Production : Concepts &

Theories

Dr.Sunitha.S
Assistant Professor
School of Management Studies,
National Institute of Technology (NIT) Calicut

Buzz words
Short run Versus Long run
Fixed cost Versus Variable cost
Marginal product
Law of Variable Proportions
Returns to Scale

Its an activity that transforms inputs in to

out puts.

Production function

Functional relationship between inputs and

outputs

Inputs

Process

Output

Land
Labour
Capital

Product or
service
generated
value added

The production function can be

mathematically written as
Q=F (L, Lb, K, T,t.)
L=land.
Lb=labor.
K=capital.
T=Technology.
t=time.
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States the relationship between inputs and outputs

Inputs the factors of production classified as:

Land all natural resources of the earth .

Price paid to acquire land = Rent

Labour all physical and mental human effort involved in

production

Price paid to labour = Wages

Capital buildings, machinery and equipment

not used for its own sake but for the contribution
it makes to production

Price paid for capital = Interest

In the short run at least one factor fixed in supply but all
other factors capable of being changed
Reflects ways in which firms respond to changes
in output (demand)
Increase in total capacity only possible
in the long run

Law of variable proportion

The long run is defined as the period of time taken to vary

all factors of production
By doing this, the firm is able to increase its total
capacity not just short term capacity
Associated with a change in the scale of production
The period of time varies according to the firm
and the industry

Returns to Scale
8

The behaviour of the firm

Firms are assumed to attempt to maximize

profits.

First, the firm must identify the profit maximizing

level of output the quantity where marginal
revenue equals marginal cost.

Next, the firm must minimize the cost of

producing that level of output.

It must choose the appropriate technology and

apply it correctly. As a part of this, it must combine
resources according to the least-cost recipe.
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LAWS OF DIMINISHING RETURNS

The Law of Variable Proportions

It refers to the behavior of output as the quantity of one input is

increased while the other inputs are held constant.

It states that as successive units of a variable resource say labor are

added to a fixed resource say land, so beyond some point the extra or
marginal product will decline.

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ASSUMPTIONS OF THE LAW OF

VARIABLE PROPORTION
Short Run
Constant Technology
Homogeneous Factors

Basic Concepts of the Law

Total Product (TP)

Marginal Product (MP)
Average Product (AP)
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Total Product means the total amount of product

produced by a producer in a given period.
Average product is always computed per unit of
an input.That is, average product per labour
means number of output produced by a producer
per the number of labour employed .
Marginal product is computed by differentiating
the total product function.That is, it refers to
change in output as a result of one unit change in
input . Or, marginal product of labour means that
what is the net addition to total output as a result
of addition of one more labour as an input.
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LAW OF VARIABLE PROPORTION

No. of Workers

Total Product

Marginal Product

10

10

25

15

45

20

60

15

70

10

75

75

70

-5

Average Product
10

Increasing
Marginal
Return

12.50
15
15

Diminishing
Marginal
Return

14
12.5
10.71

Negative
Marginal
Return

8.75

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LAW OF VARIABLE PROPORTION

TP

Stage
2
Output

Stage
1

Stage
3

AP
0
No of Workers

MP

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LAW OF VARIABLE PROPORTION

Stage

1:

Stage

2:

Stage

3:

Increasing Returns, TP increases at increasing rate,

MP increases at decreasing rate, decreases and is greater than AP,
AP goes to the maximum point.
Diminishing Returns, TP increases at decreasing rate
and reaches maximum point, MP goes on diminishing, reaches to
zero and is less than AP, AP starts decreasing.
Negative returns, TP starts decreasing, MP goes to
negative and AP goes on decreasing but greater than MP.
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Variable Proportions: Short run

production function
Stage 1:Marginal product reaches
maximum and then falls as diminishing
returns set in, while average product
reaches maximum and then falls
Stage 2: marginal product falls till it
becomes zero while the average product
keeps on falling and is positive.
Stage 3: occurs when the marginal product
is negative

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A rational producer will never operate in

stages I and III.
In stage III, the contribution of additional
labour to the total product (marginal product)
is negative so it will be unwise to employ an
input that reduces the total product.
In stage I where the average product is
rising, so an increase in input increases
output in greater proportion.
Rational producer should produce in stage II

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RETURNS TO SCALE

The laws of Returns to Scale study the behavior of production

when all the productive factors or inputs are increased or
decreased simultaneously in the same ratio.

We analyze here the effect of doubling, trebling and so on of all

the inputs of productive resources on the output of the product.

It has also three distinct stages

Increasing Returns to Scale

Constant Returns to Scale
Diminishing Returns to Scale
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 Constant

returns to the scale

out put increases in the same proportion

as the increase in the input.

Increasing

return to scale

out put increases by a greater proportion

than the increase in inputs.

Decreasing

returns to the scale.

output increases in the lesser proportion than

the increase in the inputs.

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SCALES OF PRODUCTION

It is the upper limit to the size of Production.

The size of the Plant, number of plants installed and the

technique of production adopted by the producer fixes the
scale of production.

The Scale of Production are classified as following

1.

Small Scale of Production

Large Scale of Production
Optimum Scale of Production

2.
3.

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RETURNS TO SCALE
S.
No.

Scale of Production

Total
Returns

Marginal Returns

1 Worker + 3 Acres of land

2 workers + 6 Acres of land

+9

+12

14

+15

19

+18

24

+21

28

+24

31

+27

33

Increasing
Returns
Constant
Returns
Diminishing
Returns
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RETURNS TO SCALE
5
Stage
2

4
Stage
1

MP

Stage
3

2
1
0

Scale

10
22

Why returns to scale

Increasing returns to scale: If output more
than doubles when inputs are doubled,
there are increasing returns to scale.
Due to larger scale of operations that
allows managers and works to specialise in
their tasks and to make use of more
sophisticated,large scale factories and
equipment

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Decreasing returns to scale arise as a

result of difficulties in organizing large
scale firms would result in fall in
productivity of labour and capital.

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