Unit 4 of Managerial Economics

1. Unit – 4 : Production Function
By RADHIKA
Faculty of Auditing
J H B W C

2. Introductionto Productionfunction
 Production:
The term production refers to a process of converting
input into output. Inputs refer to the factors of
production. i.e Land, Labour, Capital and
Entrepreneur. Outputs refer to the volume of goods
and services produced.

3. • Land
• Labor
• Capital
• Entrepreneur
INPUTS
• Work In
Progress
Process • Goods
&
• Service
OUTPUT

4. ProductionFunction
 Pro. Fun. states the relationship between the inputs
and the output factors of production. For any prod.
process the factors of production determine the
output.
 Land, Labor, Capital and Entrepreneur(Management)
and Technology are those five major determinants of
any output.

5. Cont.
 The dependent variable, output is a positive
function of the independent variables i.e factors of
production.
 Mathematically the production function can be
stated as…
Q = f(Ld, L, C, M, T)
Land employed in production.
Labor “
Capital “
Management “
Technology “

6. Productivitycurves
 Productivity curve indicate the various amounts of production by
the various combinations of labor and capital equipment.
 Suppose if a producer has various combinations of labor and
equipment to produce a given output. (say 1500 units)
Units no. of
Capital (K)
Units of Labor
(L)
Combination
Point
1 1 (10) A
2 2 (7) B
3 3 (5) C
4 4 (4) D

7. ISO-quantCurve

8. Cont.
 In the diagram the x-axis measures the amount of capital used and
y-axis amount of labor used.
 By combining these two factors the firm can produce 1500 units .
 Every point on the curve represents a combination of K and L
which will produce the same quantity of output.
 The producer can choose any one of the combinations to secure
the given output.
 If he chooses one combination, he will indifferent about others.
 Hence the curve IQ is known as producers indifference curve as
ISO-quant or ISO-product curve.

9.  Now a firm may be able to produce 1500 units
or 2000 and so on.
 In the next diagram IQs represent the different
combinations of labor and capital which can
produce 1500 IQs represents 2000 units & so
on.
 Every firm would like to produce the
highest possible output.
Cont.

11. ISO-CostCurve
 In order to find out the best output and the best combination to
produce that output, we will have to find out the amount of
money available to the producer for the two factors and the
prices of the two factors.
 Suppose the producer has 20,000 rs. Available to be spent on
two factors and prices of those two factors are 4,000 rs. Per unit
of capital and 800 rs. Per workers. The producer will have three
alternative before him.
1. To secure 5 units of capital
2. To secure 25 worker only
3. To secure some machines and some workers e.g 3 units of
capital and 10 workers.

12. Units of capital
Units of labor

14. Economiesof Scale
 Economies of scale are the cost advantages that enterprises
obtain due to size, output, or scale of operation, with cost per
unit of output generally decreasing with increasing scale as
fixed costs are spread out over more units of output.
 The scale or size of enterprise to the amount investment in
relatively fixed factors of production.
 Cost of production is generally lower in larger plants than in
smaller units
 This is because of a no. of economies of large scale production.

15. Cont.
 Economies of scale
Internal Economies
I. Managerial Economies
II. Financial Economies
III. Technical Economies
IV. Trade Economies
External Economies
I. Economies of Concentration [localized economies]
II. Economies of Dis-integration
III. Economies of Information

16. Cost –OutputRelationship
 In the short-run a change in output is possible only by making
changes in the variable inputs like raw materials, labour etc. Inputs
like land and buildings, plant and machinery etc. are fixed in the
short-run. It means that short-run is a period not sufficient enough
to expand the quantity of fixed inputs. Thus Total Cost (TC) in the
short-run is composed of two elements – Total Fixed Cost (TFC)
and Total Variable Cost (TVC).
 TFC remains the same throughout the period and is not influenced
by the level of activity. The firm will continue to incur these costs
even if the firm is temporarily shut down. Even though TFC
remains the same fixed cost per unit varies with changes in the
level of output.

17. Cont.
The SR is a period which doesn’t permit
alterations in the fixed equipment
(machinery , building etc) & in the size of
the org.
The LR is a period in which there is
sufficient time to alter the equipment
(machinery, building, land etc.) & the size of
the org. output can be increased without
any limits being placed by the fixed
factors of production.

18. Total, average & marginal cost
1. Total cost (TC) =
TFC + TVC, rise as output
rises
2. Average cost (AC) =
TC/output
3. Marginal cost (MC) =
change in TC as a result of
changing output by one unit
Fixed cost & variable cost
1.Total fixed cost (TFC) =
cost of using fixed factors =
cost that does not change
when output is changed, e.g.
2. Total variable cost (TVC) =
cost of using variable
factors = cost that changes
when output is changed,

21. AverageFixedCostandOutput
The greater the output, the lower the fixed
cost per unit, i.e. the average fixed cost.
Total fixed costs remain the same & do not
change with a change in output.

22. AverageVariableCostandoutput
 The avg. variable costs will first fall & then rise as more &
more units are produced in a given plant.
 Variable factors tend to produce somewhat more efficiently near
a firm’s optimum output than at very low levels of output.
 Greater output can be obtained but at much greater avg variable
cost.
 E.g. if more & more workers are appointed, it may ultimately
lead to overcrowding & bad org. moreover, workers may have
to be paid higher wages for overtime work.

23. AverageTotalcost andoutput
 Average total cost, also known as average costs,
would decline first & then rise upwards.
 Average cost consists of average fixed cost plus
average variable cost.
Average fixed cost continues to fall with an
increase in output while avg. variable cost
first declines & then rises.

24. Cont.
So , as Avg. variable cost declines the Avg. total
cost will also decline. But after a point the Avg.
variable cost will rise.
When the rise in AVC is more than the drop in
Avg. fixed cost that the Avg. total cost will show a
rise.

25. Longrun
 Long run period enables the producers to change all the
factor & he will be able to meet the demand by
adjusting supply. Change in Fixed factors like building,
machinery, managerial staff etc..
 All factors become variable in the long run.
In the long run we have only 3 costs i.e. total
cost, Average cost & Marginal Cost.

26. Cont.
 When all the short run situations are combined, it forms the long
run industry.
 During the SR, Demand is less & the plant’s capacity is limited.
When demand rises, the capacity of the plant is expanded.
 When SR avg. cost curves of all such situations are depicted, we
can derive a long run cost curve out of that.
 We can make a LR cost curve by joining the tangency points of
all SR curves.

29. All TheBest