of the
law of increasing and diminishing returns.

PRODUCTION FUCNTION WITH TWO VARIABLE INPUTS (ISOQUANT)

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.
Iqoquants 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 firms production become,
Q= f (L, K)
Where Q, the units of output is a function of the quantity of two inputs L and K.

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.
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.
An isoquant may be explained with the help of an arithmetical example.
Combinations
Labour (units)
Capital (Units)
Output (quintals)
A
1
10
50
B
2
7
50
C
3
4
50
D
4
4
50
E
5
1
50
Combination A represent 1 unit of labour and 10 units of capital and produces 50 quintals of a
product all other combinations in the table are assumed to yield the same given output of a
product say 50 quintals by employing any one of the alternative combinations of the two factors
labour and capital. 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 below.

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 50 quintals of a product.
RETURNS TO SCALE:
According to Prof. Rofer. Miller, Returns to scale refer to the relationship between changes in
output and proportionate changes in all factors of production
Assumptions:
1. All factors (inputs) are variable but enterprise is fixed
2. Technological changes are absent
3. The product is measures in quantities
Types of Returns to scale:
1. Increasing returns to scale
2. Constant returns to scale
3. Diminishing returns to scale
Explanation:
The concept of variable proportions is a short-run phenomenon as in these period fixed factors
cannot be changed and all factors cannot be changed. On the other hand in the long-term all
factors can be changed as made variable. When we study the changes in output when all factors
or inputs are changed, we study returns to scale. An increase in the scale means that all inputs or
factors are increased in the same proportion.
Factors combinations (Quintals)
1
2
3
4
5
6
7

Total product
(Quintals)
2
6
12
18
24
28
30

Marginal Product
(Quintals)
2
4
6
6
6
4
2

Cobb-Douglas production function:

Production function of the linear homogenous type is invested 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= (AKX L1-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.
There are constant returns to scale
All inputs are homogenous
There is perfect competition
There is no change in technology
MARGINAL RATE OF TECHNICAL SUBSTITUTION:
The rate at which one factor of production (input) can be substituted for other is known as
Marginal rate of technical substitution
Prof RGD Alien and JR.Hicks introduced the concept of MRTS.
This can be represented as: MRTS =
Where
Example;

(K.
Combination Labour Capital L) Output
1
5
9
100
2

10

3:5 100

15

2:5 100

20

1:5 100

The above table shows that in the second combination to keep output constant at 100 units, the
reduction of 3 units of capital requires the addition of 5 units of labour, MRTSLk= 3:5. In the third
combination, the loss of 2 units of capital is compensated for by 5 more units of labour, and so
on. In Figure 2, at point , the marginal rate of technical substitution is AS/SB, at point G, it is
BT/TG and at H, it is GR/RH.

The marginal rate of technical substitution can also be expressed as the ratio of the marginal
physical product of labour to the marginal physical product of capital, or MRTSLk= MPL/ MPK.