1. 1
INTERNAL EVALUATION
Assignment and group work in class 5
Case Study 5
Test/CP Forum 5
15 ( Pre-mid)
Mid term 20 (50)
Post mid term (Assignment) 10
Group Presentation 5
Test 5
CP /Attendance 5
25 (Post-mid)
End Semester 40 (100)
3. 3
Production involves transformation of
inputs such as capital, equipment,
labor, and land into output - goods and
services
In this production process, the manager
is concerned with efficiency in the use of
the inputs
- technical vs. economical efficiency
PRODUCTION -CONCEPT 1
4. Two Concepts of Efficiency
Economic efficiency:
occurs when the cost of producing a given
output is as low as possible
Technological efficiency:
occurs when it is not possible to increase output
without increasing inputs
4
5. Concept 2-Production Function
A production function is purely technical
relation which connects factor inputs &
outputs. It describes the transformation of
factor inputs into outputs at any particular
time period.
5
Q = f( L,K,R,Ld,T,t)
where
Q = output R= Raw Material
L= Labour Ld = Land
K= Capital T = Technology
t = time
For our current analysis, let’s reduce the
inputs to two, capital (K) and labor (L):
Q = f(L, K)
6. Short-Run and Long-Run Production
concept 3
LAW OF VARIABLE PROPORTIONS
In the short run some inputs are fixed and
some variable
e.g. the firm may be able to vary the amount
of labor, but cannot change the amount of
capital
in the short run we can talk about factor
productivity law of variable proportion/law
of diminishing returns
6
7. 7
In the long run all inputs become
variable
e.g. the long run is the period in
which a firm can adjust all inputs
to changed conditions
in the long run we can talk about
returns to scale and isoquants
Concept -4 ISOQUANTS-LONG RUN
8. Short-Run Changes in Production
Factor Productivity
8
Units of K
Employed Output Quantity (Q)
8 37 60 83 96 107 117 127 128
7 42 64 78 90 101 110 119 120
6 37 52 64 73 82 90 97 104
5 31 47 58 67 75 82 89 95
4 24 39 52 60 67 73 79 85
3 17 29 41 52 58 64 69 73
2 8 18 29 39 47 52 56 52
1 4 8 14 20 27 24 21 17
1 2 3 4 5 6 7 8
Units of L Employed
How much does the quantity of Q change,
when the quantity of L is increased?
9. Relationship Between Total, Average, and
Marginal Product: Short-Run Analysis
Labor variable-concept 5
Total Product (TP) = total quantity of
output
Average Product (AP) = total product
per total input
Marginal Product (MP) = change in
quantity when one additional unit of
input used
9
10. The Marginal Product of Labor-
concept 6
The marginal product of labor is the
increase in output obtained by adding 1
unit of labor but holding constant the
inputs of all other factors
Marginal Product of L:
MPL= Q/L (holding K constant)
Average Product of L:
APL= Q/L (holding K constant)
10
11. Law of Diminishing Returns
(Diminishing Marginal Product)
CONCEPT-7
11
The law of diminishing returns states that when more
and more units of a variable input are applied to a
given quantity of fixed inputs, the total output may
initially increase at an increasing rate and then at a
constant rate but it will eventually increases at
diminishing rates.
Assumptions. The law of diminishing returns is based
on the following assumptions: (i) the state of technology
is given (ii) labour is homogenous and (iii) input prices
are given.
12. Total and Marginal Product
12
30
90
130
161
184
196 Total Product
Q from hiring fourth worker
Q from hiring third worker
Q from hiring second worker
Q from hiring first worker
increasing
marginal returns
diminishing
marginal returns
Units of Output
Number of Workers
6
2 3 4 5
1
14. 14
CONCEPT-PRODUCTION
CONCEPT 2- LAW OF VARIABLE PROPORTIONS (SHORT RUN AND
PRODUCTION FUNCTION)- (CASE ON CALL CENTRE)
BEHAVIOUR OF TP, MP and AP with dig and example
CONCEPT 3- LAW OF DIMINISHING RETURNS(-CASE ON HEALTHCARE)
CONCEPT 4-LONG RUN PRODUCTION FUNCTION- ISOQUANT
(CASE ON ENERGY INPUT)
CONCEPT 5-ISO COST LINE – Equation
SHIFTS AND ROTATION OF ISOCOST LINE
CONCEPT 6- PRODUCER EQUILIBRIUM
CONCEPT 7-RETURNS TO SCALE – INCREASING, CONSTANT, DIMINISHING
–(CASE ON CARPET INDUSTRY IN US)
COBB DOUGLOUS PRODUCTION FUNCTION
15. 15
CONCEPT -8-TYPES OF COST- CASELET
CONCEPT 9 – SHORT RUN COST CURVES
CONCEPT -LONG RUN COST CURVES
CONCEPT 7-RETURNS TO SCALE – INCREASING, CONSTANT, DIMINISHING
–(CASE ON CARPET INDUSTRY IN US)
COBB DOUGLOUS PRODUCTION FUNCTION,SIMPLE NUMERICALS
COSTS ARE A MIRROR IMAGE OF PRODUCTION
16. 16
Case - CALL CENTRE- LAW OF VARIABLE PROPORTIONS
HEALTHCARE PRODUCTION FUNNCTION –LAW OF DIMINISHING
RETURNS
17. 17
Three Stages of Production
Stages
Labor Total Average Marginal of
Unit Product Product Product Production
(X) (Q or TP) (AP) (MP)
1 24 24 24
2 72 36 48 I
3 138 46 66 Increasing
4 216 54 78 Returns
5 300 60 84
6 384 64 84
7 462 66 78
8 528 66 66 II
9 576 64 48 Diminishing
10 600 60 24 Returns
11 594 54 -6 III
12 552 46 -42 Negative Returns
18. 18
1, 24
2, 72
3, 138
4, 216
5, 300
6, 384
7, 462
8, 528
9, 576
10, 600 11, 594
12, 552
1, 24
2, 36 3, 46 4, 54 5, 60 6, 64 7, 66 8, 66 9, 64 10, 60 11, 54 12, 46
1, 24
2, 48
3, 66
4, 78 5, 84 6, 84 7, 78
8, 66
9, 48
10, 24
11, -6
12, -42
0 2 4 6 8 10 12 14
SHORT RUN PRODUCTION FUNCTION
Total Product Average Product Marginal Product
CAPITAL(K) is constant and LABOUR (L) is variable
19. Three Stages of Production in
Short Run (Earlier slide also)
19
AP,MP
X
Stage I Stage II Stage III
APX
MPX
•TPL Increases at
increasing rate.
•MP Increases at
decreasing rate.
•AP is increasing
and reaches its
maximum at the
end of stage I
•TPL Increases at
Diminshing rate.
•MPL Begins to decline.
•TP reaches maximum
level at the end of
stage II, MP = 0.
•APL declines
• TPL begins to
decline
•MP becomes
negative
•AP continues to
decline
CONCEPT -8
20. Short-Run Analysis of Total,
Average, and Marginal Product
If MP > AP then
AP is rising
If MP < AP then
AP is falling
MP = AP when
AP is maximized
TP maximized
when MP = 0
20
21. 21
CASE ON CALL CENTRE- LAW OF VARIABLE PROPORTIONS
3 STAGES OF PRODUCTION
22. Application of Law of
Diminishing Returns:
It helps in identifying the rational and
irrational stages of operations.
It gives answers to question –
How much to produce?
What number of workers to apply to a
given fixed inputs so that the output is
maximum?
Stage 2- call centre
22
24. 24
Theory of Consumer Behaviour Theory of Production
LDMU LDMR
Indifference curve Isoquant
Two commodities X &Y Two factors L&K
Properties Same for both
Slope of IC MRS xy Slope of Isoquant:MRTS LK
Budget line is constraint
Slope= Px/Py Isocost line is constraint
Slope= w/r
Consumer Equilibrium Producer equilibrium
Tangency of budget line with IC curve Tangency of Isocost line with
Isoquant
AIM: CONSTRAINED OPTIMISATION
Maximise consumer satisfaction Maximise production subject to cost
Subject to budget constraint
25. Production in the Long-Run
concept 9
All inputs are now considered to be
variable (both L and K in our case)
How to determine the optimal
combination of inputs?
To illustrate this case we will use
production isoquants.
An isoquant is a locus of all technically
efficient methods or all possible
combinations of inputs for producing a
given level of output.
25
26. Production Table
26
Units of K
Employed Output Quantity (Q)
8 37 60 83 96 107 117 127 128
7 42 64 78 90 101 110 119 120
6 37 52 64 73 82 90 97 104
5 31 47 58 67 75 82 89 95
4 24 39 52 60 67 73 79 85
3 17 29 41 52 58 64 69 73
2 8 18 29 39 47 52 56 52
1 4 8 14 20 27 24 21 17
1 2 3 4 5 6 7 8
Units of K Employed
of L
Isoquant
Units of K
Employed
28. Properties of Isoquants-
Concept 10
Isoquants have a negative slope.
Isoquants are convex to the origin.
Isoquants cannot intersect or be tangent to each
other.
Upper Isoquants represents higher level of output
28
29. The degree of imperfection in
substitutability is measured with
marginal rate of technical substitution
(MRTS- Slope of Isoquant):
MRTS = L/K
(in this MRTS some of L is removed from
the production and substituted by K to
maintain the same level of output)
29
Marginal Rate of Technical Substitution
MRTS (Concept 11)
30. Isoquant Map (Concept 12)
Isoquant map is a set of
isoquants presented on
a two dimensional
plain. Each isoquant
shows various
combinations of two
inputs that can be used
to produce a given level
of output.
Figure : Isoquant Map
Labour X
Capital
Y
Y
O X
IQ4
IQ3
IQ2
IQ1
30
31. We will use isoquant map (1) and
isocost line (2) (Concept 13)
Figure : Isoquant Map (1)
Capital
Y
K
O L
3x
2x
x1
Figure : Isoquant Line (2)
K
O L
C/W
C/r
B
A
31
The cost line is defined by cost equation
C= (r) (k) + (w) (L)
W wage rate r= price of capital serviceIIiiI
32. :
the firm attempts either to minimize
the cost of producing a given level of
output
or
to maximize the output attainable
with a given level of cost.
Both optimization problems lead to
same rule for the allocation of inputs
and choice of technology
32
CONCEPT -CONSTRAINED OPTIMISATION PROBLEM
(Concept 14)
33. Case I
Maximization of output subject
to cost constraint
Labour
0 L1
K1
C x3
x2
X1
A
B
Capital
33
35. Condition for Equilibrium
(concept 15)
At point of tendency slope of isocost line (w/r ) =
slope of isoquant. (MPL/MPK)
The isoquants should be convex to origin
35
37. 37
LONG RUN PRODUCTION FUNCTION (Caselet on Energy)
Energy and other inputs substitution using Isoquants and Isocost lines
Energy becomes costlier what would happen to the isocost line and isoquant
39. Laws of Returns to Scale
CONCEPT 17
It explains the behavior of output in response to a
proportional and simultaneous change in input.
When a firm increases both the inputs, there are
three technical possibilities –
(i) TP may increase more than proportionately –
Increasing RTS
(ii) TP may increase proportionately – constant RTS
(iii) TP may increase less than proportionately –
diminishing RTS
39
41. 41
LDMR exists- TP increases at an increasing rate then diminishing rate and
reaches maximium and then falls
MP declines and reaches 0 and then becomes negative
AP declines continuously
Simple Numericals(Calculate MP and AP and show whether
Dimishing returns occur
Numbers of workers Number of chairs(Q) MP ( Q/L) AP (Q/L)
1 10
2 18
3 24
4 28
5 30
6 30
7 28
8 25
42. 42
If w= 3 and r= 2 and cost constraint equals 30 draw the Isocost line.
If a)w decreases to 2 indicate the rotation
b) If cost constraint expand to 60 indicate the shift
C= rk +wl
30 = 2k + 3L
60= 2K+3L
43. 43
Returns to scale (Next class) Caslet on carpet Industry
Cobb Douglas Production function
Types of Cost
Cost concepts
Relationship between production and cost
Short run cost curves
Long run cost curves
