PRODUCTION• Refers to the transformation of resources into

output of goods and services

• Short Run– Fixed Inputs– Variable Inputs

• Production Function (refers to relation b/w firm’s input of resources and output of goods)– Q = Q(L, K), where L is Labour and K is capital

• Cobb-Douglas Production Function– Q = ALµ K1-µ

• Total Product– It is the output that can be produced using

various levels of inputs

• Average Product– It is the total production divided by the number

of variable input employed

• Marginal Product– change in output resulting from a change in

factor of production

Law of Diminishing Marginal Product

• It postulates that as more units of a variable input are used with a fixed amount of other inputs, after a point, a smaller and smaller return will accrue to

• each additional unit of the variable unit. In other words, the marginal product of the variable input eventually declines

• This occurs because each additional unit of the variable input has less and less of the fixed inputs with which to work.

Law of Diminishing Marginal Product

Stages of Production

Stage I

• TPL, APL and MPL – all are rising. This implies that as more and more input

• TPL increasing at increasing rate

• (Labour) is used in the production process, the output due to labour in a given situation increases.

• When APL is maximum, is equal to MPL.

Stage II

• This stage II begins where stage I ends and continues up until stage III begins.

• In this stage, TPL is rising but at a falling rate, such that both APL are MPL are declining

• Till MPL becomes zero corresponding to TPL reaching maximum.

Stage III

• It shows that both TPL and APL are declining, so does MPL at a faster rate

• Such that it is negative (both in terms of absolute level of output and relative rate of change)

• If the firm intends to maximise production, it should employ O-L2• If the firm intends to maximise production per unit of labour, it should

employ O-L1. • If it wants to maximise additional output (production) per unit of

additional labour, it should employ O-L0. • Under no circumstances it should employ any labour beyond O-L2,

because then the (marginal) productivity of labour is zero or negative.

PRODUCTION IN LONG RUN

• Increasing returns to scale occurs when the percentage change in output is greater than the percentage change in inputs.

• Decreasing returns to scale occurs when the percentage change in input is greater than the percentage change in output.

• Constant returns to scale occurs when the percentage change in output is equal to percentage change in input.

Returns to Scale

Marginal rate of technical substitution

• Measures how one factor of production is

substituted for another while keeping the output constant

The marginal rate of technical substitution of labour for capital K can be determined as:

Isoquant

• Represents Marginal Rate of Technical Substitution between factors K and L (ML

Isoquant - Features

• Negative slope

• Upper Isoquants represent higher level of output

• Do not intersect each other

Economic Region of Production and Ridge Lines

Isocost

For any given cost, the isocost line defines all combinations of capital and labour inputs that can be purchased for Co (level of cost)

Equilibrium point of the firm