Production AnalysisProduction Analysis

Production function:

•A technical relation which relates factor inputs and outputs.

• It is based on the law of proportion, i.e., the transformation of factor inputs into products at any particular time period.

•Eg. To produce an output of 1 unit of Product ‘X’ following process can be used:

Marginal and Average

•Marginal product of a factor of production is defined as change in output resulting from a very small change in one factor input, keeping the other factor inputs constant.▫MPL = dQ/dL

•Average productivity of a factor of production is defined as the total productivity divided by its quantity▫APL = Q/L

Law of diminishing returns:

• Law of diminishing returns states that with a given state of technology if the quantity of one factor input is increased , by equal increments, the quantities of other factor inputs remaining fixed, the resulting increment of total product will first increase but decrease after a particular point.

Analyse the given production numbers

Marginal Average

Relation – Total, Average and marginal Product•The following chart will explain the interrelation-

ships among Total productivity, average productivity and marginal productivity.

Salient points…

•According to law of diminishing returns, the marginal product first increases and then decreases beyond a point.

•The Total product is maximum when the marginal product becomes 0

Short and Long Run

• Short Run – ▫Period of production during which some inputs cannot be

varied.▫Eg. For a company it is easy to add new labor than add new

equipments. So Labor as a factor of input can be varied in the short run and thus it impacts the production

• Long Run – ▫Period of production that gives managers adequate time to

vary all the inputs used to produce a good▫Eg. Adding new equipments to the existing setup to

increase the production

Returns to scale

• Law of returns to scale refers to the effects of scale relationships which implies that in the long run output can be increased by changing all factors by the same or different proportions.

• Constant returns to scale • - If an x% increase in all inputs yields exactly x% increase in

output• Increasing returns to scale ▫ - If an x% increase in all inputs yields more than a x% increase

in output• Decreasing returns to scale ▫ - If an x% increase in all inputs yields less than a x% increase

in output

Economies of scale

• Economies of scale are the cost advantages that a firm obtains due to expansion.

• Common cost advantages that rise are:▫ Lower input costs due to bulk buying of materials through

long-term contracts, and volume discounts▫Costly input such as marketing, research and development,

managerial expertise, etc. will lead to increased efficiency, and hence a decrease in the average cost of production and selling.

▫Adam Smith identified the division of labor and specialization as the two key means to achieve a larger return on production.

Isoquants

•The word isoquant is derived from the Greek word iso, meaning equal. Hence it represents “equal in quantity”.

• In economics, isoquant is used to represent those set of input combinations that give the same output.

Properties of Isoquants

• Two isoquants can never cross. Since each isoquant refers to a specific level of output, no two isoquants intersect, for such an intersection would indicate that the same combination of resources could, with equal efficiency, produce two different amounts of output.

• Every possible combination of inputs is on an isoquant. • Isoquants further from the origin represent greater output levels• Isoquants slope down to the right. Consider the capital vs. labour

isoquant. In any practical situation, the quantity of labour employed is inversely related to the quantity of capital employed, so isoquants have negative slopes.

• Isoquants are usually convex to the origin, meaning that the slope of the isoquant gets flatter down along the curve.

Marginal rate of technical substitution (MRTS)

•The firm has the ability to substitute between the two different inputs at will in order to produce the same level of output.

•The slope of an isoquant gives us the marginal rate of technical substitution (MRTS)▫MRTSXY = -∆Y / ∆X

MRTSLK indicates the rate at which additional units of labour (ΔL) can be substituted for fewer units of capital (–ΔK) while keeping output constant.

MRTS Example

•Following graph shows the isoquant for making 4 units of output

A

MRTSA = - (8 – 4) / (4 – 2)

= - 2

MRTSB = - (4 – 2) / (8 – 4)

= - 0.5B

04/10/23Sameer Gunjal – Business

Economics (MGBEN 10101)

Module V: Cost Analysis

- Economic concept of cost- Opportunity Cost- Explicit and Implicit Cost- Marginal, Incremental and Sunk Cost- Short run Cost function- Long run Cost function- Contribution Analysis, Break Even, Operating Leverage- Estimation of Cost Function

04/10/23Sameer Gunjal – Business

Economics (MGBEN 10101)

Thank You