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ECONOMICS

PRESENTATION ON
PRODUCTION FUNCTION
AND ANALYSIS.

WHAT IS PRODUCTION?
Production involves combining two or more factors of
production to produce output. Producers are suppliers
in the product market and consumers in the input
markets.
WHAT
SHOULD
THE FIRM
PRODUCE
?

HOW
HOW
SHOULD
SHOULD
THE
THE FIRM
FIRM
PRODUCE
PRODUCE
??

HOW
HOW
MUCH
MUCH
SHOULD
SHOULD
A
A FIRM
FIRM
SELL?
SELL?

HOW
HOW
SHOUL
SHOUL
D
D THE
THE
FIRM
FIRM
PROMO
PROMO
TE?
TE?

OBJECTIVE OF THE FIRM

SALES
MAXIMIZATIO
N

PROFIT
MAXIMIZATIO
N

PRODUCTION FUNCTION
Production function refers to the technical
relationship between the quantity of goods
produced(output) and the factors of
production(input) necessary to produce it.
Production function can be expressed with the
following equation:

Y= f(L, K, S)
It reads: Production(Y) is a function (f) of labor
(L), Capital(K) and land(S).

DEFINATION OF
PRODUCTION FUNCTION
Production
Function is that
function which
defines the
maximum amount
of output that can
be produced with a
given set of inputs.
Michael R
Baye

TYPES OF PRODUCTION
FUNCTON
PRODUCTION
PRODUCTION
FUNCTION
FUNCTION
INVOLVING
INVOLVING
CHANGES
CHANGES IN
IN
PROPORTION
PROPORTION

PRODUCTION
PRODUCTION
FUNCTION
FUNCTION INVOLVING
INVOLVING
CHANGE
CHANGE IN
IN SCALE
SCALE

PRODUCTION
PRODUCTION
FUNCTION
FUNCTION
INVOLVING
INVOLVING CHANGE
CHANGE
IN
IN
PROPORTION/SCALE
PROPORTION/SCALE

CHANGES
CHANGES IN
IN SINGLE
SINGLE
VARIABLE
VARIABLE

CHANGE
CHANGE IN
IN ALL
ALL
FACTORS
FACTORS IN
IN THE
THE
SAME
SAME PROPORTION
PROPORTION

CHANGE
CHANGE IN
IN TWO
TWO OR
OR
MORE
MORE INPUTS
INPUTS
WHICH
WHICH ARE
ARE
SUBSTITUTES
SUBSTITUTES

LAW
LAW OF
OF VARIABLE
VARIABLE
PROPORTION
PROPORTION
(generally
(generally short
short run)
run)

LAW
LAW OF
OF
RETURNS(always
RETURNS(always
long
long run
run analysis)
analysis)

EXPLAINED
EXPLAINED WITH
WITH
THE
THE HELP
HELP OF
OF
ISOQUANTS
ISOQUANTS

ASSUMPTIONS OF
PRODUCTION FUNCTION
Technology is assumed to be constant.
It is related to a particular or specific
period.
It is assumed that the manufacturer is
using the best technology.
All inputs are divisible.
Utilization for inputs at maximum level
of efficiency.

FIXED AND VARIABLE


INPUTS(factors of
production)
FIXED INPUT:A fixed input is defined as one, the quantity of
which cannot be changed in the short run as
the level of output changes.
VARIABLE INPUT:A variable input is defined as one, the quantity
of which maybe changed in the short run as
the level of output changes.

LAWS OF PRODUCTION

LAW
LAW OF
OF VARIABLE
VARIABLE
PROPORTIONS
PROPORTIONS OR
OR
RETURN
RETURN TO
TO A
A
FACTOR
FACTOR

A
A single
single variable
variable
factor
factor (other
(other
factors
factors constant)
constant)
Generally
Generally short
short run
run
analysis.
analysis.

LAW
LAW OF
OF RETURNS
RETURNS TO
TO
SCALE
SCALE

All
All factors
factors are
are
variable
variable in
in the
the
same
same proportion.
proportion.
Always
Always long
long run
run
analysis.
analysis.

SHORT TERM
PRODUCTION FUNCTION

PRODUCTION WITH ONE


VARIABLE INPUT
It denotes the relations between the quantity of
an individual input employed and the level of
output produced.
Return to factor exhibits three phases:
1. Increasing return to factor
2. Constant returns to factor
3. Diminishing returns to factor

LAW OF VARIABLE
PROPORTIONS
The law of variable proportion states that if the
input of one resource is increased by equal
increments per unit of time while the input of
other resources are held constant, total output will
increase but beyond sometime the resulting
output increases will become smaller and smaller.

ASSUMPTIONS TO THE
LAW

The law of diminishing returns is valid when the


following conditions are fulfilled.
The state of technology is given.
Only one factor is varied and all other factors
remain fixed
The fixed factor and the variable factor are
combined together in variable proportions in the
process of production.
The units of the variable factor are homogeneous.
The law operates in the short run.

ILLUSTRATION OF THE
LAW

UNITS OF
INPUT(L)

TOTAL
PRODUCT
(TP)

MARGINAL
PRODUCT(
MP)

AVERAGE
PRODUCT(
AP)

STAGE

100

100

100

220

120

110

360

140

120

460

100

115

530

70

106

570

40

95

595

25

85

600

75

594

-6

66

10

560

-34

56

CASE STUDY

BAJAJ AUTO Ltd- SMALL IS


BETTER
Bajaj Auto Ltd was established in 1945 as a trading
company and it obtained its production license in
1959. It is one of the Indias largest 2wheeler
manufacturers and was a dominant player until the
early 1990s .The 2 wheeler industry thrives in the
developing countries like India. But with income levels
rising, people are opting for entry-level motorcycles
rather than scooters.
The 2wheeler industry grew by 11.6% from
5.05million units in 2002-03 to 5.64million units in
2003-04. However, due to global competition, Bajajs
market share declined from 49.3% in 1994 to 38.9%in
1999. In order to overcome this problem, Bajaj auto
has DECIDED THAT SMALL IS BETTER and is
significantly reduced its head count., first in 1998 and
then in 2001 by more than 3,000 persons. In 2000-01
the company cut down its staff strength from 17,213 to

The attempt compacted its employee strength by 9,384 (21,373 in


1997 to 11,531 in 2004) , resulting in a reduction of RS 70.6/- Crore
per annum in its wage bill.
By doing this the company was able to improve its
output/employee/year from 67.7 in 1997 to 101 in 2002 and then
to 132 in 2004, an increase of almost 50% in 7years . The obvious
goal, which is to increase the productivity was made possible , says
Mr Madhur Bajaj , vice chairman . Productivity has gone up in the
last few years, from the level of 67.7 vehicles per employee/year in
the end of the year 2004. consequently , the companys research
and development (R&D) was focused on upgrading the current
products, developing new scooters, and cost reduction mainly in
the entry level segments. The company is setting up a new facility
at the Akurdi complex near Pune for design , analysis, prototyping,
and testing.
In terms of growth, the company witnessed a sharp increase of
55.4% in its sales in the year 2002, as compared to the market
growth of 40% during the previous year. Bajaj auto was also able to
offset its high raw material cost due to increased productivity of its
employees , which also led to reduction in labor cost as % of net
sales from 5.7% to 5%. In 2002, Bajaj had a workforce of 13,000
employees with a network of 422 dealers and over 1200 authorized
service centres.

YEAR

PRODUCTION

NUMBER OF
EMPLOYEES

OUTPUT/EMP
LOYEE/YEAR

1997

1439174

21273

67.7

1998

1354482

18589

72.9

1999

1381765

18585

74.3

2000

1432471

17213

83.2

2001

1212748

13819

87.8

2002

1356463

13482

100.6

2003

1457066

12338

118.1

2004

1516876

11531

131.5

LAW OF RETURN TO
SCALE & ISOQUANT
APPROACH
In this case, the firm expands its output by using
more of two variable inputs that are substitute for
each other. For this purpose a production function
with two variable inputs is introduced.
The inputs are mutually substitutable and law of
diminishing returns operates with the respect to
each output.
THE GEOMETRIC REPRESENTATION OF THIS
FUNCTIONAL RELATIONSHIP IS CALLED ISOQUANT
CURVE.

ISOQUANT CURVE
A graph of all possible combinations of inputs that
results in the production of the given level of
output.

Return to scale refers to the behavior of output in


response to change in the scale of operation of a
firm when all factor inputs are changed in some
constant proportion, given the state of technology.
There are three aspects of return to scale:
1. Increasing return to scale
2. Diminishing return to scale
3. Constant return to scale

ECONOMIC REGION OF
PRODUCTION & RIDGE
LINES
These lines represent the limits of the economic
region of production. Ridge line join those points
on different isoquant curves which determine the
economic limits of production. It will be profitable
and economical for the firm to produce only in
those segments of the isoquants which lie in
between the ridge lines.

PRODUCERS EQUILIBRIUM
(optimum combination of
factors)
It refers to the situation In which a producer
maximizes his profits.
Optimum or least cost combination is that
combination at which either
1. The output derived from the given level of
inputs is maximum.
2. The cost of producing a given output is
minimum.

The production function for two inputs,


for a given technology:
Q = F(K,L)
Labor

Q = Output, K = Capital, L =

In the long run , all the factors of


production are variable.

PRODUCTION ISOQUANTS
An isoquant(derived from quantity and the Greek
word iso, meaning equal) shows the various
combinations of two inputs that the firm can
use to produce a specific level of output.
They are also known as equal product curves or isoproduct curves or product indifference curves.
PROPERTIEs of isoquant :
An isoquant always slopes downwards to the right.
They are usually convex to the origin.
They do not intersect each other.
A higher isoquant refers to a larger output , while a
lower isoquant refers to a smaller output.

PRODUCTION FUNCTION FOR


FOOD
Labor Input
Capital Input

1 2040556575
2 4060758590
3 557590100 105
4 6585100 110 115
5 7590105 115 120

4 5

The
The Isoquant
Isoquant Map
Map
Capital
per year 5

The isoquants are derived


from the production
function for output of
of 55, 75, and 90.

4
3

In the long run both


labor and capital are
variable and both
experience diminishing
returns.

Q3 = 90
D

Q2 = 75
Q1 = 55

5 Labor per year

MARGINAL RATE OF
TECHNICAL
SUBSTITUTION

MRTS of L for K is the amount of capital that


must be sacrificed for one extra unit of labour
, quantity of output remaining unchanged.
The marginal rate of technical substitution
equals:

MRTSLK K

MPL MPK (for a fixed level of Q)

But K/L shows the slope of the curve . Therefore ,


MRTS is the slope of the curve at a given point .

MARGINAL RATE OF TECHNICAL


SUSTITUTION
Capital
5
per year

1
1

Q3 =90

2/3 1
1/3

Q2 =75
Q1 =55
5

Labor per month

LAW OF DIMINISHING MARGINAL RATE


OF TECHNICAL SUBSTITUTION
Marginal rate of substitution of X for Y will
diminish as the quantity of X is increased, output
remaining unchanged.
As the quantity of X is increased and Y
decreased , the MP of X will diminish and MP of Y
will increase and therefore less and less of Y will
be required to replace one unit of X

PERFECT SUBSTITUTES AND


COMPLEMENTARY INPUTS
The shape of the isoquant reflects
the degree to which one input can
be substituted for another in
production.
The smaller the curvature of an
isoquant , the greater is the
degree of substitutability of inputs
in production and vice versa.

ISOQUANTS WHEN INPUTS ARE


PERFECT SUBSTITUES
Capital
per
month

C
Q1

Q2

Q3

Labor
per month

eg : natural gas and fuel oil used to operate


some heating furances.

ISOQUANTS WHEN INPUTS ARE USED IN FIXED


PROPORTIONS
Capital
per
month

Q3

C
Q2

B
K1

A
L1

Q1

Labor
per month

eg : engine and body for automobiles.

APPLICATION OF EQUAL
PRODUCT CURVE
The isoquant technique is applicable to
agriculture and to all lines of manufacturing.
MRTS guides in the substitution of some units of
one input for some units of another input.
The businessman tries various permutations and
combinations and the isoquant technique helps
him in reaching the most economical
combination.

THANKYOU!

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