INTRODUCTION
Production is basically an activity of transformation which
transfers inputs into outputs.
Farms use land, labor, seeds and small amount of capital as
inputs to produce output like corn.
Similarly, a flour mill uses inputs like wheat, labor, capital
for machinery, factory building to produce output like wheat
flour.
So, an input is the goods or services which produce an
output.
The firm generally uses many inputs to produce an output.
Output of any firm may be the inputs of other firms, e.g.,
steel is an output of the steel producer, but this steel is also
an input of automobile or rail coach manufacturing or
refrigeration manufacturing or air-condition manufacturing
industries.
PRODUCTION ANALYSIS
Q
Q3 = f (K30, L)
Q2 = f (K20, L)
Q1 = f (K10, L)
L
Production Function with constant K; K10< K20< K30
PRODUCTION ANALYSIS
If instead labour is fixed in the short run, the total product of
the capital function can be similarly expressed as:
TPK = f (L0, K) .(v)
Q
Q3 = f (L30, K)
Q2 = f (L20, K)
Q1 = f (L10, K)
K
Production Function with constant L; L10< L20< L30
PRODUCTION ANALYSIS
TP
TPL
L
TP
APL
MPL
O L
TP, AP and MP Curves
PRODUCTION ANALYSIS
In the second stage, the total product increases but less
than proportionate to increase in labor.
In this stage, marginal product of labor falls and this stage
is called as diminishing returns to variable factors. Here,
MPL > 0 and MPL < APL.
The stage three is a technically inefficient stage of
production and a rational producer will never produce in
this stage. Here, MPL < 0 and total product is decreasing.
The law of returns to scale refers to the long run
analysis of production.
It refers to the effects of scale relationships which implies
that in the long run output can be increased by changing
all factors by the same proportion, or by different
proportions.
If the production function is Q0 = f (K, L) and we increase
all the factors of production by the same proportion p.
PRODUCTION ANALYSIS
So, the new production function is Q* = f [(p.K), (p.L)].
If Q* increases in the same proportion as the factors of production,
p, then we can say there are Constant Returns to Scale (CRS).
If Q* increases less than proportionately with an increase in the
factors of production, p, then we can say there are Decreasing
Returns to Scale (DRS).
If Q* increases more than proportionately with an increase in the
factors of production, p, then we can say there are Increasing
Returns to Scale (IRS).
Q IRS
CRS
DRS
Proportion (p)
O
Returns to Scale (DRS, CRS & IRS