PRODUCTION

PRODUCTION IS THE PROCESS OF CHANGING TIME, PLACE AND THE

FORM OF THE MATERIAL SO AS TO INCREASE ITS UTILITY.

ALL THOSE RESOURCES THAT ARE USED IN THIS PROCESS ARE CALLED

INPUTS, WHILE THE END RESULT OF THE PROCESS IS KNOWN AS

OUTPUT.
 SO, THE AMOUNT OF OUTPUT DEPENDS ON THE QUANTITY
OF DIFFERENT INPUTS.

THE QUATITY OF OUTPUT EXPRESSED AS THE FUNCTION OF

DIFFERENT INPUTS IS KNOWN AS PRODUCTION
FUNCTION. SYMBOLICALLY,

WHERE,
Q = f ( L, K )
Q = OUTPUT,
L = LABOUR,
K = CAPITAL.
 FEATURES OF A PRODUCTION FUNCTION

1] OUTPUT & INPUTS ARE EXPRESSED IN PHYSICAL UNITS.

2] THE LEVEL OF TECHNOLOGY IS GIVEN.

3] IT GIVES THE MAXIMUM AMOUNT OF OUTPUT THAT

CAN BE PRODUCED WITH GIVEN COMBINATIONS OF
INPUTS.

4] IT ALSO INDICATES SUBSTITUTABILITY BETWEEN THE

INPUTS.
5] PRODUCTION FUNCTION CAN BE
SHORT-RUN OR LONG-RUN

6] PRODUCTION FUNCTION CAN BE

LINEAR OR NON- LINEAR

7] PRODUCTION FUNCTION CAN BE

HOMOGENEOUS OR NON-HOMOGENEOUS
 SO, PRODUCTION FUNCTION MAY BE;

A} LINEAR HOMOGENEOUS nQ = f (nL ,nK)

B} NON=LINEAR HOMOGENEOUS mQ = f (nL ,nK)
C} LINEAR NON-HOMOGENEOUS nQ = f (nL, K)
D} NON-LINEAR NON-HOMOGENEOUS mQ = f (nL,K)
 THE LAW OF VARIABLE PROPORTION

THE LAW OF VARIABLE PROPORTION STATES THAT AS WE

USE MORE AND MORE UNITS OF SOME FACTORS OF
PRODUCTION TO WORK WITH ONE OR MORE FIXED
FACTORS, THE TOTAL PRODUCT WILL INCREASE AT AN
INCREASING RATE, THEN AT A CONSTANT RATE & FINALLY AT
A DIMINISHING RATE.
 “AS EQUAL INCREMENTS OF ONE INPUT ARE ADDED; THE INPUTS OF
OTHER PRODUCTIVE SERVICE BEING HELD CONSTANT, BEYOND A
CERTAIN POINT THE RESULTING INCREMENTS OF PRODUCT WILL
DECREASE, i.e. THE MARGINAL PRODUCT WILL DIMINISH”

- G. STIGLER

“AS THE PROPORTION OF ONE FACTOR IN A COMBINATION OF

FACTORS IS INCREASED, AFTER A POINT FIRST THE MARGINAL &
THEN THE AVERAGE PRODUCT OF THAT FACTOR WILL DIMINISH”

- F. BENHAM
 “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 ADDITIONS OF EXTRA
INPUTS WILL BECOME LESS AND LESS”

- P. A. SAMUELSON
LABOUR MP TP AP

1 15 15 15

2 20 35 17.5 STAGE I
25 60 20 STAGE OF INCREASING RETURNS
3
4 20 80 20

5 10 90 18 STAGE I I
STAGE OF DECREASING RETURNS
6 0 90 15
12 STAGE I I I
7 -6 84 STAGE OF NEGATIVE RETURNS
OUTPUT
TP

STAGE I STAGE I I STAGE I I I

AP
MP
O VARIABLE FACTOR
 AP = TP/L
MPn = output added by the nth worker
= TPn – TPn-1
Q
APL = Q/L ; MPL =
L
Q Q
MP/AP = ÷
L L
Q L
= ×Q = ELASTICITY OF Q w.r.t. LABOUR

L
 STAGE - I OUTPUT TP

 MP FIRST RISES & THEN FALLS; AP RISES

 MP > AP I II III
 ELASTICITY OF OUTPUT w.r.t. LABOUR > 1
AP
 THE STAGE – I ENDS AT A POINT WHERE,
MP = AP / AP IS MAXIMUM / EQ w.r.t. LABOUR = 1 O MP
V. FACTOR
STAGE - II
 MP & AP BOTH ARE FALLING
 EQ w.r.t. LABOUR < 1
 THE STAGE – II ENDS AT A POINT WHERE,
MP = 0 / TP IS MAXIMUM / EQ w.r.t. LABOUR = 0

STAGE - III

 MP < 0
 TP FALLS & EQ w.r.t. LABOUR IS NEGATIVE
 EXHIBIT
BAJAJ AUTO LTD. WAS ESTABLISHED IN 1945 AS A TRADING CO. IT
OBTAINED LICENSE TO MANUFACTURE TWO-WHEELERS IN 1959. IT WAS
ONE OF THE LARGEST TWO-WHEELER MANUFACTURERS, PARTICULARLY
SCOOTERS, & WAS A DOMINANT PLAYER UNTIL THE EARLY 90’S.
BUT DUE TO GLOBAL COMPETITION & PEOPLE OPTING FOR MOTOR-
CYCLE AS A RESULT OF INCREASE IN INCOME, BAJAJ’S MARKET SHARE
STARTED DECLINING IN THE LATE 90’S.
IN ORDER TO OVERCOME THIS PROBLEM, BAJAJ AUTO DECIDED TO
REDUCE ITS HEAD – COUNT. BAJAJ OFFERED TWO VRS SCHEMES, FIRST IN
1998 & THEN IN 2000 – 01 REDUCING THE WORKFORCE FROM 21,273 (1997)
11,531 (2004). AS A RESULT, THE WAGE-BILL WAS REDUCED BY Rs. 70.6 crore.
MORE IMPORTANTLY, THE PRODUCTIVITY OF LABOUR INCREASED.
YEAR PRODUCTION NO. OF EMPLOYEES OUTPUT / EMPLOYEES

14,39,174 21,273 67.7

1997
18,589 72.9
1998 13,54,482
18,585 74.3
1999 13,81, 765
17,213 83.2
2000 14,32,471
13,819 87.8
2001 12,12,748
13,482 100.6
2002 13,56,443
12,338 118.1
2003 14,57,066
131.5
2004 15,16,876 11,531
 THE GOAL OF BAJAJ AUTO WAS TO INCREASE

PRODUCTIVITY. THE FOCUS WAS ON R & D, UPGRADING

CURRENT PRODUCT, DEVELOPING NEW MODELS. THE

COMPANY DECIDED TO SET UP A NEW FACILITY AT AKURDI

COMPLEX NEAR PUNE FOR DESIGN, ANALYSIS, PROTOTYPING

& TESTING.
THE LAW OF RETURNS TO SCALE
A QUICK RECAP
 THE LAW OF VARIABLE PROPORTION IS ALSO KNOWN AS THE LAW OF
RETURNS.
THIS LAW DESCRIBES THE BEHAVIOUR OF THE SHORT-RUN PRODUCTION
FUNCTION.
IT STATES THAT AS WE INCREASE THE AMOUNT OF VARIABLE FACTOR KEEPING
THE AMOUNT OF FIXED FACTORS CONSTANT, FIRST THE AVERAGE PRODUCT RISES,
THEN IT STARTS FALLING & FINALLY, AN ADDITIONAL UNIT OF VARIABLE FACTOR
RESULTS INTO A FALL IN THE TOTAL OUTPUT, i.e. THE MARGINAL PRODUCT OF
VARIABLE FACTOR BECOMES NEGATIVE.
THUS, THE LAW DESCRIBES THREE STAGES NAMELY,
1] STAGE – I (STAGE OF INCREASING RETURNS)
2] STAGE – II (STAGE OF DIMINISHING RETUNS) &
3] STAGE – III (STAGE OF NEGATIVE RETUNS)
 THE LAW OF RETURNS TO SCALE

THIS LAW DESCRIBES THE BEHVIOUR OF A LONG-RUN PRODUCTION FUNCTION. IT

STATES THAT AS WE INCREASE ALL THE FACTORS OF PRODUCTION IN A GIVEN
PROPORTION, FIRST OUTPUT INCREASES MORE THAN PROPORTIONATELY, THEN IT
INCREASES PROPORTIONATELY AND LASTLY, IT INCREASES LESS THAN
PROPORTIONATELY.
FOR EXAMPLE, WE INCREASE ALL THE INPUTS BY 10%, OUTPUT INCREASES BY
MORE THAN 10%, SAY BY 15% OR 20%. THEN IT RISES BY 10% AND LASTLY,
INCREASE IN ALL THE INPUTS BY 10% RESULTS INTO LESS THAN 10% RISE IN THE
OUTPUT.
THUS, THE LAW OF RETURNS TO SCALE DESCRIBES THE THREE STAGES,
1] STAGE – I (STAGE OF INCREASING RETURNS TO SCALE)
2] STAGE – II (STAGE OF CONSTANT RETURNS TO SCALE)
3] STAGE – III (STAGE OF DIMINISHING RETURNS TO SCALE)
 THESE THREE STAGES CAN BE EXPLAINED WITH THE HELP OF ECONOMIES OF
SCALE.
THE CONCEPT OF ECONOMIES OF SCALE MEANS, AS WE INCREASE THE SCALE i.e.
THE LEVEL OF OUTPUT, THE AVERAGE COST OF PRODUCTION FALLS DUE TO
CERTAIN ADVANTAGES ASSOCIATED WITH LARGE-SCALE PRODUCTION.
THESE ECONOMIES OF SCALE ARE OF TWO TYPES;
1) INTERNAL ECONOMIES OF SCALE
2) EXTERNAL ECONOMIES OF SCALE
INTERNAL ECONOMIES OF SCALE ARE THOSE ADVANTAGES WHICH ARE
ENJOYED BY THE FIRM THAT EXPANDS. SO. INTERNAL ECONOMIES OF SCALE ARE
FIRM-SPECIFIC.
EXTERNAL ECONOMIES OF SCALE ARE NOT FIRM-SPECIFIC. THEY ARE
ENJOYED BY ALL THE FIRMS IN THE INDUSTRY AS A RESULT OF EXPANSION.
INTERNAL ECONOMIES OF SCALE

1. SPECIALISATION & DIVISION OF LABOUR

2. MANAGERIAL ECONOMIES OF SCALE
3. FINANCIAL ECONOMIES OF SCALE
4. MARKETING ECONOMIES OF SCALE
5. LEARNING CURVE EFFECT
6. COMMERCIAL ECONOMIES OF SCALE

EXTERNAL ECONOMIES OF SCALE

1. ECONOMIES OF CONCENTRATION
2. ECONOMIES OF INFORMATION
3. ECONOMIES OF DISINTEGRATION
 A FIRM IS BENEFITED BY BOTH INTERNAL AND EXTERNAL ECONOMIES OF SCALE
ONLY UPTO A POINT. THEREAFTER, A FURTHER INCREASE IN THE VOLUME OF
OUTPUT STARTS PRODUCING DISECONOMIES OF SCALE.
EVEN DISECONOMIES OF SCALE ARE ALSO INTERNAL AS WELL AS EXTERNAL.
INTERNAL DISECONOMIES OF SCALE ARE IN THE FORM OF LACK OF PROPER
CONTROL OR DISCIPLINE, MISMANAGEMENT, MORE REGULATION OR RESTRICTIONS
BY THE GOVERNMENT, GREATER PRESSURE FROM TRADE UNIONS, SUPPLIERS ETC.

EXTERNAL DISECONOMIES OF SCALE ARISE AS A RESULT OF OVER-

CROWDED AREA, NON-AVAILABILITY OF THE REQUIRED RAW-MATERIAL,
ELECTRICITY, COMPONENTS ETC. IN SUFFICIENT QUANTITY, DELAY IN
TRANSPORT AND SO ON AND SO FORTH.
THANK YOU
 SOME INPUTS ARE SUCH THAT THEIR QUANTITY CAN NOT
BE INCREASED IN THE SHORT-RUN. e.g. THE SIZE OF PLANT,
HEAVY MACHINERY etc. THEY ARE CALLED FIXED FACTORS.
SO, IN ORDER TO INCREASE THE VOLUME OF OUTPUT IN
THE SHORT-RUN, THE PRODUCER HAS TO KEEP THE
QUANTITY OF FIXED FACTORS CONSTANT AND INCREASE THE
QUANTITY OF THOSE INPUTS THAT CAN BE INCREASED EVEN
IN THE SHORT-RUN. SUCH FACTORS ARE CALLED VARIABLE
FACTORS, e.g. MANUAL LABOUR.
SHORT-RUN PRODUCTION FUNCTION IS ONE IN WHICH AT
LEAST ONE FACTOR IS FIXED.
A SHORT-RUN PRODUCTION FUNCTION IS EXPRESSED AS,

Q = f ( L, K )
A LONG-RUN FUNCTION IS ONE WHERE ALL FACTORS
ARE VARIABLE.

Q = f ( L, K )
 LINEAR PRODUCTION FUNCTION IS ONE WHERE
OUTPUT INCREASES IN THE SAME PROPORTION AS INPUT.
FOR EXAMPLE, IN THE SHORT-RUN, CAPITAL IS THE
FIXED FACTOR, SO IF THE VARIABLE FACTOR LABOUR
INCREASES BY 10%, OUTPUT ALSO INCREASES BY 10%.
IN THE LONG RUN, IF LABOUR & CAPITAL INCREASE BY
10%, OUTPUT ALSO INCREASES BY 10%
IN A NON-LINEAR PRODUCTION FUNCTION,
INCREASE IN LABOUR BY 10% WILL RESULT INTO EITHER
LESS THAN OR MORE THAN 10% INCREASE IN THE
OUTPUT.
 HOMOGENEOUS PRODUCTION IS ONE IN WHICH ALL THE INPUTS
CHANGE IN THE SAME PROPORTION.
IN NON-HOMOGENEOUS PRODUCTION FUNCTION ALL THE INPUTS DO
NOT VARY IN THE SAME PROPORTION.