EPM Unit 2

PRODUCTION ANALYSIS -
Production process involves the transformation of inputs into output. The inputs could be land,
labor, capital, organization etc. & the output could be goods or services. In a production process
managers take four types of decisions:
(a) whether to produce or not,

(b) how much output to produce,
(c) what input combination to use, and
(d) what type of technology to use.
PRODUCTION FUNCTION -
In general a given output can be produced with different combinations of inputs. A production
function is the functional relationship between inputs and output. It shows the maximum output
which can be obtained for a given combination of inputs. It expresses the technological relation
-ship between inputs and output of a product.
In general, we can represent the production function for a firm as:
Q = f (x1, x2, ….,xn)
Where Q is the maximum quantity of output, x1, x2, ….,xn are the quantities of various inputs,
and f stands for functional relationship between inputs and output.
@ Production Function with one variable input

@ Production Function with two variable input
Total Product –
The total product refers to the total amount (or volume) of output produced with a given
amount of input during a period of time.
Average Product
Average product, as the name suggests, refers to the per unit total product of the variable factor
AP = Total Product/ units of variable factor input = TP/L
Note: Total Product can also, therefore, be calculated as TP = AP x L
Marginal Product
The total product can be calculated by adding subsequent marginal returns to an input (also
known as the marginal product). The increase in output per unit increase in input is called
Marginal Product. Thus, if we were to assume Labor as the input used in the production
process (say), then Marginal Product can be calculated as-
MP = Change in output/ Change in input
TP = ƩMP
LAW OF VARIABLE PROPORTION -
The Law of Variable Proportions concerns itself with the way the output changes when you
increase the number of units of a variable factor. Hence, it refers to the effect of the changing
factor-ratio on the output.
It is essentially a short run production function in which production is planned with variable
input. The short run production function shows the maximum output a firm can produce when
only one of its inputs can be varied, other inputs remaining fixed
The law states that keeping other factors constant, when you increase the variable factor, then
the total product initially increases at an increases rate, then increases at a diminishing rate, &
eventually starts declining.
Stages in Law of Variable Proportion –

1. Stage I
2. Stage II
3. Stage III
Stage I – The TPP increases at an increasing rate and the MPP increases too. The MPP increases
with an increase in the units of the variable factor. Therefore, it is also called the stage of
increasing returns. In this example, the Stage I of the law runs up to three units of labor
(between the points O and L).
Causes of Increasing Returns –

1. Fuller utilization of fixed factor
2. Division of labor and increase in efficiency
3. Better coordination between the factors
Stage II – The TPP continues to increase but at a diminishing rate. However, the increase is
positive. Further, the MPP decreases with an increase in the number of units of the variable
factor. Hence, it is called the stage of diminishing returns. In this example, Stage II runs between
four to six units of labor (between the points L and M). This stage reaches a point where TPP is
maximum (18 in the above example) and MPP becomes zero (point R).
Causes of Diminishing Returns –

1. Fixity of the factor
2. Improper factor – Due to technology
3. Poor coordination between the factors
Stage III – Now, the TPP starts declining, MPP decreases and becomes negative. Therefore, it is
called the stage of negative returns. In this example, Stage III runs between seven to eight units
of labor (from the point M onwards).
Causes of Negative Returns-

1. Fixity of the factor
2. Excessive labour
STAGES TP MP
Stage I Increasing Rate Increasing
Stage II Increasing at a Diminishing Rate Decreasing but Remaining Positive
Stage III Declining Continuing to Decrease & Becoming
Negative
Assumptions of Law of Variable Proportion –
1. State of technology does not change

2. Variable factors are homogeneous
3. Variable factor should be changed continually-Labor as a variable
RETURNS TO SCALE -
Just as the Law of Diminishing Returns or Law of Variable Proportion is a short-run phenomena,
Return to Scale is a Long-run phenomenon. Return to Scale refers to the degree by which the
Level of output changes in response to a given change in all the inputs in a production system.
what would be the level of output when all inputs are increased by exactly same proportion
in the long run? There are 3 possible outcomes –
1. Constant returns
2. Increasing returns and
3. Decreasing returns
Iso-Quants :
Iso – Greek – means equal | quant – means quantity

An isoquant in economics is a curve that, when plotted on a graph, shows all the combinations
of two factors that produce a given output. Often used in manufacturing, with capital and labor
as the two factors, isoquants can show the optimal combination of inputs that will produce the
maximum output at minimum cost.
An isoquant is the locus of all technically efficient combinations ( or all possible factors of
production) for producing a given level of output. It is possible to produce the same quantity of
output using different combinations of inputs. When these combinations are plotted on a graph
we get a downward sloping curve which is the Isoquant.
Characteristics of Isoquant:
1. Downward sloping
2. Higher Isoquant represents a Higher Output.
3. Isoquants do not Intersect .
Assuming that we have to produce 150 thousand tones of output with labor and capital as can
be seen in the below table
Iso-Costs :
Iso-cost line represents the price of factors along with the amount of money an organization is
willing to spend on factors. In other words, it shows different combinations of factors that can
be purchased at a certain amount of money.
For example, a producer wants to spend Rs. 300 on the factors of production, namely X and Y.
The price of X in the market is Rs. 3 per unit and price of Y is Rs. 5 per unit.
As shown in Figure-10, if the producer spends the whole amount of money to purchase X,
then he/she can purchase 100 units of X, which is represented by OL. On the other hand, if the
producer purchases Y with the whole amount, then he/she would be able to get 60 units, which
is represented by OH.
If points H and L are joined on X and Y axes respectively, a straight line is obtained, which
is called Iso-cost line. All the combinations of X and Y that lie on this line, would have the same
amount of cost that is Rs. 300. Similarly, other iso-cost lines can be plotted by taking cost more
than Rs. 300, in case the producer is willing to spend more amount of money on production
factors. With the help of isoquant and iso-cost lines, a producer can determine the point at which
Inputs yield maximum profit by incurring minimum cost. Such a point is termed as producer’s
equilibrium.
Economics of scale :
Economies refers to lower costs; hence economies of scale would mean lowering the cost of
production by way of producing in bulk. Economies of scale refers to efficiencies associated with
large scale operations.
It is a situation in which the long run average cost of producing a good or service decrease
with increase in the level of output.

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PRODUCTION ANALYSIS -

(a) whether to produce or not,

@ Production Function with one variable input

Stages in Law of Variable Proportion –

Causes of Increasing Returns –

Causes of Diminishing Returns –

Causes of Negative Returns-

Assumptions of Law of Variable Proportion –

1. State of technology does not change

Iso – Greek – means equal | quant – means quantity

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