Production Theory

Introduction
Production means producing products & services which satisfy the needs and wants of the customers.
Production is a process. Factors of production considers as inputs. After processing the inputs can get
the outputs. Production undergoing by specific technology which convert inputs to outputs.

This process can be explained as a production function.

Q = f (K,L)
Q = Quantity produced

K = Capital

L = Labour

Production

Short Run Long Run

Short Run
Short run means the time duration that the fixed factors do not vary.

Eg : Fixed factors - Machinery, Fixed salaries, Management

Variable factors – Labour, Raw materials, energy

In short run, Production can only be increased by increasing variable factors. Change in fixed factors
tend to change the scale of the firm. It is’nt possible in the short run.

Short run production function

Q = f (K, L)

In the short run we can see 3 main production concepts

1. Total Production (TP)

Overall quantity of output that a firm produce, usually specified in relation to variable input.

2. Average production (AP)

The quantity of total output produced per unit of a variable inputs fixed.

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 AP = TP
Q
3. Marginal Production (MP)
Change in output employing one more unit of particular input.
∆TP
MP =
∆L

Graphical Presentation of TP, AP & MP.

Three stages of production

There are three main product curves under production theory: the total product curve, the average
product curve and the marginal product curve. The total product curve is a reflection of the firm’s
overall production and is the basis of the two other curves. The average product curve is the quantity
of the total output produced per unit of a "variable input," such as hours of labor. The marginal
product curve is slightly different: It measures the change in product output per unit of variable
input. For example, if the average curve depicts the number of units produced based on an overall

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number of employees, the marginal curve would show the number of additional units produced if one
more employee is added.

Stage One

Stage one is the period of most growth in a company's production. In this period, each additional
variable input will produce more products. This signifies an increasing marginal return ; the investment
on the variable input outweighs the cost of producing an additional product at an increasing rate. As
an example, if one employee produces five cans by himself, two employees may produce 15 cans
between the two of them. All three curves are increasing and positive in this stage.

Stage Two

Stage two is the period where marginal returns start to decrease . Each additional variable input will
still produce additional units but at a decreasing rate. This is because of the diminishing marginal
returns: Output steadily decreases on each additional unit of variable input, holding all other inputs
fixed. For example, if a previous employee added nine more cans to production, the next employee
may only add eight more cans to production. The total product curve is still rising in this stage, while
the average and marginal curves both start to drop.

Stage Three

In stage three, marginal returns start to turn negative. Adding more variable inputs becomes
counterproductive; an additional source of labor will lessen overall production. For example, hiring an
additional employee to produce cans will actually result in fewer cans produced overall. This may be
due to factors such as labor capacity and efficiency limitations. In this stage, the total product curve
starts to trend down, the average product curve continues its descent and the marginal curve
becomes negative.

Behavior of TP, MP and AP curves

1. Once the labour input is zero, quantity of production also zero

2. Once MP is positive TP is increasing
3. Once MP is zero TP maximized
4. Once the MP is negative TP also decreasing

The Link between MP and AP

Once AC increase MP curve will be upper than AP curve

Once AC decrease MP curve will be lower than AP curve

The base for this sort of behavior in production curve is “Diminishing marginal returns”.

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Law of Variable Proportion/ Law of diminishing marginal returns

As more and more variable factors are employed with fixed factors, total production increases at an
increasing rate, in the beginning and then increasing at a diminishing rate and finally fall.

OR

“An increase in some inputs relative to other fixed inputs will cause outputs to increase, but after a
point, the extra output resulting from the same addition of extra inputs will become less”.

The Long Run

All the factors are varying at the long run. In the long run producers can change the scale of production.
Since, all factors can be changed together there is no fixed factors in the long-run. All are variable
factors. In the long-run, output can be increased by changing all factors by the same proportion or by
different proportions.

Long-run production process is subjected to the Laws of Returns to Scale. Laws of returns to scale
describes the effects of change of all inputs together OR effect of change of scale of production, on the
level of output.

Returns to Scales

Returns to scale describe what happens to long run returns as the scale of production increases, when
all input levels including physical capital usage are variable (able to be set by the firm). The concept of
returns to scale arises in the context of a firm's production function. It explains the long run linkage of
the rate of increase in output (production) relative to associated increases in the inputs (factors of
production). In the long run, all factors of production are variable and subject to change in response to a
given increase in production scale. While economies of scale show the effect of an increased output
level on unit costs, returns to scale focus only on the relation between input and output quantities.
There are three possible types of returns to scale: increasing returns to scale, constant returns to scale,
and diminishing (or decreasing) returns to scale. If output increases by the same proportional change
as all inputs change then there are constant returns to scale (CRS). If output increases by less than that

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proportional change in all inputs, there are decreasing returns to scale (DRS). If output increases by
more than the proportional change in all inputs, there are increasing returns to scale (IRS). A firm's
production function could exhibit different types of returns to scale in different ranges of output.
Typically, there could be increasing returns at relatively low output levels, decreasing returns at
relatively high output levels, and constant returns at some range of output levels between those
extremes.
The returns to scale faced by a firm are purely technologically imposed and are not influenced by
economic decisions or by market conditions (i.e., conclusions about returns to scale are derived from
the specific mathematical structure of the production function in isolation).

Economies of scale of Production

What are the reasons behind the returns to scale?
As economists explain, broadly, the reasons for returns to scale are,
i. division of labor and specialization and
ii. technological factors related to the production.
Increasing returns to scale is the result of these economies of scale. When scale of production increases
up to a certain point, the firm/producer gets these economies.
The advantages the production process gain due to these factors are called Economies of scale.
The economies of scale which yield increasing returns to scale would not continue for a long-term when
inputs increase further and further. The size of production will unmanageable and so inefficiency
creeps. Moreover, it may be difficult to get certain critical inputs in the same proportions as others.
The disadvantages that the production process get due to the expansion of its scale is called
diseconomies of scale. Decreasing returns to scale is the result of these diseconomies.