1. Introduction to Production,
Factors of Production and
Scales
Nitish Kumar Arya
M.A. Economics
Banaras Hindu University
Varanasi – 221005

2. What is Production?
• Production to an economist, is the creation of utilities to
satisfy wants; whether that means the creation of a good
itself in agriculture or industry; its transport from the
point of production to the point of consumption
(geographical distribution); its transport through time
from the moment of production to the moment of
consumption, in stock-piles, cold stores, warehouses or
granaries (distribution through time); or the provision
of personal services directly enjoyed by individuals or
groups such as health education, health and
entertainment

3. Types of Production
• Primary production - Man’s inheritance of
natural wealth such as mining, agriculture,
fishery, forestry etc
• Secondary production - derived production
from natural primary products - industry for
example
• Tertiary production
– Commercial services - wholesale, banks,
insurance, export house
– Personal services - professor, doctor, advocates

4. Production Theory
• In production resources used for the production
of a product or service are known as factors of
production (also known as inputs)
– land
– labour
– capital
– organization
• Production Function
– P = f(A,B,C,D)

5. Law of Variable Proportions
• “as the quantity of a variable input is increased
by equal doses, keeping the quantities of other
inputs constant, the total product will increase,
but after a point, at a diminishing rate”
• In other words, when more and more units of
the variable factor is used (holding the
quantities of other factors constant), a point is
reached beyond which the marginal product,
then the average product and finally the total
product will diminish
• This law is also known as law of diminishing
returns

6. Law of Diminishing Returns

7. -20
0
20
40
60
80
0 5 10
Total Pdt
Avge Pdt
Marginal Pdt
Law of Diminishing Returns

8. Importance of Law
• It applies to not only agriculture but also
industry - universal applicability
• By substituting one factor in place of other,
efficiency (or higher levels of production
and productivity) can be achieved
• Remember the importance of capital and
labour as factors of production in
developing nations

9. Law of Returns to Scale
• What happens when all the inputs are
increased in the same proportion?
• The scale of production will increase - but
effect on production shows three stages
– Increasing Returns to Scale
– Constant Returns to Scale
– Diminishing Returns to Scale

10. Law of Returns to Scale

11. LawofReturnstoScale
0
5
10
15
0 20 40 60 80
Scale
Returns

12. Production Function
Isoquant and Isocost Approach
• An isoquant is a curve on which the various
combinations of labor and capital show the
same output. This curve is also known as
production indifference curve

13. Production Function
Isocost Approach
• Isocost curves are also known as outlay lines,
price lines, input-price lines, factor-cost lines,
constant-outlay lines etc. Each isocost line
represents the different combinations of two
inputs that a firm can buy for a given sum of
money at the given price of each point.

14. Isocost - Diagram
• The point where the isocost line tangent to an isoquant curve
represent the least-cost combination of the two factors
capital
labour

15. Equilibrium of a Firm -What is
equilibrium?
• Firms will produce in such a way that the profit is
maximized
• Firms will not change the production function at
equilibrium output
• Profit = TR-TC
• TR = P x Q (price x quantity)
• AR = TR/Q = (P x Q)/Q = P
– therefore, AR curve showing different values of AR at
various levels of output is same as the demand curve
faced by an individual firm (latter shows quantities)

16. Shape of Demand Curve
• Relationship between AR and Q is shown by the
shape of the demand or AR curve
– AR upward sloping or rising left to right
– AR downward sloping
– AR horizontal to X axis
• First possibility is unlikely - a firm may not be
able to sell larger and larger output by charging
higher and higher price
• The second and third depends on the type of
market

17. Marginal Revenue
• MR= TR (N+1) - TR (N) or change in total
revenue upon change in quantity
• Therefore, MR is equal to the slope of TR curve
• Relation between AR and MR
– MR = change TR/change Q
• MR = change (PxQ)/change Q
• = change (ARxQ)change Q
• =AR(change Q/change Q) + Q (change AR/change Q)
– MR=AR+Q(change AR/change Q)
– therefore (MR-AR) = Qx(slope of AR curve)
• MR = AR when AR is horizontal and MR is <AR when
AR is downward sloping