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Production Function

Introduction & Meaning

Production is the transformation of inputs into outputs. Inputs are the factors of production -land, labor, capital raw materials and business services. Meaning: The relationship between the quantities of inputs and the maximum quantities of outputs produced is called the "production function." The maximum output that can be produced with a given quantity of inputs (Land ,Labor, capital and Machinery).It describes the productive capabilities of a firm.

Concept of Production Function

Production function can be defined as the specification of the minimum input requirements needed to produce the maximum output. With the given set of all technically feasible combinations of output and inputs.
This focus on the allocation efficiency ,making allonative choices How much of each input factor to use. How much to produce With the given cost (Purchase Price).

Production Function as the Equation

Production Function in the form of Equation
Q = f( X1,X2,X3n) Where Q is the quantity X1,X2,X3.n are the factor inputs

Production Function as the graph

Stages of production
To simplify the interpretation of a production function, it is common to divide its range into 3 stages. In Stage 1 (from the origin to point B) the variable input is being used with increasing output per unit, the latter reaching a maximum at point B (since the average physical product is at its maximum at that point). Because the output per unit of the variable input is improving throughout stage 1, a price-taking firm will always operate beyond this stage. In Stage 2, output increases at a decreasing rate, and the average and marginal physical product are declining. However the average product of fixed inputs (not shown) is still rising, because output is rising while fixed input usage is constant.

Contd
In this stage, the employment of additional variable inputs increases the output per unit of fixed input but decreases the output per unit of the variable input. The optimum input/output combination for the price-taking firm will be in stage 2, although a firm facing a downward-sloped demand curve might find it most profitable to operate in Stage 1. In Stage 3, too much variable input is being used relative to the available fixed inputs: variable inputs are over-utilized in the sense that their presence on the margin obstructs the production process rather than enhancing it. The output per unit of both the fixed and the variable input declines throughout this stage. At the boundary between stage 2 and stage 3, the highest possible output is being obtained from the fixed input.

Total, Average and Marginal Product.

Under Production Function we can calculate the three important production concepts. Total Product :- Total physical product which designates the total amount of output produced , in the physical units. Marginal Product :- The Marginal Product of a Input is the extra output produced by 1 additional unit of that input while other inputs are held constant. Average Product is the total output of units divided by total units of input.

Total Product, In this example, output increases as more inputs are employed up until point A. The maximum output possible with this production function.

Average Product , If there are 10 employees working on a production process that manufactures 50 units per day, then the average product of variable labor input is 5 units per day. It can be obtained by drawing a vector from the origin to various points on the total product curve. The continuous marginal product of a variable input can be calculated as the derivative of quantity produced with respect to the variable input employed. The MPP curve obtained from the slope of the TPP.

Total, Marginal and Average Product

Units of Input TP MP 2000 1000 500 300 AP 2000 1500 1167 950

0 1
2 3 4 5

0 2000
3000 3500 3800 3900

100

Law of Diminishing Returns

The Law of diminishing returns states that when we add additional input while holding the other inputs constant. The marginal product of the each unit of input will decline as the amount of that input increases. It holds true to increase in each of other input . Law of Diminishing Returns express the relationship between the variable input and the output, as the variable input increases, the output also increases, but at a decreasing rate. For Example: A farmer will find that a certain number of farm laborers will yield the maximum output . If that number is exceeded, the output per worker will fall.

Output

Inputs

Here is a picture of the relationship between the variable input and the output in the numerical example in the above table. The curve slope gets flatter: as the variable input Increases, output increases at a decreasing rate. This is a visualization of the Law of Diminishing Returns.

Short and Long Run

Some inputs can be varied flexibly in a relatively short period of time. Labor and Raw Materials as "variable inputs". Other inputs require a commitment over a longer period of time. Capital goods are thought of as "fixed inputs". A capital good represents a relatively large expenditure at a particular time, with the expectation that the investment will be repaid -- and any profit paid -- by producing goods and services for sale over the useful life of the capital good. In this sense, a capital investment is a long-term commitment. So capital is thought of as being variable only in the long run, but fixed in the short run.

Contd
Thus, we distinguish between the short run and the long run as follows: In the perspective of the short run, the number and equipment of firms operating in each industry is fixed. In the perspective of the long run, all inputs are variable and firms can come into existence or cease to exist, so the number of firms is also variable. In the long run the firm have the various choices of production function, whereas it is limited under short run.

Returns to Scale
In microeconomics, diminishing returns as a short run. In the long run, all inputs can be increased or decreased in proportion. Reductions in the marginal productivity of labor, due to increasing the labor input, can be offset by increasing the tools and equipment the workers have to work with. The returns to scale concept is an inherently long run concept. In the long run we define three possible cases:

Increasing returns to scale

A production function for which any given proportional change in all inputs leads to a more than proportional change in output. If an increase in all inputs in the same proportion (k) leads to an increase of output of a proportion greater than k, we have increasing returns to scale. Example: If we increase the inputs to a software engineering firm by 50% output increases by 60%, we have increasing returns to scale in software engineering. This is also known as "economies of scale," since production is cheaper when the scale is larger

Decreasing returns to scale

A production function for which a proportional change in all inputs causes a less than proportional change in output If an increase in all inputs in the same proportion k leads to an increase of output of a proportion less than k, we have decreasing returns to scale. Example: If we increase the inputs to a dairy farm (cows, land, barns, feed, labor, everything) by 50% and milk output increases by only 40%, we have decreasing returns to scale in dairy farming. This is also known as "diseconomies of scale," since production is less cheap when the scale is larger.

Constant returns to scale

A production function for which a proportional change in all inputs causes output to change by the same proportion. If an increase in all inputs in the same proportion k leads to an increase of output in the same proportion k, we have constant returns to scale. Example: If we increase the number of machinists and machine tools each by 50%, and the number of standard pieces produced increases also by 50%, then we have constant returns in machinery production.

Optimum Production
It states the amount of product by every possible combination of factors, assuming the most efficient available methods of production. The production function can thus measure the marginal productivity of a particular factor of production and determine the cheapest combination of productive factors.

Least cost combination of Inputs

Firms minimize their cost of production. It will strive to produce its output at the lowest possible cost and thereby have maximum amount of revenue. It applies Perfect Competition Monopolistic Non profit organization.

Least Cost Rule

To produce a given level of output at the least cost, a firm should buy inputs until it has equalized the marginal product spent on each input. Marginal Product of L Price of L Marginal Product of A Price of A