Production
(ISO
Quant)
1
Production and Cost
Production
process
involves
the
Analysis
transformation of inputs in to output.
Basic Questions
1.
2.
3.
4.
Whether to produce or not.
How much output to produce.
What input combination to use.
What type of Technology to use.
Production Function
A production function is the functional
relationship between inputs and output
Maximum output. That can be obtained
for a given combination of inputs.
It
expresses
the
technological
relationship between inputs and output
of a product
Q = f (L, K)
Economic Efficiency vs
Technical Efficiency
A firm is Technically efficient
when it obtains maximum
level of output from given
inputs. A producer cannot
reduce one input and at the
same
time
maintain
the
output at same level .
4
A
firm
is
economically
efficient when it produces a
given amount of output at
the lowest possible costs for
a
combination
of
inputs
provided that prices of inputs
are given/ constant. How to
produce a given amount of
output at lowest cost.
5
Short Run & Long Run
All inputs can be divided in to
Fixed
inputs
Plant,
Buildings,
Equipment.
Variable Inputs Amount can be changed
during the short run.
Short Run is defined to be that period
when some of the firms inputs are fixed.
Long Run is that period
over which all the firms
inputs are variable and the
firm has the flexibility to
adjust
or
change
its
environment.
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Production Function
Short Run PF Long Run PF
Returns to a factor Returns to Scale
One variable factor
All factors variable
Short run analysis Long run analysis
Law of variable
Proportions
Law of returns to
Scale
8
Stage of Production
Stage I MP>O, AP rising thus
MP>AP
Stage II MP>O, AP falling. MP<AP
but TP rising (because MP>O)
Stage III MP<O. In this case TP is
falling
9
Question : Why a profit maximizing
producer would produce in stage II and
not in stage I or III. Explain.
Causes of the operation
of
Law
of
variable
proportion
Indivisibility
of
factors
(a
critical
minimum factor to be employed, fuller
use of fixed factor)
Division of labour or specialization
Imperfect
substitution
Leads
to
diminishing returns.
10
Significance of law of
variable proportion
Firm
to use its resources
rationally (Capacity Building)/
Capacity Planning
Firm to understand the trade
off between marginal benefit
and costs
11
Law of returns to a factor
& returns to scale
Law of returns to a factor is a
short
run
phenomenon,
whereas the law of returns to
scale operation in the long run.
Returns to scale refers to the
change in output as all factors
change in the same proportion.
12
I. Q = f (l, k)
II. Q1 = f (al, ak)
Stages of Returns to
Scale
I. Increasing Returns to Scale
II. Constant Returns to Scale
III. Diminishing Returns to
Scale
13
Theory of Production : IS
Quant Curve Approach
ISO = Equal
Quant = Quantity of Product
An ISO-Quant curve approach
is a curve which represents
different combinations of two
factors which field same level
of output.
14
Other Names of ISOQuant
Equal product curve
Product Indifference
curve
Constant Product
curve
15
Assumption of the
concept of ISO-Quants
There are only two factors of
production
There exists substitutability of
the factor i.e K (Capital) and
Labour
Technique of production is
constant
Factors can be substituted
16
Returns to scale & ISOQuant Approach
Constant Returns to
Scale
Doubling the input
doubles the output
Input and output are
increasing proportionately
17
Diminishing Returns
to Scale
Change in factor inputs
results
in
to
proportionately smaller
changes in outputs.
18
Increasing Returns
to Scale
Doubling of Resources
more than doubles
the level of output.
19
Factors of production can be divided in
to smaller units.
An ISO Quant Map is a set or family of
ISO- Quants.
The concept of ISO-Quant is based on
Marginal rate of technical substitution
(MRTS)
MRTS = Rate at which one input can be
substituted for another input without
changing the level of output.
MRTS = K
L
20
To be in equilibrium the entrepreneur
equates the MRTS or the ratio of
Marginal Physical product of two factors
with the Price Ratio of the two factors.
Expansion Path
An expansion path is the line which
reflect best input combinations, least
cost method of producing different levels
of output assuming that input prices are
constant.
21
Optimum Combination
MRTS
=
PL
of
Inputs
PK
or
Marginal productivity of Labour = PL
Marginal productivity of K
PK
or
MP of Labour= MP of K
Price of Labour
Price of K
22
ISO- Cost Line
It is a locus of all combinations
of two inputs which the
producer can buy using his
fixed outlay at fixed input
price.
Other Names:
Factor Price Line
Outlay line
Firms Budget Control Line
23
Producer Equilibrium
MRTS = PL
PK
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