Isoquants, MRTS, Concept of Total Product, Average & Marginal Product, Short Run and Long Run analysis of production, The Law of Variable proportion, Returns to scale, Production Cost – Concept of Cost, Classification of Short run cost – Long run cost,

1. By Harshitha.S and
Imran Pasha

2. Part 1
Part 2
Part 3
Part 4
Part 5
Part 6
Contents
Introduction
Concept of production function – Isoquants, MRTS
Concept of Total Product, Average & MarginalProduct
Short Run and Long Run analysis of production
The Law of Variable proportion – Returns to scale
Production Cost – Concept of Cost, Classification of
Short run cost – Longrun cost

3. Introduction
Part 1
Part 2
Part 3
Part 4
Part 5
 Production is a very important economic activity.
 It is important both from the individual as well as the social points of view.
 The standard of living of a people is the ultimate analysis which depends on
the volume and variety of production.
 The performance of an economy is judged by the level of its production. i.e.
Those countries which produce goods in large quantities are rich and those which
produce little of them are poor.
 The process of growth or development consists of increasing level of
production in the economy.
The term ‘Production’ in economics refers to the creation of those goods and
services which have exchange value. The process by which man utilises or
converts the resources of nature, working upon them so as to make them satisfy
the human wants.
“Production as any activity whether physical or mental, which is directed to the
satisfaction of other people’s wants through exchange.” – Prof. J. R. Hicks
Part 6

4. Introduction
Part 3
Part 4
Part 5
Production consists of various processes to add utility to natural resources for
gaining greater satisfaction from them by:
1. Changing the form of natural resources.
2. Changing the place of the resources.
3. Making available materials at times when they are not normally available.
4. Making use of personal skills in the form of services.
Part 6
Thus the entire process of production is nothing but creation of form utility,
place utility and/or personal utility.
Assumptions:
a) Specified period of time.
b) Technical knowledge does not change.
c) Most efficient technique available.
d) Factors of production are divisible into
units.
Part 2
Part 1

5. Introduction
Part 3
Part 4
Part 5
Part 6
0
20
40
60
80
100
120
140
160
180
200
1 2 3 4 5 6 7 8 9 10
© TheYoungIndianEconomists.com
Labor (in millions)
GDP(inbillions)
Y= (L)f
Part 2
Part 1

6. Iso-quant or Equal product curves
Part 3
Part 4
Part 5
 A production function with two variable inputs can be represented by a family of
isoproduct curves or isoquants.
 They are also known as equal product curves or production indifference curves.
 It is a curve along which the maximum achievable rate of production is constant.
 It represents all possible combinations of the two factors that will give the same
total product per unit of time.
Properties of isoquants:
1. Slope downwards from left to the right( Negative slope)
2. Convex to the origin
3. Isoquants to the right represent a larger output
4. Never cut each other
5. Units of output shown on isoquants are purely arbitrary
6. Between two isoquants there can be a number of isoquants
7. No isoquants can touch either axis.Part 6
Part 2
Part 1

7. Iso-quant curves
Part 3
Part 4
Part 5
Part 6
5
4
3
2
1
Capitalperyear
Labor per year
1 2 3 4 5
A B C
D
E
300 Units
200 Units
100 Units
Part 2
Part 1

8. Difference between isoquants and indifference
curve
Part 3
Part 4
Part 5
Part 6
Sl.N
o.
Isoquant curve Indifference Curve
1. Isoquant curves related with
production theory.
There are related with demand theory.
2. It shows the various combination of
two inputs on an equal output
It shows the various combinations of two
commodities.
3. Isoquant curve show constant levels
of output which can be measured.
These curves show the constant level of
satisfaction which cannot be measured.
4. It represents combination of two
factors.
It represents combination of two good /
commodity.
5. It provide economic and uneconomic
information region of production.
It provides no any information about
economic and uneconomic region of
consumption of goods.
6. Its slope influenced by the technical
possibility of substitution between
production
Its slope influenced depends upon Marginal
Rate of Substitution between commodities
consumed by the consumer.
Part 2
Part 1

9. Marginal Rate of Technical Substitution
Part 3
Part 4
Part 5
Part 6
 The concept of the marginal rate of technical substitution plays an important
role in the modern theory of production.
 As isoquants in the theory of production are the counterparts of the
indifference curves in the theory of consumptions.
 The marginal rate of technical substitution (MRTS) in the theory of production
is matched by the marginal rate of substitution (MRS) in the theory of
consumption.
 The rate at which a factor of production can be substituted for another at the
margin without effecting any change in the quantity of output, is known as
Marginal Rate of Technical Substitution.
 MRTS shows negative slope.
 The amount by which the quantity of one input can be reduced when one extra
unit of another input is used so that output remains constant.
L
LK
K
MP
MRTS
MP

Part 2
Part 1

10. Part 3
Part 4
Part 5
The marginal rate of technical substitution can also be expressed as the ratio of
the marginal physical product of labour to the marginal physical product of
capital,
or
Though the output remains constant, the process of substitution brings change.
Part 6
L
LK
k
MP
MRTS
MP

Combin
a-tions
Labour
Capita
l
MRTS
(-dk/dl)
Outpu
t
1 5 9 100
2 10 6 3:05 100
3 15 4 2:05 100
4 20 3 1:05 100
9
8
7
6
5
4
3
2
1
5 10 15 20
Capital
Labor
(100 Units)
A
B
G
H
3
S 5
2
5T
R
1
5
Y
X
Marginal Rate of Technical Substitution
Part 2
Part 1
LK
L
MRTS
K

 


11. Part 3
Part 4
Part 5
Part 6
The above table shows that:
 In the second combination to keep output constant at 100 units, the reduction
of 3 units of capital requires the addition of 5 units of labour, MRTSLK = 3:5.
 In the third combination, the loss of 2 units of capital is compensated for by 5
more units of labour, and so on.
 In the diagram, at point В, the marginal rate of technical substitution is AS/SB;
at point G, it is BT/TG; and at H, it is GR/RH.
Marginal Rate of Technical Substitution
Part 2
Part 1

12. Total, Average and Marginal Product
Part 1
Part 4
Part 5
As the quantity of labour is increased and the amount of capital that is required to
be replaced by an additional unit of labour has to diminish in order to maintain the
output at a constant level.
Total product:
• Total product is also known as total physical product
• It is the total quantity of output produced by a firm in the given inputs.
• It identifies the specific outputs which are possible using variable levels of counts.
• It is essential for the short-run analysis of a firm's production.
• Changes in total product are taken into account closely when there are changes
in variable costs (labour) of production.
Average product: Ratio of total product to the total quantity of an input used
to produce the product. The total product per unit of the variable factor.Part 6
Part 3
Part 2

13. Part 4
Part 5
Part 6
Marginal Product
• Is similar to average product but is looked at from another perspective.
• Discrete marginal product is defined as the change in total product that comes as
a result of a one unit increase in the variable input/capital level of a firm.
• Continuous marginal product is calculated as the derivative of total product with
respect to the variable input employed.
This can be represented as,
Where TP is total product, MP is marginal product and VI is variable inputs.
The analysis of marginal product is foundational to explaining the law of supply
(upward-sloping supply curve) via the Law of Diminishing Marginal Returns. Since
marginal product is measured in physical units produced, it is also called Marginal
Physical Product
TP
MP
VI



Total, Average and Marginal Product
Part 1
Part 3
Part 2

14. Part 3
Part 5
Part 6
TP
AP
MP
1 2 3 4 5 6 7
20
18
16
14
12
10
8
6
4
2
0
Input Quantity
OutputQuantity
Total, Average and Marginal Product
Part 1
Part 4
Part 2

15. Short-run and Long-run Production Functions
Part 2
Part 3
Part 5
Types of production function:
1. Production function with one variable- It is a short-term production
function.
2. Production function with all variable inputs- It is a long-term production
function.
Part 6
Short-Run q= (L)
Long-Run q= (K,L)
f
f
C
Output
LaborO
Short-run Pruduction Function
Part 1
Part 4

16. Part 2
Part 3
Part 5
Short-term production function:
In case of two factors, capital and labour, when capital is fixed and labour is
variable, the production function is expressed as:
 The slope of the curve depicts the total product of labour and the amount of
output that can be produced by a given amount of labour.
 Output rises with labour until it reaches its maximum at point C; with extra
workers, the number of units produced falls.
 Initially output increases more than in proportion to labour, so that the average
product of labour rises.
 As the number of workers rises further, output may not increase as much per
worker total output increases less than in proportion to labour, so the average
product falls.
 The marginal product of labour also declines. Production beyond point C is not
part of the production function, because no firm would produce with that many
workers.
Part 6
q= (L, K)f
Short-run and Long-run Production Functions
Part 1
Part 4

17. Part 2
Part 3
Part 5
Long-term production function:
 In the long term, all inputs are variable.
 With both labour and capital being variable, a firm can usually produce a given
level of output by using a great amount of labour and very little capital, a great
amount of capital and very little labour or moderate amount of both.
 The firm can substitute one input for another while continuing to produce the
same level of output.
 The combinations of labour and capital the produce various levels of output can
be shown by isoquants.
Part 6
O
200 Units
100 Units
300 Units
Labor
Capital
C2
C1
C
L2L1L
a
b
c
Long-run Pruduction Function
Short-run and Long-run Production Functions
Part 1
Part 4

18. The law of variable proportions
Part 2
Part 3
Part 4
 The Classical Economists like Adam smith, David Ricardo and Malthus associated the
law of diminishing returns with agriculture.
 Dr. Marshall, modern Economist, said the law works not only in agriculture, but also
in other fields of economic activity including manufacturing industries.
 The law of variable proportions or the law of diminishing returns examines the
production function with one factor variable, keeping quantities of other factors fixed.
 It refers to input-output relationship, when the output is increased by varying the
quantity of one input.
 This law operates in the short-run ‘when all the factors of production cannot be
increased or decreased simultaneously.
 Total product curve goes on increasing to a point and after that it starts declining
 Average product and marginal product curves, first rise and then decline; Marginal
product curve starts declining earlier than average product curve.
Part 6
Part 5
Part 1

19. Part 2
Part 3
Part 4
Assumptions:
1. Techniques of production remain constant. If there is any improvement in
technology, then marginal and average product may rise instead of falling.
2. There must be some inputs whose quantity is kept fixed. This law does not
apply to cases when all factors are proportionately varied. If so, law of
returns to scale are applicable.
3. The law does not apply where the factors must be used in fixed
proportions to yield product. Because an increase in one factor would not
lead to any increase in output i.e., marginal product of the variable factor
will then be zero and not diminishing.
4. We consider only physical inputs and outputs and not economic
profitability in monetary terms.
Part 6
The law of variable proportions
Part 5
Part 1

20. Part 2
Part 3
Part 4
Part 6
TP
AP
MP
0 Amount of a variable factor
Output
S
Stage 1 Stage 2 Stage 3
Point of Inflexion
Labor
and
capital
Total
product
Avera
ge
product
Margin
al
product
1 8 8 8
2 20 10 12
3 36 12 16
4 48 12 12
5 55 11 7
6 60 10 5
7 60 8.6 6
8 65 7 -4
The law of variable proportions
Part 5
Part 1

21. Part 2
Part 3
Part 4
The law states an increase in some inputs relative to other fixed inputs will, in
a given state of technology, cause output to increase; but after a point the
extra output resulting from the same addition of extra inputs will become less
and less.
The behaviour of output in the form of total, average and marginal products of
the variable factor consequent to the increase in its amount are classified into
different stages or laws.
The three distinct stages or laws:
1. The law of increasing returns
2. The law of diminishing returns
3. Law of negative returns
Part 6
The law of variable proportions
Part 5
Part 1

22. Part 2
Part 3
Part 4
Stage 1:
 Total product increases at an increasing rate upon a point, marginal product also
rises and is maximum and average product goes on rising but at a diminishing rate.
 Marginal product falls but is positive and the average curve reaches its highest
point. This happens in the beginning stage.
 When the quantity of fixed factors is abundant relative to the quantity of the
variable factor; as more units of variable factor are added to the constant quantity of
the fixed -factors, then the fixed factors are more intensively and effectively utilised.
Part 6
TP
AP
0 Amount of a variable factor
Output
S
Stage 1 Stage 2 Stage 3
Point of Inflexion
 This causes the production to increase at a rapid
rate.
 As fixed factors are indivisible, more units of the
variable factor are employed to work with an
indivisible fixed factor, output greatly increase due to
full utilisation of the latter.
 As more units of the variable factors are employed,
the efficiency of the variable factors itself increases.
TP
AP
MP
AP
MP
The law of variable proportions
Part 5
Part 1

23. Part 2
Part 3
Part 4
Stage 2:
 The total product continues to increase at a diminishing rate until it reaches its
maximum point.
 Both marginal and average product of the variable factor is diminishing but is
positive.
 Once the point is reached at which the amount of variable factors is sufficient to
ensure efficient utilisation of the fixed factor, then further increases in the variable
factor will cause marginal and average-product to decline.
Part 6
 The fixed factor then becomes inadequate
relative to the quantity of the variable factor.
 It is imperfect substitutability of one factor
for one another.
 The average product of the variable factor
diminishes in the second stage when the fixed
indivisible factor is being worked too hard.
TP
AP
vari ab le f ac tor
S
S tage 1 S tage 2 S tage 3
on TP
AP
0 Amount of a variable factor
Output
S
Stage 1 Stage 2 Stage 3
Point of Inflexion
TP
AP
MP
AP
MP
The law of variable proportions
Part 5
Part 1

24. Part 2
Part 3
Part 4
Stage3:
 Total product declines, MP is negative, average
product is diminishing.
 Variable factor continues to be increasing to
constant quantity of the other, a stage is
reached when the total product-declines and
marginal product becomes negative.
 The quantity of variable factor becomes too
excessive relative to the fixed factor; as a result
total output falls instead of rising.
 In such situation a reduction in the units of the
variable factor will increase the total output.
 A rational producer will never produce in this
stage as the marginal product of the variable
factor is negative.
Part 6
TP
AP
MP
riable factor
S
ge 1 Stage 2 Stage 3 TP
AP
MP
0 Amount of a variable factor
Output
S
Stage 1 Stage 2 Stage 3
Point of Inflexion
The law of variable proportions
Part 5
Part 1

25. Significance of the law of diminishing returns
Part 2
Part 3
Part 4
Significance of the law of diminishing returns:
1. Universal applicability
2. Basis of Malthus theory of population
3. Basis of Ricardo’s theory of rent
4. Migration of population
5. Basis of marginal productivity theory
6. Undeveloped countries
7. Affects the Standard of living
8. Responsible for research and inventionsPart 6
Part 5
Part 1

26. Returns to scale
Part 2
Part 3
Part 4
Returns to scale:
The theory of returns to scale
studies the production function in
the long run. The rate of change in
output, when all factors of
production, in a particular
production function are increased
or decreased in some proportion
simultaneously. Returns to scale
may be constant, increasing or
decreasing.
Part 6
5
4
3
2
1
P
S
Q
R
1 2 3 4 5 6 7
Stage 1 Stage 2 Stage 3
MarginalProduct
Scale of Production
Constant Returns
to scale
Part 5
Part 1

27. Part 2
Part 3
Part 4
Constant returns to scale: The increase in the scale in some proportion,
output increases in the same proportion. It has been found that production
function for the economy as a whole corresponds to production function
exhibiting constant returns to scale. Also, firm passes through a long phase of
constant returns to scale in its lifetime.
Increasing returns to scale: The output increases in a greater proportion
than the increase in inputs. When a firm expands and the indivisibility of
factors are the reasons for increasing returns to scale. This leads greater
possibilities of specialisation of land and machinery.
Decreasing returns to scale: When output increases in a smaller proportion
with an increase in all inputs, decreasing returns to scale are said to prevail.
When a firm goes on expanding by increasing all inputs, finally leads to
diminishing returns to scale. Difficulties of management, coordination and
control are the reasons for decreasing returns to scale.
Part 6
Returns to scale
Part 5
Part 1

28. Production Cost
Part 2
Part 3
Part 4
Part 5
 A cost incurred by a business when manufacturing a good or producing a service.
 Production costs combine raw material and labour.
 To figure out the cost of production per unit, the cost of production is divided by
the number of units produced.
 A company that knows how much it will cost to produce an item, or produce a
service, will have a clear picture of how to better price the item or service and what
will be the total cost to the company.
 Businesses that know their production costs know the total expense to the
production line, or how much the entire process will cost to produce the item.
 If costs are too high, these can be decreased or possibly eliminated.
 Production costs can be used to compare the expenses of different activities within
the company.
 In production, there are direct costs and indirect costs.
For example, direct costs for manufacturing an automobile are materials such as the
plastic, metal or labour incurred to produce such an item. Indirect costs include
overhead such as rent, salaries or utility expense.
Part 6
Part 1

29. Production cost
Part 2
Part 3
Part 4
Part 5
Concept of cost
Cost function refers to the mathematical relation between cost of a
product and the various determinants of costs. In cost function, the dependent
variable is unit cost or total cost and the independent variables are the price of
a factor, size of the output. Cost function can be linear or curvilinear
depending upon the cost behaviour and response to the dependent variable.
C = f (O, S, T, U, P..... )
Where,
C is cost
O is level of output
S is the size of plant
T is time under consideration
P is the prices of factors of production
Determinants of cost:
1.Operation of law of returns.
2.Size of the plant or firm.
3.Term of period under consideration
4.Level of capacity utilisation
5.Prices of factors of production
6.Technology
7.Efficiency in use of inputs
Part 6
Part 1

30. Production cost
Part 2
Part 3
Part 4
Part 5
Total, fixed and variable costs
Variable costs: Some factors which can be easily adjusted with changes in the level
of output. Thus a firm can readily employ more workers if it has to increase
output.
Fixed costs: Factors like capital assets cannot be readily varied and require a longer
period to adjust.
Total cost: The total money of cost of production of a commodity. Total cost of a
business is thus sum of total variable cost and total fixed cost.
TC= TFC+ TVC
TVCTC
TFC
OUTPUT
COST
0
X
Y As shown in the graph, Total Fixed Cost (TFC) is parallel to the output
(X-axis). This curve starts from the point on the Y-axis that fixed cost
will be incurred even if the output is zero. Total variable cost curve
(TVC) raises upward showing output increases, TVC also increases.
This curve starts from the origin which shows that when the output is
zero, variable costs are also nil. The total cost curve has been obtained
by adding vertically total fixed cost curve and total variable cost curve.Part 6
Part 1

31. Production cost
Part 2
Part 3
Part 4
Part 5
Total, Average and Marginal cost curves
The total money cost of production of a commodity.
Average cost is obtained by dividing total cost of production by the number of
units of the commodity produced.
 Marginal cost is the cost of producing the final or the marginal unit of the
commodity.
 Even if only the total curve is there, the other two curves namely, the AC and
the MC curves could be derived from it; the relationship between the average and
the marginal costs.
 As long as the average cost (AC) curve is falling, the marginal cost (MC) curve
is below it.
 Likewise, when the average cost curve start rising, the marginal cost curve is
above it.
 If the average cost curve is U-shaped, then its corresponding marginal cost
curve will cut at its lower point.
Part 6
Part 1
Total Cost
Average Cost=
Output

32. Classification of Short run cost – Long run cost
Part 2
Part 3
Part 4
Part 5
Classification of Short run cost – Long run cost
 Corresponding to the distinction between variable and fixed factors, we
distinguish between short run and long run periods of time.
 Economists are generally interested in two types of cost functions, the short
run and long run curves.
 Related to short run and long run periods, we have fixed cost concept and
variable cost concept.
Short run is a period of time in which output can be increased or decreased
by changing only the amount of variable factors.
The quantities of fixed factors cannot be varied in accordance with changes in
output. Ex: raw material, labour, etc.
Long run is a period of time in which the quantities of all factors may be
varied. Ex: fuel, power, transportation, etc.
Part 6
Part 1

33. Short-run Average cost
Part 2
Part 3
Part 4
Part 5
1. Average fixed cost (AFC)
Average fixed cost is the total fixed cost divided by the
number of units of output produced. AFC= TFC/ Q where
Q is the number of units produced. Thus AFC is the fixed
cost per unit. AFC cannot be zero. Since total fixed cost is
a constant amount, average fixed cost will be steadily fall as
output increases.
OUTPUT
COST
AFC
0
Y
2. Average variable cost (AVC)
Average variable cost is the total variable cost divided by
the number of units of output produced. AVC=TVC/Q
where Q is the number of units produced. Thus AVC is
the variable cost per unit of output.
AVC normally falls as output increases from zero to
normal capacity output due to occurrence of increasing
returns. Beyond this, AVC will rise steeply because of the
operation of diminishing returns. AVC will first fall, then
reach a minimum and then rise again.
OUTPUT
COST
0
X
Y
AVC
Part 6
Part 1

34. Short-run Average cost
Part 2
Part 3
Part 4
Part 5
3. Average total cost(ATC)
 Average total cost is a sum of average variable
cost and average fixed cost. ATC=AFC+AVC.
 The total cost divided by the number of units
produced.
 The behaviour of average total cost curve
depends upon the behaviour of average variable
cost curve and average fixed cost curve.
 It is ‘U’ shape curve.
 When both AVC and AFC curves fall, the ATC
curve will also fall sharply in the beginning.
 When AVC curve begins to rise, but AFC curve
still falls steeply, ATC curve continues to fall.
 The fall in AFC curve is greater than the rise in
the AVC curve but as output increases, there is a
rise in AVC which makes AFC to fall.
OUTPUT
COST
0
X
Y ATC
Part 6
Part 1

35. Short-run Average cost
Part 2
Part 3
Part 4
Part 5
4. Marginal cost (MC)
 Marginal cost is the addition made to the total
cost by production of an additional unit of
output.
 It is the total cost of producing ‘t’ units instead
of t-1 units, where t is any given number.
 It is independent of fixed cost and dependent
on variable costs.
 Marginal cost curve falls as output increases in
the beginning.
 It starts rising after a certain level of output.
 The curve is U shaped.
 This influences the law of variable proportions.
OUTPUT
COST
0
X
Y
MC
Part 6
Part 1

36. Relationship between the costs
Part 2
Part 3
Part 4
Part 5 OUTPUT
COST
AFC
0
X
Y
AVC
ATC
MC
Short-run Average cost and
Marginal cost curves
Units of
output
TFC TV
C
TC AF
C
AVC AT
C
MC per
unit
0 150 0 150
6 150 50 20
0
25.
0
8.33 33.
33
50/6=8.3
3
16 150 100 25
0
9.3
8
6.25 15.
63
50/10=5.
00
29 150 150 30
0
5.17 5.17 10.
34
50/13=3.
85
44 150 20
0
35
0
3.41 4.55 7.9
5
50/15=3.
33
55 150 25
0
40
0
2.7
3
4.55 7.2
7
50/11=4.5
5
60 150 30
0
45
0
2.5
0
5.00 7.5
0
50/5=10.
00
Part 6
Part
1

37. Relationship between the costs
Part 2
Part 3
Part 4
Part 5
OUTPUT
AVERAGECOST
0
X
Y SAC1 SAC2
SAC3
A B C D
H
L
Q
K
RJ
Part 6
Part 1

38. Long-run Average cost curves
Part 2
Part 3
Part 4
Part 5
 Long run is a period of time during which the firm can vary all of its inputs-
unlike short run where some inputs are fixed and others are variable.
 It is the least possible cost of producing any given level of output when all
individual factors are variable.
 It depicts the functional relationship between output and the long run cost of
production.
 The firm will examine with the short average cost curve. It will operate to produce
a given level of output so that total cost is at minimum.
 The firm has a choice in the employment of plant which yields minimum possible
unit cost for producing a given output.
 It is often called a planning curve because a firm plans to produce any output in
the long run by choosing a plant corresponding to the given output.
 It helps the firm in the choice of the size of the plant for producing a specific
output at the least possible cost.
 Long run curve is U-shape curve and depends upon the returns to scale.
Part 6
Part 1

39. Long-run Average cost curve
Part 2
Part 3
Part 4
Part 5
OUTPUT
AVERAGECOST
0
X
Y
G
K
H
F J
T
P
SAC1
SAC2
SAC3
SAC4
SAC7
SAC6
SAC5
LAC
M N V Q W
Part 6
Part 1

40. Conclusion
Part 2
Part 3
Part 4
Part 5
The relation between cost and output is called “Cost Function”.
Cost function of a firm depends upon its production function
and the prices of factors of production. The cost of production is
the most important force for governing the supply of a product.
It should be noted that it is assumed that for each level of
output, the firm chooses the least cost combination of factors.
Part 6
Part 1