Chapter: - 2

2.4 Theory of production

2.4.1 Concept Of Production And Production Function (Short And Long Run)
2.4.2 Total, Average And Marginal Products And Their Derivation
2.4.3 Law Of Variable Proportions
2.4.4 Laws Of Returns To Scale
Concept of Production
Production is the art of transferring inputs into output. In economic sense,
Production is the process of creating utility in goods and services by transforming inputs (factors of
production) into outputs (finished goods and services) for sale. It also includes any types of Goods and
Services that can satisfy the wants of people.

According to J. L. Hanson "In economics, however, production is not restricted to the manufacture
of commodities but also includes the provision of direct services, such as those of the lawyer, the actor,
or musician etc.".

Production Function
Production function is defined as the technological relation between quantities of physical inputs and
quantities of the output. In its general form, it tells that the production of a commodity depends on
certain specific inputs (labour, Capital ….. ).
The production function is generally expressed as;
Q = f(L_{b}, L, K, M, T, t…..)
In simplicity,
Q = f(L, K)
Where,
Q =Output f =Function (depends upon)
Lb =Land and building L =Labour
K = Capital M = Materials
T = Technology t = Time

Types of Production Function

There are two types of production function which are as follows:

1. Short-run Production Function

Short-run is the time period that a firm can not change all of its inputs or factors of productions. In
the short-run, some factors of production like land, factory size, machinery, etc. remain constant or
fixed but some factors of production like labour, fuel, raw material, etc. are variable. The input and
output relationship in the short-run is studied under the law of variable proportions. This law relates
to the short-run production function because only one or few factors of production are varied in the
short-run. It is also known as the production function with one variable input.
It can be expressed as = f(L, K)
Where labour (L) is variable factor and capital (K) is fixed factor.

2. Long-run Production Function

Long-run is the time period that a firm can change all of its inputs or factors of production. It means
that in the long-run, all factors of production are variable or no factor of production is fixed. The input
and output relationship in the long-run is studied under the laws of returns to scale. It is also know
as the production function with two variable inputs.
It can be expressed as Q=f(L,K)
Where both labour (L) and capital (K) are variable factors.

Concept Of Total Product (Tp), Average Product (Ap)And Marginal Product (Mp) And
their Derivation

1. Total Production (TP)

Total product of a factor is defined as the total amount of a commodity produced by a given amount
of variable factor say, labour, keeping the quantity of all other factors such as land, capital, technology
etc. as constant. In other words, total product is defined as the cumulative value of marginal
production of a factor in the process of production.
It can be expressed as (TP) = MP
= AP × L
= AP × K
Where,
TP = Total Product
MP = Marginal Product
AP = Average Product
L/K = Units of variable
2. Average Production (AP)
Average production is defined as total output per unit of input. It is obtained by dividing total
production (TP) by the amount of variable factor (labour), keeping the other factors as constant.
𝐓𝐏
It can be expressed as (AP) = 𝐋
Where,
AP = Average Product
TP = Total Product
L = Units of variable
3. Marginal Production (MP)
Marginal product is defined as the ratio of the change in total production (ΔTP) to the change in labour (ΔL),
keeping other inputs constant.
It can be expressed as (MP) =TPn - TPn-1
ΔTP
=
ΔL
Where,
TPn = Total Product of 'n' unit of factor inputs
TPn-1= Total Product of 'n-1' unit of factor inputs
ΔTP = Change in total product
Δ L = Change in labour units
Derivation
Key Points:
 When MP > AP, AP is increasing.
 When MP < AP, AP is decreasing.
 When MP = AP, AP is at its maximum point.
 MP curve intersects the AP curve at its maximum point of AP.
 If TP is always positive, MP may be Positive, Zero, and Negative but AP never becomes Zero and
negative.

Table of TP, AP and MP

Unit (Labour) TP MP AP
1 10 10 10
2 30 20 15
3 60 30 20
4 80 20 20
5 90 10 18
6 90 0 15
7 80 -10 11.4

Figure : TP, AP and MP

In the upper part of the graph, the TP curve increases at an increasing rate in the early production
stage. It increases at a decreasing rate until it reaches maximum point E. Then, TP starts to decline
due to the increase in units of labour.

In the lower part of the graph, the MP curve initially rises faster than AP. Then MP starts falling and
becomes equal to AP. Thereafter, MP becomes zero and becomes negative with every increase in
units of labour.

Law of Variable Proportion

Meaning of Law of Variable Proportion
The Law of Variable Proportions was introduced and developed by well-known economists like
Marshall, Benham, and Joan Robinson. This law explains how production works in the short run,
which is a period where some inputs (like machinery or land) are fixed, while others (like labor) can
be changed.
For simplicity,
Q = f (L, K)
This law is an important economic idea that explains how changes in inputs affect output in
production. It says that when you change one input (like labor or materials) while keeping others the
same, the output will change. However, the change in output won’t be the same or in proportion to
the change in the input. “If a producer increases the units of a variable factor while keeping other
factors fixed, then initially the total product increases at an increasing rate, then it increases at a
diminishing rate, and finally starts declining.”

Assumptions to Law of Variable Proportion

The law of variable proportion is based on the following assumptions
 The state of technology remains the same.
 Only one-factor input is variable, the other being constant.
 There must be the possibility of varying the proportion of inputs.
 All units of the variable factor are homogeneous.

Table: Law of Variable Proportion

Land (Katha) Unit of TP AP MP Stage Results

Labour
10 1 10 10 10
10 2 30 15 20 Increasing
First Returns
10 3 60 20 30
10 4 80 20 20
10 5 90 18 10 Diminishing
Second Returns
10 6 90 15 0
10 7 80 11.4 -10 Negative
Third Returns
 Figure: Law of Variable Proportion

In the table and diagram, we see that when we increase the number of workers (labour) while
keeping capital fixed, the total production (TP) increases at an increasing rate at first, then increases
at a decreasing rate, reaches its highest point, and finally starts to fall.
For the first 3 units of labour, TP increases quickly: from 10 kg to 30 kg to 60 kg. But when we add
more labour (from the 3rd to the 4th and 5th unit), TP still increases but at a slower rate: from 60 kg
to 80 kg to 90 kg. At the 6th unit of labour, TP reaches its maximum at 90 kg. If we add a 7th unit of
labour, TP starts to decrease and becomes negative, reaching -10 kg.
Both Average Product (AP) and Marginal Product (MP) follow a similar pattern. At first, both increase,
reach their highest point, and then start to fall. Up to the 3rd unit of labour, MP increases and reaches
its peak, after which it begins to decline. Similarly, AP increases up to the 4th unit of labour and then
starts to decline, but it always stays positive.
Stages of the Law of Variable Proportions

Stage 1: Increasing Returns to a Variable Input

 In this stage, total output (TP) increases at a Increasing rate at first, and then increases at a
decreasing rate after reaching a point d.
 This happens because the variable input (like labor) is used efficiently, and the fixed input (like
machinery) is fully utilized.
 Marginal Product (MP)is increase when it’s becomes maximum at a point C and start decline.
Average Product (AP) increase in this stage at point d where MP and AP are equal.

Stage 2: Diminishing Returns to a Variable Input

 In this stage, TP continues to increases at decreasing rate (from point d to point f)and it’s
becomes maximum at the point f.
 This is because the fixed input becomes scarce, and there is an imbalance between the
variable and fixed inputs.
 Both MP and AP start to decline in this stage. And MP becomes 0 unit.

Stage 3: Negative Returns to a Variable Input

 In this final stage, TP starts to decline from maximum point of TP. AP also decreases but never
reaches zero, while MP becomes negative.
 This happens because the fixed input is overused, the variable input is not being used
effectively, or the production process is not managed properly.

Laws Of Returns To Scale

Meaning of Laws Of Returns To Scale

When the output changes in the same proportion due to the changes in the inputs of the production
process, it is referred to as the law of returns to scale. The law of returns to scale is only applied in the
case of the long run. Because in the long run production process, no factor is fixed.
“when all the inputs are increased in the same proportion, a total product may increase at an increasing
rate, at a constant rate or at a diminishing rate. It defines the total effect on output with proportionate
change in all factors of production.”

On the basis of these possibilities, law of returns can be classified into three categories:
1. Increasing Returns to Scale:
If the proportional change in the output of an organization is greater than the proportional change in
inputs, the production is said to reflect increasing returns to scale.
 Figure- shows the increasing returns to scale:

In Figure a movement from a to b indicates that the amount of input is doubled. Now, the combination
of inputs has reached to 2K+2L from 1K+1L. However, the output has Increased from 10 to 25 (150%
increase), which is more than double. Similarly, when input changes from 2K-H2L to 3K + 3L, then
output changes from 25 to 50(100% increase), which is greater than change in input. This shows
increasing returns to scale.

2. Constant Returns to Scale:

The production is said to generate constant returns to scale when the proportionate change in input
is equal to the proportionate change in output.

Figure- shows the constant returns to scale:

In the figure, moving from a to b doubles the input (1K+1L to 2K+2L), increasing output from 10 to
20. Similarly, moving from 2K+2L to 3K+3L increases output from 20 to 30, matching the input change.
This shows constant returns to scale.

3. Diminishing Returns to Scale:

Diminishing returns to scale refers to a situation when the proportionate change in output is less than
the proportionate change in input. For example, when capital and labor are doubled but the output
generated is less than doubled, the returns to scale would be termed diminishing returns to scale.
 Figure- shows the diminishing returns to scale:

In Figure-15, moving from point a to point b (1K+1L to 2K+2L) doubles the input, but output increases
from 10 to 18, less than the input change. Similarly, when input changes from 2K+2L to 3K+3L, output
increases from 18 to 24, again less than the input change. This shows diminishing returns to scale.
Numerical Example
Numerical problems

2. Conider the following table:

Unit of capital Unit of labour TP MP AP
2 unit 0 0 0 0
2 unit 1 10 10 10
2 unit 2 22 12 11
2 unit 3 36 14 12
2 unit 4 48 12 12
What stage of law of variable proportions does it exhibit and why?

→ The above table exhibits increasing returns or first stage of law of variable
proportions because both AP and MP are increasing at 4th units of labour and both
are equal.
b. Figure of TP, MP and AP
c. Three stages of production or law of variable proportions are explained below:

Stage I: In this stage, TP first increases at an increasing rate up to the 3rd unit of labour is employed
and increases at a diminishing rate up to the 4th unit of labour is employed. AP is increasing
throughout the stage. MP first increases and after reaching its maximum point, starts falling. This
stage ends at the point where AP = MP. AP and MP are equal at 4th unit of labour.
Stage II: In this stage, TP increases at a diminishing rate. Both AP and MP are decreasing. This stage
ends at the point where MP = 0 or TP is the maximum and constant. This stage ends with the
employment of 6th unit of labour, where TP is maximum and constant and MP is zero.

Stage III: In this stage, TP is declining. AP is also declining. MP is negative. AP never becomes zero
and negative.

d. The relationship between AP and MP are as follows:

i. When AP < MP, AP increases.

ii. When AP = MP, AP is maximum.

When AP > MP, AP is decreasing.