Factors of production, Production function and law of diminishing marginal product.

1. Production Function
Dr Raju Indukoori

2. Production
 It is the process of combining various material
and immaterial inputs in order to make
consumable goods.
 It is the act of creating an output, a good or
service which has value and contributes to the
utility of individuals.
 It is the process transforming inputs into outputs
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3. Forms of Production
1. Unit or job production: Customized production. EX: Small business
like restaurants
2. Batch production: Production in batches with limited quantity. Ex:
Retail products like FMCG
3. Mass production / Flow Production / Assembly line
production: The final product is the result of various subsets of
production in a production layout.
4. Process production or continuous production: It is continuous
on 24*7 basis with more intervention of machine than human beings.
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4. Factors of Production
1. Land
2. Labor
3. Capital
4. Entrepreneurship
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5. Production Function
P = f(C, L)
Where
P = Production
C = Capital
L = Labor
T = Technology is assumed to be constant
*Land is fixed variable
* This is the production function for an agricultural land
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6. Production Function
In Business Economics Material is the prime
variable in production. accordingly
P = f(M,C, L)
Where
P = Production
M = Material
C = Capital
L = Labor
T = Technology is assumed to be constant
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7. Cobb-Douglas Production Function
 Developed and tested against statistical evidence by
Charles Cobb and Paul Douglas during 1927–1947.
 It represents the technological relationship between the
amounts of two or more inputs (particularly physical
capital and labor) and the amount of output that can be
produced by those inputs.
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8. Cobb-Douglas Production Function
Y=ALβ K∞
Where
Y = Total annual production
L = Total annual person work hours
K = Capital input. It is a measure of all machinery, equipment and buildings. It
is the value of capital input divided by the price of capital.
∞ = Output elasticity of capital
β = Output elasticity of labor
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9. Laws of Production
 Law of diminishing returns : One of the
Factors of production changes keeping other
factors constant.
 Law of variable proportions or Law of
returns to scale: All factors of production
changes.
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10. Law of diminishing returns
 It is also known as
 Law of diminishing marginal returns
 Law of variable proportions
 Law of returns to scale.
 This was propounded by Alfred Marshall
 Law: An increase in the capital and labor applied in the
cultivation of land causes in general a less than
proportionate increase in the amount of produce raised
unless it happens to coincide with an improvement in the
arts of agriculture.
 It is known as law of variable proportions or law of returns
to scale, if all the inputs are proportionately changed.
 It applies to physical production of goods too.
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11. Law of diminishing returns
Assumptions
 All the units of the variable input are homogeneous
 Techniques of production remain constant
 It is possible to vary one input, keeping the others constant
 The analysis relates to the short run
 Diminishing returns arise after a stage
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12. Law of diminishing returns - Interpretation
 Land is kept constant
 Factor inputs capital and labor are increased
 It results in increase in production or returns
 Marginal return increases initially till a point due to the
underutilization of the land earlier
 Beyond that point, marginal returns diminish.
 It can be split into three stages
 Increasing marginal return
 Constant marginal return
 Diminishing marginal return
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13. Law of diminishing returns – Product variation
 Variable factor input: Number of units of labor increases
 Total product
 It is the sum of all additional products due to additional labor.
 It increases as the labor units increase.
 Marginal product: It is the additional product due to the additional
unit of labor
 First stage : Increases
 Second stage : Decreases or diminishes
 Third stage : Becomes negative
 Average product: It Follows the marginal product and it cannot be
negative.
 First stage : Increases as marginal product increases
 Second stage : Stabilizes as marginal product decreases.
 Third stage : Decreases as marginal product decreases.
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14. Law of diminishing returns - Example
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Production schedule of a 10,000 SFt auto ancillary unit
Stage
Number
workers
Additional
workers
Total
Product
Additional
products
Marginal
product
Average
Product
1 40 600 15.0
1 50 10 810 210 4.2 16.2
1 60 10 1,050 240 4.0 17.5
1 70 10 1,320 270 3.9 18.9
2 80 10 1,600 280 3.5 20.0
2 90 10 1,880 280 3.1 20.9
3 100 10 2,150 270 2.7 21.5
3 110 10 2,390 240 2.2 21.7
3 120 10 2,575 185 1.5 21.5
3 130 10 2,670 95 0.7 20.5
4 140 10 2,670 0 0.0 19.1
4 150 10 2,600 -70 -0.5 17.3

15. Product Curves
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0
500
1,000
1,500
2,000
2,500
3,000
1 2 3 4 5 6 7 8 9 10 11 12
-1.0
0.0
1.0
2.0
3.0
4.0
5.0
1 2 3 4 5 6 7 8 9 10 11
0.0
5.0
10.0
15.0
20.0
25.0
1 2 3 4 5 6 7 8 9 10 11 12
Total Product
Average Product
Marginal Product

16. Marginal and total product curves
 As MP increases, TP increases at an increasing rate.
 As MP decreases TP increases at a decreasing rate.
 When MP is zero, TP is maximum and constant.
 As TP decreases, MP becomes negative.
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17. Marginal product and total product
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With the increase quantity of
inputs, the total returns or total
product increases as marginal
product increases.

18. Average and marginal product curves
 When average product increases, marginal product will be
above it.
 When average product is constant, marginal product will be
equal to it.
 When average product decreases, marginal product will be
below it.
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19. Marginal and Average Product curves
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With the increase in variable
factor inputs, marginal and
average product increases
to some respective points
and decrease from there. It
happens due to the
decrease in marginal
product followed by average
product

20. Law of diminishing returns – Limitations
In spite of great utility of this law by the manufacturers in
realty it limitations as follow
 It operates on the assumption that technology is constant
which is not in real.
 Diminishing returns happen in the later stage not in the first
and middle.
 This is applicable in short term, in long term the fixed
variables also change.
 Input variables cannot be homogeneous.
 Input variables mix cannot be in the same proportion.
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