Lecture 7 - Theory of Production | Microeconomics- Interaction between individual buyer-seller PDF Download

 Page 1


Theory of Production 
Institute of Lifelong Learning, University of Delhi 
 
 
 
 
 
 
Subject: Maicroeconomics 
Lesson: Theory of Production 
Lesson Developer: S.K.Taneja 
College/ Department: RLA(E), University of Delhi 
 
  
Page 2


Theory of Production 
Institute of Lifelong Learning, University of Delhi 
 
 
 
 
 
 
Subject: Maicroeconomics 
Lesson: Theory of Production 
Lesson Developer: S.K.Taneja 
College/ Department: RLA(E), University of Delhi 
 
  
Theory of Production 
Institute of Lifelong Learning, University of Delhi 
 
 Learning Objectives 
The purpose of this chapter is to make you understand the theory of production. This 
chapter introduces the following :  
Production : Firms convert inputs into output using different technologies. 
Short Run Production function : In the short run firm can increase (or decrease) only 
some inputs for increasing its output. 
Long Run Production function : In the long run all inputs are variable. The firm has more 
choices in while selecting input combinations for producing different levels of output. 
Return to Factor : How does the output change when only one input is changed keeping 
all other inputs constant. 
Return to Scale : How does the ratio of output and inputs varies when all the inputs are 
increased in the same proportion. 
 
Theory of Production  
A firm produces goods and services. Production means conversion of inputs into 
output. A firm making shirts for men transforms cloth into shirts of different sizes which are 
ultimately used by the people who purchase them. In order to explain the theory of 
production, we shall first introduce terms on the basis of which it will become easier to 
explain the theory of production.  
Output : The  product is called the output In the example mentioned above, number of 
shirts produced by the firm per unit of time period is the output of the firm. 
Inputs :  Inputs are the resources which are used to produce the output. For example a 
readymade garments manufacturing firms uses cloth, machines, labour, power and other 
materials to produce garments. In general, a firm uses labour, capital (equipment) and 
other raw material to produce the output.  
Technology:  It means all possible methods of producing the product. Different methods of 
production result in different levels of output with the same amount of inputs. Inputs like 
land, labour, capital  and entrepreneurship are called factors of production. The words 
inputs and factors of production will be used by us as synonyms.   
 
Variable Inputs and Fixed inputs 
Short run is a period such that some of the inputs cannot be increased or 
decreased. The reason may be that these inputs are made to order. There may be a 
capacity constraint of the input producing firm. Inputs can be procured at short 
notice but the firms are required to pay a hefty premium on them. Therefore, these 
inputs are not changed at short notice. Those inputs which are not variable when the 
Page 3


Theory of Production 
Institute of Lifelong Learning, University of Delhi 
 
 
 
 
 
 
Subject: Maicroeconomics 
Lesson: Theory of Production 
Lesson Developer: S.K.Taneja 
College/ Department: RLA(E), University of Delhi 
 
  
Theory of Production 
Institute of Lifelong Learning, University of Delhi 
 
 Learning Objectives 
The purpose of this chapter is to make you understand the theory of production. This 
chapter introduces the following :  
Production : Firms convert inputs into output using different technologies. 
Short Run Production function : In the short run firm can increase (or decrease) only 
some inputs for increasing its output. 
Long Run Production function : In the long run all inputs are variable. The firm has more 
choices in while selecting input combinations for producing different levels of output. 
Return to Factor : How does the output change when only one input is changed keeping 
all other inputs constant. 
Return to Scale : How does the ratio of output and inputs varies when all the inputs are 
increased in the same proportion. 
 
Theory of Production  
A firm produces goods and services. Production means conversion of inputs into 
output. A firm making shirts for men transforms cloth into shirts of different sizes which are 
ultimately used by the people who purchase them. In order to explain the theory of 
production, we shall first introduce terms on the basis of which it will become easier to 
explain the theory of production.  
Output : The  product is called the output In the example mentioned above, number of 
shirts produced by the firm per unit of time period is the output of the firm. 
Inputs :  Inputs are the resources which are used to produce the output. For example a 
readymade garments manufacturing firms uses cloth, machines, labour, power and other 
materials to produce garments. In general, a firm uses labour, capital (equipment) and 
other raw material to produce the output.  
Technology:  It means all possible methods of producing the product. Different methods of 
production result in different levels of output with the same amount of inputs. Inputs like 
land, labour, capital  and entrepreneurship are called factors of production. The words 
inputs and factors of production will be used by us as synonyms.   
 
Variable Inputs and Fixed inputs 
Short run is a period such that some of the inputs cannot be increased or 
decreased. The reason may be that these inputs are made to order. There may be a 
capacity constraint of the input producing firm. Inputs can be procured at short 
notice but the firms are required to pay a hefty premium on them. Therefore, these 
inputs are not changed at short notice. Those inputs which are not variable when the 
Theory of Production 
Institute of Lifelong Learning, University of Delhi 
 
firm increases or decreases its output, are called fixed inputs or fixed resources. 
Inputs which are changed with the level of output are called variable inputs.  
Long Run:  Long run is a period in which all inputs can be varied. New machines, 
and labour force and new technology can be procured. In the long run all inputs are 
variable inputs.  
How short is the short period.?  It is different for different products. It 
depends upon the nature of product and the technology. If technology is complex, 
longer will be the short period.  
Production Function :  A production function is a technical relation between 
output and inputs. Production function shows the quantity of output (maximum 
quantity) that can be produced per unit of time for each set of alternative inputs, 
when the best production technologies (methods) available are used. Production 
function can be shown by an equation, table or graph. Mathematically we represent 
production function as : 
Q = f (L, K) 
Where Q is the quantity of output, L refers to quantity of labour and K represents 
quantity of capital. The equation states that quantity of output depends upon 
quantity of labour and quantity of capital given that sate of technology is fixed.  
Production function with one variable input: Suppose the quantity of capital 
available in the firm is fixed. We can change the level of output by increasing the 
quantity of labour. The behavior of output is depicted in the Table-1 given below:  
Table-1 
K L TP AP
L
 MP
L
 
 
2 0 0 0 0 
2 1 1 1 1 
2 2 3 1.5 2 
2 3 6 2 3 
2 4 10 2.5 4 
2 5 13 2.6 3 
2 6 15 2.5 2 
2 7 15 2.11 0 
2 8 14 1.75 -1 
2 9 12 1.33 -2 
 
TP  = Total Product  
AP
L
 = Average Product  
MP
L
 = Marginal Product 
Page 4


Theory of Production 
Institute of Lifelong Learning, University of Delhi 
 
 
 
 
 
 
Subject: Maicroeconomics 
Lesson: Theory of Production 
Lesson Developer: S.K.Taneja 
College/ Department: RLA(E), University of Delhi 
 
  
Theory of Production 
Institute of Lifelong Learning, University of Delhi 
 
 Learning Objectives 
The purpose of this chapter is to make you understand the theory of production. This 
chapter introduces the following :  
Production : Firms convert inputs into output using different technologies. 
Short Run Production function : In the short run firm can increase (or decrease) only 
some inputs for increasing its output. 
Long Run Production function : In the long run all inputs are variable. The firm has more 
choices in while selecting input combinations for producing different levels of output. 
Return to Factor : How does the output change when only one input is changed keeping 
all other inputs constant. 
Return to Scale : How does the ratio of output and inputs varies when all the inputs are 
increased in the same proportion. 
 
Theory of Production  
A firm produces goods and services. Production means conversion of inputs into 
output. A firm making shirts for men transforms cloth into shirts of different sizes which are 
ultimately used by the people who purchase them. In order to explain the theory of 
production, we shall first introduce terms on the basis of which it will become easier to 
explain the theory of production.  
Output : The  product is called the output In the example mentioned above, number of 
shirts produced by the firm per unit of time period is the output of the firm. 
Inputs :  Inputs are the resources which are used to produce the output. For example a 
readymade garments manufacturing firms uses cloth, machines, labour, power and other 
materials to produce garments. In general, a firm uses labour, capital (equipment) and 
other raw material to produce the output.  
Technology:  It means all possible methods of producing the product. Different methods of 
production result in different levels of output with the same amount of inputs. Inputs like 
land, labour, capital  and entrepreneurship are called factors of production. The words 
inputs and factors of production will be used by us as synonyms.   
 
Variable Inputs and Fixed inputs 
Short run is a period such that some of the inputs cannot be increased or 
decreased. The reason may be that these inputs are made to order. There may be a 
capacity constraint of the input producing firm. Inputs can be procured at short 
notice but the firms are required to pay a hefty premium on them. Therefore, these 
inputs are not changed at short notice. Those inputs which are not variable when the 
Theory of Production 
Institute of Lifelong Learning, University of Delhi 
 
firm increases or decreases its output, are called fixed inputs or fixed resources. 
Inputs which are changed with the level of output are called variable inputs.  
Long Run:  Long run is a period in which all inputs can be varied. New machines, 
and labour force and new technology can be procured. In the long run all inputs are 
variable inputs.  
How short is the short period.?  It is different for different products. It 
depends upon the nature of product and the technology. If technology is complex, 
longer will be the short period.  
Production Function :  A production function is a technical relation between 
output and inputs. Production function shows the quantity of output (maximum 
quantity) that can be produced per unit of time for each set of alternative inputs, 
when the best production technologies (methods) available are used. Production 
function can be shown by an equation, table or graph. Mathematically we represent 
production function as : 
Q = f (L, K) 
Where Q is the quantity of output, L refers to quantity of labour and K represents 
quantity of capital. The equation states that quantity of output depends upon 
quantity of labour and quantity of capital given that sate of technology is fixed.  
Production function with one variable input: Suppose the quantity of capital 
available in the firm is fixed. We can change the level of output by increasing the 
quantity of labour. The behavior of output is depicted in the Table-1 given below:  
Table-1 
K L TP AP
L
 MP
L
 
 
2 0 0 0 0 
2 1 1 1 1 
2 2 3 1.5 2 
2 3 6 2 3 
2 4 10 2.5 4 
2 5 13 2.6 3 
2 6 15 2.5 2 
2 7 15 2.11 0 
2 8 14 1.75 -1 
2 9 12 1.33 -2 
 
TP  = Total Product  
AP
L
 = Average Product  
MP
L
 = Marginal Product 
Theory of Production 
Institute of Lifelong Learning, University of Delhi 
 
Variable Proportions:  The proportion in which labour and capital are being 
used is changing. Capital labour ratio is decreasing. When one factor (capital) is fixed 
and other is increased the factor proportion changes.  
Return to a factor :  When we increase the quantity of one input keeping 
other inputs constant, the change in output is called return to factor. In Table1, the 
quantity of capital is fixed and quantity of labour is increased the resulting output is 
the return to labour. Total product increases upto a point and then it starts 
decreasing. 
Average Product of Labour: Average product of labour AP
L
 is defined as total 
production (TP) divided by the number of units of labour used.  
Marginal product of labour:  MP
L
 is the change in total product per unit of 
change in quantity of labour used.  
Graphical Representation of average product and marginal product.  
The shapes of AP
L
 and MP
L
  are determined by the slope of total product 
curve. In Fig. 1 we have drawn the total product curve and in Fig 2 we have AP
L
 and 
MP
L
 curve. The average product at any point on TP
L
 curve is given by the slope of 
straight line from the origin to that point. In our diagram the slope of this line in 
rising first (till 4 units of labour are being used). If we furthers increase the quantity 
of labour the slope of the straight line from origin to the points on TP starts 
declining. The AP
L
 curve first rises, reaches a maximum point and then fall but 
remains positive as long as TP is positive. Example in Table-1 also shows this trend.  
 
Labour 
Page 5


Theory of Production 
Institute of Lifelong Learning, University of Delhi 
 
 
 
 
 
 
Subject: Maicroeconomics 
Lesson: Theory of Production 
Lesson Developer: S.K.Taneja 
College/ Department: RLA(E), University of Delhi 
 
  
Theory of Production 
Institute of Lifelong Learning, University of Delhi 
 
 Learning Objectives 
The purpose of this chapter is to make you understand the theory of production. This 
chapter introduces the following :  
Production : Firms convert inputs into output using different technologies. 
Short Run Production function : In the short run firm can increase (or decrease) only 
some inputs for increasing its output. 
Long Run Production function : In the long run all inputs are variable. The firm has more 
choices in while selecting input combinations for producing different levels of output. 
Return to Factor : How does the output change when only one input is changed keeping 
all other inputs constant. 
Return to Scale : How does the ratio of output and inputs varies when all the inputs are 
increased in the same proportion. 
 
Theory of Production  
A firm produces goods and services. Production means conversion of inputs into 
output. A firm making shirts for men transforms cloth into shirts of different sizes which are 
ultimately used by the people who purchase them. In order to explain the theory of 
production, we shall first introduce terms on the basis of which it will become easier to 
explain the theory of production.  
Output : The  product is called the output In the example mentioned above, number of 
shirts produced by the firm per unit of time period is the output of the firm. 
Inputs :  Inputs are the resources which are used to produce the output. For example a 
readymade garments manufacturing firms uses cloth, machines, labour, power and other 
materials to produce garments. In general, a firm uses labour, capital (equipment) and 
other raw material to produce the output.  
Technology:  It means all possible methods of producing the product. Different methods of 
production result in different levels of output with the same amount of inputs. Inputs like 
land, labour, capital  and entrepreneurship are called factors of production. The words 
inputs and factors of production will be used by us as synonyms.   
 
Variable Inputs and Fixed inputs 
Short run is a period such that some of the inputs cannot be increased or 
decreased. The reason may be that these inputs are made to order. There may be a 
capacity constraint of the input producing firm. Inputs can be procured at short 
notice but the firms are required to pay a hefty premium on them. Therefore, these 
inputs are not changed at short notice. Those inputs which are not variable when the 
Theory of Production 
Institute of Lifelong Learning, University of Delhi 
 
firm increases or decreases its output, are called fixed inputs or fixed resources. 
Inputs which are changed with the level of output are called variable inputs.  
Long Run:  Long run is a period in which all inputs can be varied. New machines, 
and labour force and new technology can be procured. In the long run all inputs are 
variable inputs.  
How short is the short period.?  It is different for different products. It 
depends upon the nature of product and the technology. If technology is complex, 
longer will be the short period.  
Production Function :  A production function is a technical relation between 
output and inputs. Production function shows the quantity of output (maximum 
quantity) that can be produced per unit of time for each set of alternative inputs, 
when the best production technologies (methods) available are used. Production 
function can be shown by an equation, table or graph. Mathematically we represent 
production function as : 
Q = f (L, K) 
Where Q is the quantity of output, L refers to quantity of labour and K represents 
quantity of capital. The equation states that quantity of output depends upon 
quantity of labour and quantity of capital given that sate of technology is fixed.  
Production function with one variable input: Suppose the quantity of capital 
available in the firm is fixed. We can change the level of output by increasing the 
quantity of labour. The behavior of output is depicted in the Table-1 given below:  
Table-1 
K L TP AP
L
 MP
L
 
 
2 0 0 0 0 
2 1 1 1 1 
2 2 3 1.5 2 
2 3 6 2 3 
2 4 10 2.5 4 
2 5 13 2.6 3 
2 6 15 2.5 2 
2 7 15 2.11 0 
2 8 14 1.75 -1 
2 9 12 1.33 -2 
 
TP  = Total Product  
AP
L
 = Average Product  
MP
L
 = Marginal Product 
Theory of Production 
Institute of Lifelong Learning, University of Delhi 
 
Variable Proportions:  The proportion in which labour and capital are being 
used is changing. Capital labour ratio is decreasing. When one factor (capital) is fixed 
and other is increased the factor proportion changes.  
Return to a factor :  When we increase the quantity of one input keeping 
other inputs constant, the change in output is called return to factor. In Table1, the 
quantity of capital is fixed and quantity of labour is increased the resulting output is 
the return to labour. Total product increases upto a point and then it starts 
decreasing. 
Average Product of Labour: Average product of labour AP
L
 is defined as total 
production (TP) divided by the number of units of labour used.  
Marginal product of labour:  MP
L
 is the change in total product per unit of 
change in quantity of labour used.  
Graphical Representation of average product and marginal product.  
The shapes of AP
L
 and MP
L
  are determined by the slope of total product 
curve. In Fig. 1 we have drawn the total product curve and in Fig 2 we have AP
L
 and 
MP
L
 curve. The average product at any point on TP
L
 curve is given by the slope of 
straight line from the origin to that point. In our diagram the slope of this line in 
rising first (till 4 units of labour are being used). If we furthers increase the quantity 
of labour the slope of the straight line from origin to the points on TP starts 
declining. The AP
L
 curve first rises, reaches a maximum point and then fall but 
remains positive as long as TP is positive. Example in Table-1 also shows this trend.  
 
Labour 
Theory of Production 
Institute of Lifelong Learning, University of Delhi 
 
Figure : 1 
Marginal Product of Labour:  MP
L
 between two points on the total product 
curve is the slope of TP
L
 curve between these two points. MP
L
 is first rising, reaches a 
maximum point and then declines. MP
L
 curve reaches maximum point before the AP
L
 
reaches its maximum point. The MP
L
 becomes zero when TP is maximum and 
negative when TP begins to decline. The falling portion of MP
L
 shows the law of 
diminishing returns.   
Relation between MP
L
 and AP
L
:  Increase in MP
L
 pushes up the AP
L
. Decrease in 
MP
L
 pushes down the AP
L
. This is clear from the Table II given below:  
L TP AP
L
 MP
L
 
0 0 0 0 
1 1 1 1 
2 3 1.5 2 
3 4 1.5 1 
 
The table makes it clear that when AP
L
 is increasing MP
L
 is greater then AP
L
. When 
AP is declining MP
L
 is less then AP
L
. When AP
L
 is neither increasing nor decreasing 
(Maximum AP
L
) MP
L
 is equal to AP
L
. This means MP
L
 intersects the AP
L
 curve at its 
maximum point.  
Law of Variable Proportions 
This is a law of production which operates in the short run. Keeping capital 
constant and increasing the quantity of labour how does the output change. Refer to 
Table I. As equal increments of one unit of labour are added, (keeping capital 
constant) the resulting increment of output will first increase and then decrease. The 
law simply states that when all other inputs are kept constant and the quantity of 
variable input is increased the marginal product of the variable input eventually 
declines.  
 In the beginning as we increase the quantity of labour MP
L 
increases. As more 
and more units of labour are added MP
L
 starts  decreasing.  
In the beginning there is excess of fixed factor. When more and more units of 
labour are added to fixed factor it becomes possible to use fixed inputs more 
efficiently. When only one worker was employed he was required to perform all 
activities. The work can be divided between the two workers. Each worker has to 
concentrate on fewer activities. This increases the efficiency of the worker. So we 
have increasing returns to a factor. In no field of economis activity increasing returns 
to factor occur permanently. According to many economists constant returns to 
variable factor occur before the occurrence of diminishing returns.  Constant returns 
represent optimum combination of inputs.  
Diminishing returns to variable input: