Production behaviour of firm

What is production.
Production transforms inputs into outputs.
Production function.
The term Production Function refers to the relationship between inputs and output.
Production function indicates the maximum level of output the firm can produce for any
combination of inputs.
The functional form of a simple production function can be written as,
Q = f ( L, K)

Factors of production
Land: Land means natural resources. According to Marshall, the land means the material and the
forces which Nature gives freely to mans aid in land and water, in air and light and heat.
Labour: Any human work or service which is performed with the help of mind or physique with
a view to earn income.
Capital. It consists of those man made physical goods which are used for further production of
communitys wealth. The physical goods are machinery, plants, factories, dames, canals,
transport, stores, stocks of finished and unfinished material etc.
Entrepreneur. The entrepreneur is the organizer. He is the person who organizes production by
bringing together the other three factors of production, land, labour, and capital.

Short run time period.

Long run time period.

LAW OF VARIABLE PROPORTIONS.

The law of Variable Proportions. OR The law of Eventually Diminishing returns. OR The
law of Variability.
Ans:
Total Production. The total output of a firm of a particular good at a specific time period is
called its total production.
Marginal Production. The change in total production resulting from an additional unit of a
variable input is called marginal production.
The law of variable proportions is defined as:
The marginal production of a variable input (labour), which is being added to the
other inputs(capital & land) that are fixed in a quantity, will eventually (

) declines.

Assumptions:
1

Short-run: The firm is operating under the conditions of short-run time period.

Fixed factor: At least one factor of production is fixed.

Constant technology: The techniques of production remain constant. There is no change

in technology.

Homogeneous Units. It is assumed that all the units of variable factor of production are
homogenous in quantity and quality.

Single variable factor. There is only a single variable factor (labour).

Now the law is explained with the following table and diagram.

MP
TP
AP

Fig-1

100

TP MP

AP

10

10

10

10

10

30

20

15

10

60

30

20

10

80

20

20

10

90

10

18

20

10

90

15

10

10

80

-10

11.4

10

60

-20

7.5

90
80
70
60
50
40
30

0
-10

-20
Labour

Explanation of the Law:

With the help of above table we constructed the Fig. 1. In this figure we have the total
product (TP) curve shown by Q = f(L), the average product curve by AP and marginal product
curve by MP. In the beginning from 1st labour to 3rd TP is increasing at an increasing rate. Here
both AP and MP increase but MP increases more than AP. This situation corresponds to Law of
increasing returns. The point C corresponds to point of inflexion because here slope of TP curve
changes. When the firm employs 4th unit of Labour, AP has reached its maximum. And both MP
and AP are equal here. By employing 4th unit of labour the TP of firm increases at a decreasing
rate. As a result both MP and AP fall but MP falls more than AP. When the firm employs 6th unit
of labour there is no change in TP. Consequently MP is zero. By employing 7th and 8th units of
labour the TP of the firm falls. Here MP becomes negative.
Stage I. In the first stage, as a labour is added to fixed amount of capital the total product rises.
This stage is not feasible for the firm. Because here MP is greater than AP. If firm decides to pay
according to the marginal productivity theory, then she has to pay more wages.
Stage II. In the second stage, the total production continues to increase at a diminishing rate until
it reaches its maximum point F. This stage is economically feasible to the firm. Because here MP
is less than AP. And in this stage the firm attains its maximum production.
Stage III. In the third stage, the total production declines. The TP curve slopes downward from
point F and onward. This stage is also not feasible to the firm.

The I and III stages are known as uneconomic regions. As for as the stage II is considered as
economic region, a rational producer always operates in stage II.
Relations between MP and TP.
1 when MP increases TP increases at an increasing rate.
2 When MP decreases, TP increases at a decreasing rate.
3 When MP is zero then TP is maximum.
4 When MP is negative then TP decreases.
Relations between MP and AP.
1 When AP increases MP also increases but MP curve remains above the AP curve.
2 When AP is maximum then MP curve passes through that maximum point.
3 When AP decreases then MP also decreases but MP curve remains below the AP curve.
Importance of the Law.
The law is helpful in understanding clearly that how much TP or MP is affected by a change in
proportionate of the factor inputs.
The law tells us that the tendency of diminishing returns is found in all sectors of the economy,
which might be agricultural or industrial.

------------------------------------------------------------------------------------------------------Definition of managerial economics.

Managerial economics is the study of how managers make decisions about the use of
scarce resources.
Scarcity.
Scarcity is a condition that exists when resources are not able to meet the entire demand
for a product.