PRODUCTION & BUSINESS

ORGANIZATION

AIMS & OBJECTIVES

After studying this lesson, you will be able to understand:

The production function Short run vs Long run Total, Average and Marginal Product Law of Diminishing Returns to a factor Stages of Production Returns to Scale Concepts of isoquant & isocost line Idea of producers equilibrium

PRODUCTION FUNCTIONS

Is a technical relation that connects factor inputs and output. It specifies the maximum output that can be produced with a given quantity of inputs. It is defined for a given state of engineering and technical knowledge It may be represented as Q = Q (K, L) Where, the production process employs only two inputs Labour (L) and Capital (K) and Q is the quantity of output

A general form of production function can be expressed as Q = Q (I1, I2, I3.In) Where Q is the quantity of output and inputs are represented as I1,I2..In Cobb- Douglas is a type of production function and is given as Q = AKL Where A denotes state of technology, K & L are the inputs/factors and & are called the transformation parameters
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SHORT RUN VS LONG RUN

Short run in production refers to a time period when some inputs used in production are fixed and some are variable Long run in production refers to a time period when all inputs used in production are variable

TP, AP, MP

Three very important concepts related to production analysis are: Total product (TP) Average product (AP) Marginal product (MP)

TOTAL PRODUCT

Total product is total output.

AVERAGE PRODUCT

It is the total product divided by the number of variable input employed. That is, it is the production per unit of input. It may be represented as, APx = Q/x Where Q denotes total product and x denotes quantity of input x

MARGINAL PRODUCT
Marginal product is the change in output caused by increasing input use. It is represented as: MPX=Q/X If MPX=Q/X> 0, total product is rising. If MPX=Q/X< 0, total product is falling (rare).

AP curve rises at first, reaches a maximum and falls thereafter. MP also rises at first, reaches a maximum and falls thereafter. When AP is rising MP > AP When AP is maximum MP = AP When AP is falling MP < AP

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LAW OF DIMINISHING RETURNS TO VARIABLE FACTOR/LAW OF VARIABLE PROPORTION

As more and more of a variable input is added in production while holding all other inputs fixed, the additional output obtained is gradually lesser and lesser Alternatively stated, the Marginal Product of each unit of input will decline as the amount of that input increases, holding all other inputs constant. Diminishing Returns to a Factor explains the shape of the TP curve and also explains the most efficient stage of production

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STAGES OF PRODUCTION
Stage I origin to X2 Stage II X2 to X3 Stage III- beyond X3

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Stage I origin to X2 Stage II X2 to X3 the most efficient stage of production Stage III- beyond X3

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RETURNS TO SCALE

Returns to scale show the output effect of increasing all inputs. Three types of returns to scale

Increasing returns to scale Q/Q Xi/Xi > 1 Constant returns to scale Q/Q Xi/Xi = 1 Decreasing returns to scale Q/Q Xi/Xi < 1

Where Q/Q denotes proportional change in output Xi/Xi denotes proportional change in input

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RETURNS TO SCALE AND RETURNS TO A FACTOR

Returns to scale measure output effect of increasing all inputs.- Long run phenomenon Returns to a factor measure output effect of increasing one input. Short run phenomenon

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INPUT COMBINATION CHOICE

Two tools are used Production Isoquants and Isocost lines

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ISOQUANTS

Drawn in an input space it shows the different combination of inputs that can produce the same level of output. Characteristics of an isoquant Downward sloping implies input substitutability. Convex to the origin No two isoquants intersect each other - imply imperfect substitutability Higher isoquants represent higher levels of output

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Perfect substitutes

Perfect complements

Usual Shape

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Different Shapes of an Isoquant

MARGINAL RATE OF TECHNICAL SUBSTITUTION

This shows the rate at which one factor may be substituted for another. Its is given as MRTSXY = - Y/X = -MPX/MPY. MRTSXY gives the slope of an isoquant

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ISOCOST LINE

This shows the various combinations of the inputs that can be had for the same cost outlay. It is represented as C = Px.x + Py. y Where C denotes the total cost outlay x & y are the quantity of the two inputs used Px & Py are the given respective prices of the two inputs
y C = Px.x + Py. y

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PRODUCERS EQUILIBRIUM

Producer reaches his equilibrium when he maximizes his profit by Producing the maximum possible output for a given cost or ...a Minimizing cost for a given level of output b
Case: a Case: b

E E

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PRODUCERS EQUILIBRIUM
Equilibrium in both these cases occurs when an isocost line gets tangent to an isoquant In case a, the given isocost line became tangent to the highest possible isoqant at E In case b, the lowest possible isocost line became tangent to the given isoquant The condition for producers equilibrium is thus, the same in both case: Slope of isoquant = slope of isocost MRTSxy = Px/Py Or MPx/MPy = Px/Py Additionally, the isoquant must be convex to the origin
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BUSINESS ORGANIZATIONS

Refer Pages 148 154 of text book

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