Describes the theory of production

1. ECONOMIC ANALYSIS (PART-V)
Compiled by
Dr.S.Vigneswaran.,M.A.,Ph.D.,(NET, SET)
Assistant Professor of Economics,
Mannar Thirumalai Naicker College, Madurai-04.

2. TOPICS COVERED
 Theory of Production
Meaning and Characteristics of factors of production
– Land, Labour, Capital, Organization –Division of
Labour –Types - The Law of Variable Proportions –
Law of Returns to Scale -Theory of Production
Function: Meaning and Types – Iso Quant – Iso
Cost.

3. FACTORS OF PRODUCTION
Meaning:
Resources which are required to produce a product are called
Factors of Production.
Classification
Land – Rent
Labour – Wage
Capital – Interest
Organization – Profit

4. I. LAND
Meaning:
All the natural resources which are the free gifts of nature used
in the production.
Features or Characteristics:
1. Free gift of nature
2.Fixed in supply
3. Permanent
4.Lacks Mobility
5.Differs in fertility
6.Used for variety of purposes
7.Subject to the Law of Diminishing Returns

5. II. LABOUR
Meaning:
Any work whether physical or mental undertaken for securing
income.
Features/ Characteristics:
1. Inseparable.
2. Perishable.
3.Less Mobile.
4.Labour Changes Slowly.
5. Labourer has to deliver labour in person.
6. Heterogeneous.
7. Has weak bargaining power.

6. DIVISION OF LABOUR
Meaning:
Specialization of Labour in particular type of jobs.
Types of Division of Labour:
1. Simple Division of Labour
Division of labour according to the major occupations.
2.Complex Division of Labour:
The work processes is done by a separate set of workers. No
group of workers produces a complete article.
3. Territorial Division of Labour:
Concentration of large number of factories producing the same
commodity in a particular area or region or locality.

7. III. CAPITAL
Meaning:
Money that is used to make more money.
Characteristics of Capital:
1.Capital is man made.
2. Capital is productive.
3. Capital is mobile.
4.Supply of capital is elastic.
5. Capital is non-permanent.

8. ORGANIZATION
Meaning: Organization is the act of coordinating the other
three factors of production namely land, labour and capital.
Features of Organization:
1. Division of Work.
2. Coordination.
3. Plurality of Persons.
4. Common Objectives.
5. Organization is a Machine of Management.

9. THE LAW OF VARIABLE PROPORTION
 The law which states that when the quantity of one
factor of production is increased, while keeping all
other factors constant, it will result in the decline of
the marginal product of that factor.

10. ASSUMPTIONS
 Constant state of Technology:
With improvements in the technology, the production will
improve. So there constant state of technology is in force.
 Variable Factor Proportions:
The law is not valid, if factors of production are fixed.
 Homogeneous factor units:
This assumes that all the units produced are identical in
quality, quantity and price in nature.
 Short Run:
This law is applicable for a short term, where it is not possible
to alter all factor inputs.

11. Table
 The table shows the different amounts of output
when apply different units of labour to one acre of
land which needs fixing that is, the land is the fixed
factor and labour is the variable factor.

12. DIAGRAM

13. STAGES OF LAW OF VARIABLE PROPORTION
 First Stage or Stage of Increasing returns:
In this stage, the total product increases at an increasing rate. This
happens because the efficiency of the fixed factors increases with
addition of variable inputs to the product.
 Second Stage or Stage of Diminishing Returns:
In this stage, the total product increases at a diminishing rate until
it reaches the maximum point. The marginal and average product
are positive but diminishing gradually.
 Third Stage or Stage of Negative Returns:
In this stage, the total product declines and the marginal product
becomes negative.

14. THE LAW OF RETURNS TO SCALE
Meaning:
 Changes in output when all factors change in the same
proportion are referred to as the law of returns to scale.
Assumptions
 All the factors of production (such as land, labor, and capital)
but organization are variable
 The law assumes a constant technological state. It means that
there is no change in technology during the time considered.
 The market is perfectly competitive.
 Outputs or returns are measured in physical terms.

15. TABLE
Unit Scale of Production
Total
Returns
Marginal Returns
1 1 Labor + 2 Acres of Land 4 4 (Stage I - Increasing
Returns)
2 2 Labor + 4 Acres of Land 10 6
3 3 Labor + 6 Acres of Land 18 8
4 4 Labor + 8 Acres of Land 28 10 (Stage II - Constant
Returns)
5 5 Labor + 10 Acres of Land 38 10
6 6 Labor + 12 Acres of Land 48 10
7 7 Labor + 14 Acres of Land 56 8 (Stage III - Decreasing
Returns)
8 8 Labor + 16 Acres of Land 62 6

16. DIAGRAM

17.  Stage I represents increasing returns to scale. During this
stage, the firm enjoys various internal and external
economies.
 Stage II represents constant returns to scale. During this
stage, the economies accrued during the first stage start
vanishing and diseconomies arise.
 Stage III represents diminishing returns or decreasing returns.
This situation arises when a firm expands its operation even
after the point of constant returns.

18. THEORY OF PRODUCTION FUNCTION
Meaning:
The production function shows the relation between
input changes and output changes.
 Q = f(L, C, N)
 Where ‘Q’ = quantity of output
 ‘L’ = labor
 ‘C’ = capital
 ‘N’ = land.

19. TYPES OF PRODUCTION FUNCTION
There are two types of production operations; they are short
run and long runs:
 Short Run Production Function: –In short time period, the
factors of production are fixed and variable.
 Factors of production that are given in quantity in the short
term are known fixed factors of production.
 Factors of production whose quantity can be changed are
called variable factors of production.
 Short-run refers to a period of time that is too short to allow a
manufacturer to change its plant capacity, yet it is sufficient to
change the level at which the fixed plant is used.
 The short-term production function is written as: –
Q = f (L) where, ‘Q’= Quantity of output and ‘L’= Labour

20. LONG RUN PRODUCTION FUNCTION:
 In long-term production, all functions, factors of
production are variable.
 In long run we measure that by how much proportion the
output changes if we change the proportion of input.
 From the point of view of existing firms, the long term
refers to the period that is sufficient to allow these firms
to change the quantities of all resources which are
employed in the production, including plant capacity.
 The producer can convert all inputs and establish the
necessary plant capacity to maximize profit.
 Long run production can be written as: –
Q= f(L,C) Where, ‘Q’= Quantity of output, ‘L’= Labour
and ‘C’= Capital

21. ISOQUANTS
 Isoquant is a graphical representation of all the
various combinations of inputs which are produce
the same level of output.
 Isoquants are called equal-product or iso-product
curves.

22. DIAGRAM – ISO QUANTS

23. ISO-COST LINES
 An iso-cost line graphically represents all the
combinations of the inputs which the firm can
achieve with a given budget for production or given
outlay.
 Iso-cost lines represent the prices of factors.

24. DIAGRAM ISO-COST LINES

25. PRODUCTION OPTIMISATION
 Isocosts and Isoquants can together helps to
determine the optimum production for a firm.
 Production optimisation can be achieved in two
ways. Either by maximize the production for a given
outlay or by minimize the cost of producing a given
level of output.

26. The least-cost combinations for three different iso-quants show
above at a point where the isocosts are tangential to the
isoquants.
Evidently, the least cost combination for a given isoquant is at the
point of tangency of the isoquant with the isocost line.

27. The End