Microeconomic techniques are used to analyze production efficiency, optimum factor
allocation, costs, and economies of scale and to estimate the firm's cost function. A production function is a function that specifies the output of a firm, an industry, or an entire economy for all combinations of inputs. This function is an assumed technological relationship, based on the current state of engineering knowledge; it does not represent the result of economic choices, but rather is an externally given entity that influences economic decision-making. Almost all economic theories presuppose a production function, either on the firm level or the aggregate level.
Introduction
The maximum output of a technologically-determined production process is a mathematical function of one or more inputs. Put another way, given the set of all technically feasible combinations of output and inputs, only the combinations encompassing a maximum output for a specified set of inputs would constitute the production function. Alternatively, a production function can be defined as the specification of the minimum input requirements needed to produce designated quantities of output, given available technology. It is usually presumed that unique production functions can be constructed for every production technology By assuming that the maximum output technologically possible from a given set of inputs is achieved, economists using a production function in analysis are abstracting from the engineering and managerial problems inherently associated with a particular production process. The engineering and managerial problems of technical efficiency are assumed to be solved, so that analysis can focus on the problems of allocative efficiency. The firm is assumed to be making allocative choices concerning how much of each input factor to use and how much output to produce, given the cost (purchase price) of each factor, the selling price of the output, and the technological determinants represented by the production function. A decision frame in which one or more inputs are held constant may be used; for example, (physical) capital may be assumed to be fixed (constant) in the short run, and labour and possibly other inputs such as raw materials variable, while in the long run, the quantities of both capital and the other factors that may be chosen by the firm are variable. In the long run, the firm may even have a choice of technologies, represented by various possible production functions. The relationship of output to inputs is non-monetary; that is, a production function relates physical inputs to physical outputs, and prices and costs are not reflected in the function. But the production function is not a full model of the production process: it deliberately abstracts from inherent aspects of physical production processes that some would argue are essential, including error, entropy or waste. Moreover, production functions do not ordinarily model the business processes, either, ignoring the role of management. A Cobb Douglas production function is a one of the famous type of Production function it is express as
Where: Y = total production (the monetary value of all goods produced in a year) L = labor input K = capital input A = total factor productivity and are the output elasticities of labor and capital, respectively. These values are constants determined by available technology.
Graphical representation:
Explanation From the origin to point A, the firm is experiencing increasing returns to variable inputs: As additional inputs are employed, output increases at an increasing rate. Both marginal physical product (MPP, the derivative of the production function) and average physical product (APP, the ratio of output to the variable input) are rising. The inflection point A defines the point beyond which there are diminishing marginal returns, as can be seen from the declining MPP curve beyond point X. From point A to point C, the firm is experiencing positive but decreasing marginal returns to the variable input. As additional units of the input are employed, output increases but at a decreasing rate. Point B is the point beyond which there are diminishing average returns, as shown by the declining slope of the average physical product curve (APP) beyond point Y. Point B is just tangent to the steepest ray from the origin hence the average physical product is at a maximum. Beyond point B, mathematical necessity requires that the marginal curve must be below the average curve
Production function
Production theory is the study of production, or the economic process of converting inputs into outputs. Production uses resources to create a good or service that is suitable for use, gift-giving in a gift economy, or exchange in a market economy. This can include manufacturing, storing, shipping, and packaging. Some economists define production broadly as all economic activity other than consumption. They see every commercial activity other than the final purchase as some form of production. Production is a process, and as such it occurs through time and space. Because it is a flow concept, production is measured as a rate of output per period of time. There are three aspects to production processes: 1. the quantity of the good or service produced, 2. the form of the good or service created, 3. the temporal and spatial distribution of the good or service produced. A production process can be defined as any activity that increases the similarity between the pattern of demand for goods and services, and the quantity, form, shape, size, length and distribution of these goods and services available to the market place.
Factors of production The inputs or resources used in the production process are called factors of production by economists. The myriad of possible inputs are usually grouped into five categories. These factors are: Raw materials Machinery Labor services Capital goods Land
In the long run, all of these factors of production can be adjusted by management. The short run, however, is defined as a period in which at least one of the factors of production is fixed. A fixed factor of production is one whose quantity cannot readily be changed. Examples include major pieces of equipment, suitable factory space, and key managerial personnel. A variable factor of production is one whose usage rate can be changed easily. Examples include electrical power consumption, transportation services, and most raw material inputs. In the short run, a firms scale of operations determines the maximum number of outputs that can be produced. In the long run, there are no scale limitations. total, average, and marginal product The shape of total product curve is The total product (or total physical product) of a variable factor of production identifies what outputs are possible using various levels of the variable input. This can be displayed in either a chart that lists the output level corresponding to various levels of input, or a graph that summarizes the data into a total product curve. The diagram shows a typical total product curve. In this example, output increases as more inputs are employed up until point A. The maximum output possible with this production process is Qm. (If there are other inputs used in the process, they are assumed to be fixed.) The average physical product is the total production divided by the number of units of variable input employed. It is the output of each unit of input. If there are 10 employees working on a production process that manufactures 50 units per day, then the average product of variable labour input is 5 units per day. The shape of Average and Marginal Physical product Curves is
The average product typically varies as more of the input is employed, so this relationship can also be expressed as a chart or as a graph. A typical average physical product curve is shown (APP). It can be obtained by drawing a vector from the origin to various points on the total product curve and plotting the slopes of these vectors. The marginal physical product of a variable input is the change in total output due to a one unit change in the variable input (called the discrete marginal product) or alternatively the rate of change in total output due to an infinitesimally small change in the variable input (called the continuous marginal product). The discrete marginal product of capital is the additional output resulting from the use of an additional unit of capital (assuming all other factors are fixed). The continuous marginal product of a variable input can be calculated as the derivative of quantity produced with respect to variable input employed. The marginal physical product curve is shown (MPP). It can be obtained from the slope of the total product curve. Because the marginal product drives changes in the average product, we know that when the average physical product is falling, the marginal physical product must be less than the average. Likewise, when the average physical product is rising, it must be due to a marginal physical product greater than the average. For this reason, the marginal physical product curve must intersect the maximum point on the average physical product curve. Diminishing returns Diminishing returns can be divided into three categories: 1. Diminishing Total return, which implies reduction in total product with every additional unit of input. This occurs after point A in the graph. 2. Diminishing Average returns, which refers to the portion of the APP curve after its intersection with MPP curve. 3. Diminishing Marginal returns, refers to the point where the MPP curve starts to slope down and travels all the way down to the x-axis and beyond. Putting it in a chronological order, at first the marginal returns start to diminish, then the average returns, followed finally by the total returns. Diminishing marginal returns These curves illustrate the principle of diminishing marginal returns to a variable input (not to be confused with diseconomies of scale which is a long term phenomenon in which all factors are allowed to change). This states that as you add more and more of a variable input, you will reach a point beyond which the resulting increase in output starts to diminish.. Other ways of expressing the production relationship The total, average, and marginal physical product curves mentioned above are just one way of showing production relationships. They express the quantity of output relative to the amount of variable input employed while holding fixed inputs constant. Because they depict a short run relationship, they are sometimes called short run production functions. If all inputs are allowed to be varied, then the diagram would express outputs relative to total inputs, and the function would be a long run production function. If the mix of inputs is held constant, then output would be expressed relative to inputs of a fixed composition, and the function would indicate long run economies of scale. Rather than comparing inputs to outputs, it is also possible to assess the mix of inputs employed in production. An isoquant (see below) relates the quantities of one input to the quantities of another input. It indicates all possible combinations of inputs that are capable of producing a given level of output. Rather than looking at the inputs used in production, it is possible to look at the mix of outputs that are possible for any given production process. This is done with a production. It indicates what combinations of outputs are possible given the available factor endowment and the prevailing production technology. Isoquants
An isoquant represents those combinations of inputs, which will be capable of producing an equal quantity of output; the producer would be indifferent between them. The isoquants are thus contour lines, which trace the loci of equal outputs. As the production remains the same on any point of this line, it is also called equal product curve. Let Q0 = f(L,K) be a production factor, where Q0 = A is a fixed level of production. L = Labour K = Capital If three combinations of labour and capital A, B and C produces 10 units of product, than the isoquant will be like Figure 1. Here we see that the combination of L1 labour and K3 capital can produce 10 units of product, which is A on the isoquant. Now to increase the labour keeping the production the same the organization has to decrease capital.In Figure 1 B is the point where capital decreases to K2, while labour increases to L2. Similarly, 10 units of product may be produced at point C on the isoquant with capital K1 and labour L3. Each of the factor combinations A, B and C produces the same level of output, 10 units.
The marginal rate of technical substitution
Marginal Rate of Technical Substitution Isoquants are typically convex to the origin reflecting the fact that the two factors are substitutable for each other at varying rates. This rate of substitutability is called the marginal rate of technical substitution (MRTS) or occasionally the marginal rate of substitution in production. It measures the reduction in one input per unit increase in the other input that is just sufficient to maintain a constant level of production. For example, the marginal rate of substitution of labour for capital gives the amount of capital that can be replaced by one unit of labour while keeping output unchanged. To move from point A to point B in the diagram, the amount of capital is reduced from Ka to Kb while the amount of labour is increased only from La to Lb. To move from point C to point D, the amount of capital is reduced from Kc to Kd while the amount of labour is increased from Lc to Ld. The marginal rate of technical substitution of labour for capital is equivalent to the absolute slope of the isoquant at that point (change in capital divided by change in labour). It is equal to 0 where the isoquant becomes horizontal, and equal to infinity where it becomes vertical. The opposite is true when going in the other direction (from D to C to B to A). In this case we are looking at the marginal rate of technical substitution capital for labour (which is the reciprocal of the marginal rate of technical substitution labour for capital). It can also be shown that the marginal rate of substitution labour for capital, is equal to the marginal physical product of labour divided by the marginal physical product of capital. In the unusual case of two inputs that are perfect substitutes for each other in production, the isoquant would be linear (linear in the sense of a function y = a bx ). If, on the other hand, there is only one production process available, factor proportions would be fixed, and these zero-substitutability isoquants would be shown as horizontal or vertical lines. Production function and elasticity
In microeconomics and macroeconomics, a production function is a function that specifies the output of a firm, an industry, or an entire economy for all combinations of inputs. This function is an assumed technological relationship, based on the current state of engineering knowledge; it does not represent the result of economic choices, but rather is an externally given entity that influences economic decision-making. Almost all economic theories presuppose a production function, either on the firm level or the aggregate level. In this sense, the production function is one of the key concepts of mainstream neoclassical theories. Some non-mainstream economists, however, reject the very concept of an aggregate production function.
Concept of production functions In micro-economics a production function is a function that specifies the output of a firm for all combinations of inputs. A meta-production function (sometimes metaproduction function) compares the practice of the existing entities converting inputs into output to determine the most efficient practice production function of the existing entities, whether the most efficient feasible practice production or the most efficient actual practice production. In either case, the maximum output of a technologically-determined production process is a function of one or more inputs. Put another way, given the set of all technically feasible combinations of output and inputs, only the combinations encompassing a maximum output for a specified set of inputs would constitute the production function. Alternatively, a production function can be defined as the specification of the minimum input requirements needed to produce designated quantities of output, given available technology. It is usually presumed that unique production functions can be constructed for every production technology. By assuming that the maximum output technologically possible from a given set of inputs is achieved, economists using a production function in analysis are abstracting from the engineering and managerial problems inherently associated with a particular production process. The engineering and managerial problems of efficiency are assumed to be solved, so that analysis can focus on the problems of allocative efficiency. The firm is assumed to be making allocative choices concerning how much of each input factor to use and how much output to produce, given the cost (purchase price) of each factor, the selling price of the output, and the technological determinants represented by the production function. A decision frame in which one or more inputs are held constant may be used; for example, (physical) capital may be assumed to be fixed (constant) in the short run, and labour and possibly other inputs such as raw materials variable, while in the long run, the quantities of both capital and the other factors that may be chosen by the firm are variable. In the long run, the firm may even have a choice of technologies, represented by various possible production functions. The relationship of output to inputs is non-monetary; that is, a production function relates physical inputs to physical outputs, and prices and costs are not reflected in the function. But the production function is not a full model of the production process: it deliberately abstracts from inherent aspects of physical production processes that some would argue are essential, including error, entropy or waste. Moreover, production functions do not ordinarily model the business processes, either, ignoring the role of management. The primary purpose of the production function is to address allocative efficiency in the use of factor inputs in production and the resulting distribution of income to those factors. Under certain assumptions, the production function can be used to derive a marginal for each factor, which implies an ideal division of the income generated from output into an income due to each input factor of production. Specifying the production function A production function can be expressed in a functional form as the right side of Q = f(X 1 ,X 2 ,X 3 ,...,X n ) Where: Q = quantity of output X 1 , X2, X3,..., Xn = quantities of factor inputs (such as capital, labour, land or raw materials). If Q is not a matrix (i.e. a scalar, a vector, or even a diagonal matrix), then this form does not encompass joint production, which is a production process that has multiple co-products. On the other hand, if f maps from R n to R k then it is a joint production function expressing the determination of k different types of output based on the joint usage of the specified quantities of the n inputs. One formulation, unlikely to be relevant in practice, is as a linear function: Q = a + bX 1 + cX 2 + dX 3 +... Where a, b, c, and d are parameters that are determined empirically. Another is as a Cobb-Douglas production function:
The Leontief production function applies to situations in which inputs must be used in fixed proportions; starting from those proportions, if usage of one input is increased without another being increased, output will not change. This production function is given by
Other forms include the constant elasticity of substitution production function (CES), which is a generalized form of the Cobb-Douglas function, and the quadratic production function. The best form of the equation to use and the values of the parameters (a, b, c,... ) vary from company to company and industry to industry. In a short run production function at least one of the X 's (inputs) is fixed. In the long run all factor inputs are variable at the discretion of management. Production function as a graph
Any of these equations can be plotted on a graph. A typical (quadratic) production function is shown in the following diagram under the assumption of a single variable input . From the origin, through points A, B, and C, the production function is rising, indicating that as additional units of inputs are used, the quantity of output also increases. Beyond point C, the employment of additional units of inputs produces no additional output (in fact, total output starts to decline); the variable input is being used too intensively. With too much variable input use relative to the available fixed inputs, the company is experiencing negative marginal returns to variable inputs, and diminishing total returns. In the diagram this is illustrated by the negative marginal physical product curve (MPP) beyond point Z, and the declining production function beyond point C. From the origin to point A, the firm is experiencing increasing returns to variable inputs: As additional inputs are employed, output increases at an increasing rate. Both marginal (MPP, the derivative of the production function) and average physical product (APP, the ratio of output to the variable input) are rising. The inflection point A defines the point beyond which there are diminishing marginal returns, as can be seen from the declining MPP curve beyond point X. From point A to point C, the firm is experiencing positive but decreasing marginal returns to the variable input. As additional units of the input are employed, output increases but at a decreasing rate. Point B is the point beyond which there are diminishing average returns, as shown by the declining slope of the average physical product curve (APP) beyond point Y. Point B is just tangent to the steepest ray from the origin hence the average physical product is at a maximum. Beyond point B, mathematical necessity requires that the marginal curve must be below the average curve. Shifting a production function By definition, in the long run the firm can change its scale of operations by adjusting the level of inputs that are fixed in the short run, thereby shifting the production function upward as plotted against the variable input. If fixed inputs are lumpy, adjustments to the scale of operations may be more significant than what is required to merely balance production capacity with demand. For example, you may only need to increase production by a million units per year to keep up with demand, but the production equipment upgrades that are available may involve increasing productive capacity by 2 million units per year.
If a firm is operating at a profit-maximizing level in stage one, it might, in the long run, choose to reduce its scale of operations (by selling capital equipment). By reducing the amount of fixed capital inputs, the production function will shift down. The beginning of stage 2 shifts from B1 to B2.
Law of variable proportion
The law of variable proportion is the most important law in economics. Economists like Alfred Marshall, Benham, and Samulson contributed maximum to this law. This law is based on short run production function. 1. Understand short run production Function. 2. Effect of continuous increase of variable factors on Fixed Factors and on output in the short run. 3 How this Law operates in each and every stage of life? The Law of Variable Proportions which is the new name of the famous Law of Diminishing Returns.
According to Stigler "As equal increments of one input are added, the inputs of other productive services being held constant, beyond a certain point, the resulting increments of produce will decrease i.e., the marginal product will diminish. According to Paul Samulson "An increase in some inputs relative to other fixed inputs will in a given state of technology cause output to increase, but after a point, the extra output resulting from the same addition of extra inputs will become less". The law of variable proportions states that as the quantity of one factor is increased, keeping the other factors fixed, the marginal product of that factor will eventually decline. This means that up to the use of a certain amount of variable factor, marginal product of the factor may increase and after a certain stage it starts diminishing. When the variable factor becomes relatively abundant, the marginal product may become negative. Assumptions of Law. Constant technology--- This law assumes that technology does not change throughout the operation of the law. Fixed amount of some factors.One factor of production has to be fixed for this law. Possibility of varying factor proportionsThis law assumes that variable factors can be - -changed in the short run. Diagrammatic Representation Following table explains the working of law.
Diagrammatic Representation of Law.
This law has THREE stages 1. Increasing Returns. 2. Diminishing Returns. 3. Negative Returns. Increasing Returns: In this stage, Average Product increases, Marginal Product increases and also Total Product. TP increases at more proportionate rate. TP increases from 10 to 25 units. This stage is known as increasing returns. This stage of increasing output by increasing labour does not last for a long time. This continues up to 3 rd units. The point F onwards TP increases at a diminishing rate. In the first stage, marginal product curve of a variable factor rises in a part and then falls. The average product curve rises throughout and remains below the MP curve. MP reaches maximum in this stage. Diminishing Returns: This is the most important stage in the production function. In stage 2, the total production continues to increase at a diminishing rate until it reaches its maximum point where the 2nd stage ends. In this stage both the marginal product (MP) and average product of the variable factor are diminishing but are positive. When TP reaches the maximum, MP is zero.MP intersects the X axis in this stage. As more and more variable factors are used on fixed factor, marginal and average product begins to decrease. Factors of production are indivisible. Economically this is the most viable area of production. 3. Negative Returns. In the 3rd stage, the TP decreases. The TP, curve slopes downward (From point H onward). The MP curve falls to zero at point L 2 and then is negative. When we increase the labour even after MP becomes zero, then MP becomes negative and it goes below the X axis. This is the most unviable region. In our table from 8 th unit onwards, this stage starts. Any sensible producer will stop the production in the second stage where AP and MP begin to decrease, but MP has not become negative. The producer will employ the variable factor (say labor) up to the point where the marginal product of the labor equals to the wage rate.
Practical aspects With reference of Pakistani Economy We can review Increasing and decreasing and constant return of Pakistani economics sector from the Economic survey 2011 01. GROWTH AND INVESTMENT ` The Real GDP is estimated to grow at 2.4 percent on the back of strong performance of services sector as against actual growth of 3.8 percent last year and target of 4.5 percent. ` The growth in the agriculture is estimated at 1.2 percent on the back of 3.7 percent growth in the livestock sector. Major Crops accounting for 31.1 percent of agricultural value added registered negative growth of 4.0percent compared to a negative growth of 2.4 percent last year and a target of 3.7 percent. Minor crops registered a growth rate of 4.8 percent compared to the target of 3.0 percent and massive negative growth of 7.8 percent last year. Output in the manufacturing sector has witnessed expansion of 3 percent in 2010-11 as compared to expansion of 5.5 percent last year on the back of strong performance from small and medium manufacturing sector Large-scale manufacturing grew by 0.98 percent (July-February 2010-11 incorporated in the national ` 02. AGRICULTURE The agriculture growth this year is estimated at 1.2 percent as compared with 0.6 percent during 2009-10. Cotton production has decreased from 12,913 thousand bales in 2009-10 to 11,460 thousand bales in 2010-11, showing a decrease of 11.3 percent. Wheat production has increased from 23,311 thousand tons in 2009-10 to 24,214 thousand tons in 2010-11, showing an increase of 3.9 percent. Rice production has decreased from 6,883 thousand tons in 2009-10 to 4,823 thousand tons in 2010-11, showing a decrease of 29.9 percent. Sugarcane production has increased by 12 percent to 55.3 million tons in 2010-11 from 49.4 million tons last year. Gram production has increased from 562 thousand tons in 2009-10 to 523 thousand tons in 2010-11, showing a decrease of 6.9 percent. Maize production has increased from 3,262 thousand tons in 2009-10 to 3,341 thousand tons in 2010.In minor crops, the production of potato, onion and mash increased by 18.6 percent, 11.2 percent and 1.0 percent, respectively. However, the production of mung, chillies and mash decreased by 35.5 percent, 8.6 percent and 2.7 percent respectively. Agriculture credit disbursement of Rs. 168.7 billion during July-March 2010-11 is higher by 1.4 percent, as compared to Rs. 166.3 billion over the same period last year. The domestic production of fertilizers during the first nine months (July-March 2010-11) of the current fiscal year was higher by 2.7 percent as compared with corresponding period last year. On the other hand, the import of fertilizer decreased by 50.4 percent, the off-take of fertilizer also decreased by 11.3 percent during the same period last year.
03. Crude Oil Production of crude oil per day has increased to 65,996.50 barrels during July-March 2010-11 from 65,245.69 barrels per day during the same period last year, showing an increase of 1.15 percent. The transport sector consumed 47.82 percent of petroleum products, followed by power sector (42.84 percent), industry (6.66 percent), other government (1.93 percent), household (0.49 percent) and agriculture (0.26 percent) during July-March 2010-11 04. Natural Gas The average production of natural gas per day stood at 4050.84 million cubic feet during July-March 2010-11, as compared to 4,048.76 million cubic feet over the same period last year showing an increase of 0.05 percent. The power sector consumed 23.81 percent of gas followed by industrial (20.15 percent), household (16.75 percent), fertilizer (15.04 percent), commercial (2.45 percent) and cement sector (0.05 percent) during July-March 2010-11 05. Electricity The total installed capacity of PEPCO system is 20,681 MW as of March 2011, compared to 20,190MW in first nine months of the last fiscal year. Total installed capacity of WAPDA stood at 11,439 MW during July-March 2010-11 of which hydel accounts 57.30 percent or 6,555 MW, thermal accounts for 42.70 percent or 4,884 MW. During the first nine month of current fiscal year 66,928 GWh of electricity has been generated by WAPDA as against 64,935 GWh in the same period last year showing an increase of 3.07 percent. The number of villages electrified increased to 160,110 by March 2011 from 147,038 recorded in March 2010. 06. CNG Presently there are 3329 CNG stations operating throughout the country. By March 2011 about 2.5 millions have been converted to CNG 07. Coal Supply of coal during July-March 2010-11 has been recorded at 5.85 million tonnes compared to 5.304 million tonnes in the first nine months of last fiscal year. Brick kilns and cement industry consumed 56.6 percent and 42.7 percent respectively of the suppliedcoal.The government is developing Thar Coalfield in order to increase the share of coal in energy mix and to reduce dependency on expensive imported fuel. 08. Telecommunication 3G in Pakistan has got the approval of auction from the Economic Coordination Committee in the opening week of August and the auction will take place in the October. The project manager of "3G in Pakistan" is a senior official in the Ministry of Information Technology; he said that the committee of the cabinet wants to issue the license for 3G in Pakistan as early as possible without any kind of limitations. In my view the launch of 3G in Pakistan is a big step of Pakistan Telecommunication Authority towards advancement in the telecom industry according to international standards. It will be helpful for the economy as its generating income for the current fiscal year through auction for 3G and it is also a thrilling offer for data users in Pakistan Conclusion and suggestions The Telecommunication and Growth and Investment sector of Pakistan is suffering increasing returns as in both sectors we are producing larger than previous year product. The Agriculture sector is suffering decreeing returns and the Energy(electricity) sector and CNG sector is suffering negative returns. We should improve our inputs qualities, eliminate corruption and should use technically efficient methods for production so that we can produce all goods and services on increasing returns scale.
Lahore College For Women University Lahore
Assignment of Computer Applications
Presented to:
Mrs.Uzma Shahid
Presented by:
Hira Bashir Roll no :427 Bs(3)5 th semester Major:Economics Section: A
Lahore College For Women University Lahore
Assignment of Managerial Economics
Presented to:
Mrs.sameera
Presented by:
Hira Bashir Roll no :427 Bs(3)5 th semester Major:Economics Section: A