– We will focus on supply in this chapter. We will
analyze how the factors of production are
combined in a firm to produce goods and services.
– Production means the process of using the factors
of production to produce goods or services
– Also can be stated as, ‘Transformation of inputs
4. • Factors of production
5. • Production function
The functional relationship between inputs(factors of
production) and outputs ( goods and services)
It is able to show maximum output that can be
produce with the given inputs
It can be represented in the form of a mathematical
equation such as :
Where Q is amount of output per unit of time
K,L,M,etc. are the various factors of production like
capital, labour, raw material, etc.
Production function can be represented in the form of
a table, equation or graph
Q = f(K,L,M,etc.)
6. Short-run and Long Run Production function
Short run and Long Run depend on the inputs, which
can be varied in production
There are two type of factor inputs :
fixed input - an input in which the quantity does
not change according to output. Fro example,
machinery, land, buildings, tools, equipment, etc.
Variable input – an input in which the quantity
changes according to output. For example, raw
materials, electricity, fuel, transportation,
7. The short run period is the time frame which at least
of the inputs (factors of production) is fixed but the
other inouts are varied
The long run period is the time frame in which all
inout are variable. In the long run firms can alter the
inputs to increase the output.
8. Law of Diminishing Marginal Returns
This law explain the behaviour of production
functions in the short run.
The law states that if quantities of certain factors
are increased while the quantities of one or more
factors are held constant, beyond of certain level
of production, the rate of increase in output will
decrease (total pruduction wil increase in
decreasing rate) and eventually the marginal
The law also known as the law of variable
proportions because it show how output varies
when the proportion of a variable input to fixed
input used in production varies.
9. Total Product (TP) -- It is the amount of output
when given amount of that input is used together
with fixed input
Average Product (AP) -- It can be obtained by dividing
the total product by the amount of that input used.
In this case labour is used.
Average Product (APL) = Total Production
Average Product (APK) = Total Production
10. Marginal Product (MP) – It is the change in the total
product of that input corresponding to an addition or
unit change in its labour. Marginal product is the
additional to total product when one more unit of
labour is employed.
Marginal Product (MPL) = Change in Total Product
Change in Labour
MPL = ∆TP
Marginal Product (MPK) = Change in Total Product
Change in Capital
MPK = ∆TP
13. Relationship between Total Product(TP) and Marginal
• When MP is increasing, TP will increase at an increasing rate.
• When MP is decreasing, TP will increase at a decreasing rate
• When MP is zero, TP is at Maximum.
• When MP is negative, TP declines
Relationship between Marginal Product(MP) and
Average Product (AP)
• When MP is above AP, AP is increasing
• When MP equals to AP, AP is at maximum.
• When MP below to AP, AP is decreasing.
15. • Isoquant Analysis
– The term isoquant bas been derived from “iso” which
means equal, and “Quant” meaning quantity .
– An isoquant represent all the possible combinations of
variable input that are used to generate the same level of
output (total product).
– The isoquant analysis illustrates that there are various
ways to generate a given quantity of output in one period
16. • Let us take the example of a firm roducing soymilk that used
the input of labour and capital.
• Table 6.4 below lists the output that the firm can produce
with various combinations of input.
1 2 3 4 5
1 250 450 600 700 800
2 450 650 800 900 950
3 550 800 950 1050 1100
4 700 900 1050 1150 1200
5 800 950 1100 1200 1250
18. The properties of isoquant are :
1. Isoquant curve slopes downward from left to
2. Isoquant curve is convex to origin
3. An isoquant far away from the origin
represents a larger output
4. Isoquant curve never intersect with each
19. Isoquant Map
• An isoquant map is a number of isoquants that combined in a
• The isoquant map can be used to estimates the maximum
attainable output from different combinations of inputs.
• Figure 6.6 show four different isoquants based on data from
20. • A firm has two options of producing maximum
output. The first option is that a firm can using
1 machine and 5 labours as shown in point A,
Another option is by using 5 machines and 1
labour as shown in point D
• All the points on this isoquant curve represent
the input combinations that can produce 800
can of soy milk per month
• A higher isoquant curve represent a higher
level of output
21. • Marginal Rae of Technical Substitution
MRTS = - Change in Capital
Change in Labour
= - ∆K
22. Long Run Production Function
– In the long run, all factors including plants and machinery
are variable. A firm can expand its scale of productivity by
increasing all inputs such as more labour, more equipment,
more buildings, etc.
– The law of returns to scale applies in the long run
– The law refers to the effects of changes in the scale of
– The responsiveness of output to a given proportionate
change in quantities of all inputs is called returns to scale
– We will look into how proportion output changes when
there is some proportionate change in the amount of all
23. There are three possibilities
1. Increasing Returns to Scale -
Quantity of all inputs < Outputs double
(labour and capital)
24. 2. Constant Returns to Scale
Quantity of all inputs = Output doubles
(labour and capital)
• In this chapter, we will explain the relationship between
costs and output
• We will also define the cost of production, identify various
types of costs and analyze short-run costs and long run
• Cost of production refers to the expenses incurred by the
producer in producing a particular quantity of output.
• There are different concepts of cost such as implicit and
explicit costs, opportunity costs and social costs
28. o Implicit Cost and Explicit Cost
Implicit costs – the value of input service that are used in
production which are nor purchased in the market.
It is the value self owned, self employed resources utilized in
Implicit is included in economic cost but excluded in
Example of implicit costs would be the opporturnity cost of
the owner’s wife providing (labour) service in production, a
self-owned factory and the interest saved because the capital
is one’s own.
29. Explicit Cost - the value of resources purchased for
Explicit both included in both economic and accounting costs
Examples of explicit cost are wages and salaries to workers,
payment for fuel, transportation, electricity and power and
expenditure in machinery and equipment
Therefore economic cost, which included both implicit and
explicit cost, is higher than accounting cost.
ACCOUNTING COST < EONOMIC COST
30. o Opportunity Cost
The value of the next best use of a resource.
In other words, opportunity costs of a particular oroduct is
the value of the forgone alternative product.
o Social Cost
The total cost of production of a product and includes direct
ad indirect costs incurred by society
Examples of social costs are water pollution from industrial
waste contaminating rivers, and air pollution from mining
activities, factory smoke and exhaust fumes from a lare
number of vehicles.
31. o Sunk Cost
The cost that a firm cannot recover from the expenditure it
has been made is called as sunk costs.
Only counted in accounting costs and not in economic costs
Example, a firm purchased specialized machinery for the
purpose of production. The equipment that firm purchased
was design only to do specific work with no alternative use.
Then the purchase of such equipment is sunk cost for a firm
because it has no alternative use and has zero opportunity
Therefore, sunk cos not included in economic cost because it
has no opportunity costs
IN conclusion, sunk cost is irrelevant to firm when making
future economic decisions.