Production

_________________________________________________________
Meaning of Production
Production means a process of converting raw materials into finished product causing value addition. In
fact, production is a process of utility creation and value addition. Utility may be form utility, place
utility, time utility etc.
Factors of production
According to Ulmer, “The sources of services which enter into the process of production are called
factors of production.” In simple words, factors of production are those things or services are used or
applied to produce a good or render a service.
According to traditional classification there are four categories of factors of production. These are as
follows:
1. Land
Land means all the gifts given by the nature to us. For example: the surface of the earth, the soil,
forests, oceans, mountains, climate etc. Eminent economist Alfred Marshall says that, “Land
means the materials and forces which nature gives freely for man’s aid in land and water, in air
and light and heat.” Thus all the natural resources are taken in the category of land.
2. Labour
Labour means mental or/and physical work exercised by an individual for some monetary reward.
In economics, labour includes the services of a factory worker, chief executive officer of a
company, an engineer, an advocate, an accountant, a doctor, a watchman etc. It should be kept in
mind that in economics mental or physical work exercised by someone for pleasure or happiness
without any monetary or benefit is not labour.
3. Capital
Capital includes tools, equipments, buildings, plants, machines, roads, railways etc. These are
physical capital, but modern economists say that human capital is also included in capital. Human
capital means the process of addition to knowledge, skills, and capacities of all people of a nation.
4. Entrepreneurship
Land, labour and capital are located at different places i.e. they are not available at one place. An
entrepreneur brings them together to do business bearing risk.

Notes:
1. Many economists say that entrepreneurship is not a fourth factor of production but is a special
type of labour.
2. Modern economists say that there are only two factors of production i.e. labour and capital.
Capital includes land also.
 3. According to Karl Marx there is only factor of production i.e. labour because he thinks that
without man capital, land are all useless.

Production function
For a given technology, a production function connects/links or relates the quantity of output to the
quantities of the inputs, labour (L) and capital (K). In other words, if we have a particular technology, a
production function can tell us how much quantity of a good can be produced with a given amount of
labour and capital. Symbolically, a production function can be presented as follows:
Quantity of output = = ,
Therefore, if with a given technology , = + is a production function, then it means with 5
hours of labour and 4 machines (capital) the quantity of output is
, = × + × = units

Cobb-Douglas Production Function: Very popular production function

Cobb-Douglas production function is defined as follows:
= , =�
Where A, α, β are some constants representing efficiency parameter, labour elasticity and capital
elasticity respectively.
A Cobb-Douglas production function is a homogeneous function i.e.
+ +
� ,� =� (� )=� ,
Here α + β is known as the degree of the function.

Types of production function

There are two types of production function described below:
1. Short run production function
Short run is a period of time in which a firm can not change its all the inputs (labour and capital).
In other words, short run means a period of time in which quantities of one or more inputs (also
known as factors of production) remain constant or unchanged and generally this constant input is
capital. Short run production function shows the behavior of the total output when one input is
constant and the other input is variable. Symbolically short run production function can be
represented as follows:
= ,̅
Or
= ̅,
Where the bar over K and L represent that K is constant and L is constant respectively.
 The short run production function is also known as the law of variable proportion or the law of
returns to a factor.

2. Long run production function

Long run is a period of time in which a firm is able to change its all inputs. Thus, in long run no
input is fixed. Long run production function shows the relationship between the output and the
inputs in long run. The long run production function is described by the law of returns to scale.

Marginal production
Marginal production of an input (labour or capital) means the ratio of change in the total production and
change in the input. Therefore,
�ℎ � � � ∆
� = =
�ℎ � � ∆

�ℎ � � � ∆
� � = =
�ℎ � � � ∆

Geometrically, marginal production of an input means the slope of any tangent drawn at any point a total
production curve.
Average production
Average production of an input (labour or capital) means the ratio of in the total production and the input.
Therefore,
� �
� � = =
� �

� �
� � �= =
� � �

Geometrically, average production of an input means the slope of a line starting from the origin and
touching or intersecting a total production curve.

Short run or short period

Long run or long period

Law of diminishing marginal production

Or
Law of variable proportion

Or

Law of returns to a factor

Or

Law of production in short -run

Supposing that all the factors of production like machine, land etc. except the labour are
constant, then in the short- run we have the following three stages:
Stage 1
In the first stage, the total production increases at increasing rate as long as the marginal
production of labour keeps on increasing but in the same stage, after sometime, the marginal
production of labour gets maximum and then it starts to fall causing the total production to rise
at decreasing rate. Apart, the average production also increases and reaches to its maximum in
such a way it remains less than the marginal production. The first stage ends when the average
production is the highest where the marginal production and the average production are the
same. The reason of this stage is the indivisibility of the fixed factors of production and the
benefit of division of labour.

In the diagram (sketched from the data of the production schedule given below) we can see that
when labour increases from 0 to 3, then the marginal production increases and it is maximum
with value 21 when the labour is 3. If labour is increased further, then the marginal production
curve falls intersecting the average production curve where the average production is the highest
when the labour is 4. Thus, the first stage ends when labour is 4.

Stage 2
In the second stage, the total production continues to increase at decreasing rate because the
marginal production is decreasing. Apart, the average production also falls in such a way that it
remains above or greater than the marginal production curve. The second stage ends when the
marginal production is zero. The reason of this stage is the one factor of production can not be
substituted with another factor of production infinitely.

In the diagram, we can see that when labour increases from 4 to 7, then the marginal production
decreases and it is zero when the labour is 7 causing the end of the second stage.
Stage 3
In the third stage, the total production starts to fall because the marginal production negative
but the average production continues to fall in such a way that it remains above or greater than
the marginal production curve and it never becomes negative. The third stage starts when the
marginal production has become zero and continues afterwards. The reason of this stage is the
excessive use of the fixed capital. There is a proverb in this regard i.e. too many cooks spoil the
broth.
In the diagram, the third stage starts when labour is 7 and continues beyond that and the marginal
production curve has crosses the X-axis meaning negative marginal production.

Labour Total Marginal Average Production Law of variable proportion

(A) Production Production (D) = (B) / (A)
(B) (C)

0 0 - - Stage I
 TP increases at increasing rate
1 8 8 8 and after some time at
decreasing rate.
2 24 16 12  MP increases and gets
maximum and then falls.
3 45 21 15  AP increases but is lower than
MP and gets maximum when
4 60 15 15 AP=MP

5 70 10 14 Stage II
 TP continues to increase at
6 75 5 12.5 decreasing rate.
 MP falls.
7 75 0 10.7  AP falls but it is greater than
MP.

8 70 -5 8.75 Stage III

 TP starts to fall
 MP is negative.
 AP falls.
 6; 75 7; 75
77
5; 70 8; 70
72
67 TP
4; 60
62
57 Stage I Stage II Stage III

52
3; 45
47
TP / MP / AP

42
37
32
27 2; 24
3, 21
22
2, 16 3; 15 4, 15
4;
17 5; 14
2; 12 6; 12.5
5, 10 7; 10.7
12 1, 8
1; 8; 8.75
6, 5
7
AP
0; 0 7, 0
2
8, -5
-3 0 1 2 3 4 5 6 7 8 9
-8 MP
Labour

Which stage is the best to produce and hiring of the labour

Consider stage III first. In this stage a cost minimizing firm would not be ready to hire labour
because the marginal production of labour is negative and any addition of labour will reduce
total production. Thus, stage III must be rejected to decide how much labour to hire and how
much to produce.

Now, consider stage I. In this stage the average production keeps on increasing and the stage
ends when the average production reaches to its maximum. Increasing average production of
labour means decreasing averaging provided the wage rate is constant. Thus, if labour is hired
till the average production gets the maximum, then the average cost can be minimized. Thus,
stopping the production before the end of the stage I, is not a wise decision.
Now consider stage II. This is the stage only in which the profit maximising output and labour
levels fall. What are those particular levels? Then the answer depends upon the prices of the
factors.

Conclusion: In this way the conclusion is that, production should be done in stage II. Producing
in stage I or stage III is not economically good and that is why these stages are called the stage of
economic nonsense.

Reasons of the increasing marginal production

1. Indivisibility of fixed capital

A certain amount of capital requires a certain amount of labour to use the capital at full. In other
words, there is an optimum capital-labour ratio, say, 1:5 meaning for 1 acre of land can be used
fully if 5 labour units are hired. If the labour is less than 5, then the land (capital) will be under
utilized. This is not possible to divide the capital for a given quantity of labour. This is known as
the indivisibility of fixed capital. Stonier and Hague say that “most factors of production can be
most efficiently employed at the output they were designed for and work less efficiently at smaller
outputs because they can not be divided into smaller units. They are indivisible. A manager can
not be chopped in half and asked to produce half the current output. Plant can not be used less
fully without being used less economically.” Therefore, initially when labour is less, then fixed
capital is under utilized and adding more workers increase the utilization of the capital which in
turn increases the productivity.
2. Benefit of specialization i.e. division of labour
When the quantity of labour is large, then the benefit of specialization starts to arise i.e. a person
is given that job in which he or she is specialized or best, there is avoidance of wastage of time in
shifting from one job to another etc.

Reasons of the decreasing marginal production

Once the optimum capital-labour is achieved, any further increase in the labour makes the capital
overloaded. It results in inefficiency of production. When the optimum capital-labour is achieved, then
additional workers will mean substitution of capital with labour, but technically one factor can be
substituted with another factor to a limited extent. Therefore to substitute the same amount of capital,
more and more workers will have to be employed because per worker marginal productivity decreases. If
this overload increases, then the marginal production becomes negative.

Isoquant curve

An isoquant curve shows all those combinations of inputs (labour, L and capital, K) which yield the
same output. Thus, on an isoquant curve the output does not change irrespective of the combinations of
inputs being adopted. In the diagram, IQ is an isoquant curve that shows that combination A gives the
same output as combination B does even A and B have different quantities of two inputs L and K.
Mathematically, an isoquant can be defined as follows:

̅= ,
̅ = Constant utility; L = Labour ; K = Capital
Where Q

Capital

K1 A
A

K2 B
IQ
0 L1 L2 Labour

In the above diagram, we see that when the labour, L increases from L1 to L2, then the capital, K decreases
from K1 to K2. Thus, for extra L1L2 labour, K is sacrificed by K1K2. If we want to know that for extra one
unit of L how much quantity of K should be sacrificed, then we have the answer i.e. the ratio K1K2/L1L2.
This ratio is known as the marginal rate of technical substitution (MRTSLK) and in geometry this ratio
is called the slope of the isoquant curve. Thus,

Change in capital ∆K KK
Slope of an isoquant curve = MRTSLK = − =− =−
Change in labour ∆L LL

Law of returns to scale

Or

Law of production in long run

In long run all the factors of production i.e. labour and capital are variable. In the long run there are three
types of returns.
1. Increasing returns to scale
When doubling of inputs (labour and capital) makes output more than double, there are
increasing returns to scale. In other words, when the percentage change in the output is greater
than the percentage change in the factors of production/inputs, there are increasing returns to
scale.
 Mathematically, if =� is a Cobb-Douglas production function where Q is output and L
is labour, K is capital and A, α, β are some constant numbers, then the condition for increasing
returns to scale is:
+ >

Increasing returns to scale using isoquant curve

Increasing returns to scale can be explained using isoquant curves also. In the diagram, we have
three isoquant curves IQ1, IQ2 and IQ3 showing the outputs 100 units, 200 units and 300 units
respectively. Point A on isoquant IQ1 shows that L units of labour and K units of capital are used
to produce 100 units of output. Point B on isoquant IQ2 shows that 2L units of labour (i.e. labour
units are doubled) and 2K units of capital (i.e. capital units are doubled) are used to produce 300
units of output. Thus, doubling of the inputs has caused the output to increase more than
double. From the diagram it is clear that to double the output i.e. 200 units we need less than 2L
units of labour and 2K units of capital. One interesting point to be noted here is that the
isoquant curves come closer. Symbolically, AE > EB.

Capital, K

B
2K
E
IQ3 = 300
A
K IQ2 = 200

IQ1 = 100

0 L 2L Labour, L

2. Constant returns to scale

When doubling of inputs (labour and capital) makes output double, there are constant returns to
scale. In other words, when the percentage change in the output is equal to the percentage change
in the factors of production/inputs, there are constant returns to scale.
Mathematically, if =� is a Cobb-Douglas production function where Y is output and L
is labour, K is capital and A, α, β are some constant numbers, then the condition for constant
returns to scale is:
+ =
Constant returns to scale using isoquant curve

Increasing returns to scale can be explained using isoquant curves also. In the diagram, we have
three isoquant curves IQ1, IQ2 and IQ3 showing outputs 100 units, 200 units and 300 units
 respectively. Point A on isoquant IQ1 shows that L units of labour and K units of capital are used
to produce 100 units of output. Point B on isoquant IQ2 shows that 2L units of labour (i.e. labour
units are doubled) and 2K units of capital (i.e. capital units are doubled) are used to produce 200
units of output and point C on isoquant IQ3 shows that 3L units of labour (i.e. labour is tripled)
and 3K units of capital (i.e. capital is tripled) are used to produce 300 units. Thus, doubling of the
inputs has caused the output to get double and similarly tripling of the inputs has caused the
output to get double. One interesting point to be noted here is that the distances between the
isoquants remain the same. Symbolically, AB=BC.

Capital, K

C
3K

IQ3=300
B
2K

IQ2 = 200
A
K

IQ1 = 100

0 L 2L 3L Labour, L

3. Decreasing returns to scale

When doubling of labour and capital makes output less than double, there are decreasing returns
to scale. In other words, when the percentage change in the output is less than the percentage
change in the factors of production/inputs, there are decreasing returns to scale.

Mathematically, if � = � is a Cobb-Douglas production function where Y is output and L

is labour, K is capital and A, α, β are some constant numbers, then the condition for decreasing
returns to scale is:
+ <

Decreasing returns to scale using isoquant curve

Decreasing returns to scale can be explained using isoquant curves also. In the diagram, we have
three isoquant curves IQ1, IQ2 and IQ3 showing the outputs 100 units, 150 units and 200 units
respectively. Point A on isoquant IQ1 shows that L units of labour and K units of capital are used
to produce 100 units of output. Point B on isoquant IQ2 shows that 2L units of labour (i.e. labour
units are doubled) and 2K units of capital (i.e. capital units are doubled) are used to produce 150
units of output. Thus, doubling of the inputs has caused the output to increase less than double.
From the diagram it is clear that to double the output i.e. 200 units we need more than 2L units of
labour and 2K units of capital. One interesting point to be noted here is that the isoquant curves
go far from each other i.e. the distances between the isoquants curve keep on increasing.
Symbolically, AB < BC.

Capital, K

IQ3 = 200

2K B

IQ2 =150
K A

IQ1 = 100

0 L 2L Labour, L